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Buy Religare Enterprises- -Emergent financial supermarket
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Religare is rapidly building out a financial services platform infused with capable
management and significant synergies well-positioned to tap into the broad growth
opportunities in Indian financial services. If well-executed, its strategy to create an
emerging market-focused investment bank and global asset management platform
should be a key differentiator and structural value creator. Initiating at BUY.
Catalysts
Securing a commercial bank licence, demonstrating a growing flow of investment
banking mandates, and macro delivery on financial services growth potential.
Anchor themes
Deep relative under-penetration across the entire spectrum of financial services in
India gives integrated financial services platforms significant scope for structural
growth, especially if cross-platform synergies can be tapped. Ability to intermediate
capital flows into the investment-hungry economy is another lucrative opportunity.
Emergent financial supermarket
Core operations: equity broking, NBFC lending
Religare Securities is among the top-three equity brokers in India, with
a market share of c.3.5%. To mitigate sustained yield pressure, the
operating model stresses cross-selling supported by a cost-efficient
national network of more than 2,000 branches. Religare Finvest is
growing rapidly, with a focus on property and share margin financing –
85% of the book is secured, with an average LTV below 50%.
New growth areas: IB, asset management, insurance
Religare is investing heavily in creating an India-anchored, emerging
market investment banking platform, with targeted acquisitions and
hiring of top-tier bankers expediting operational scaling-up. A similarly
market-differentiated strategy is being pursued in establishing a global,
multi-boutique asset management platform with scalable skill sets and
relationships. Capital committed to life insurance is recyclable and has
a minimum 12% IRR as guaranteed by joint venture partner AEGON.
Macro attraction, bank license bid, shareholder support
Religare’s expanding product platform dovetails with low penetration of
financial services within the high-growth, demographically friendly
Indian economy. Clinching a bank licence would have a far-reaching
positive impact on the franchise, we believe, with concerns about
related capital demands mitigated by a supportive majority shareholder.
Parallels to thriving CIMB MK; SOTP PT of Rs545
We find parallels in the management style and growth strategy of
Religare and Malaysian universal banking group CIMB, where
successful execution of a similar strategy from 2006 has since seen
earnings grow by 4.5x and the share price triple. Noting a significant
short-term earnings drag due to a loss-making investment phase at
key subsidiaries, we use SOTP valuation to derive our Rs545 PT
Religare: the big picture
Starting operations as a retail-oriented equity and commodities broker in 2002 and
spending the next few years building up infrastructure and reach, the company
changed its name to Religare Enterprises (Religare) in 2006. Religare is a Latin word
that translates as “to bind together”, and this effectively underscores the group’s aim to
build a diversified and synergistic financial services platform. Following a spate of
acquisitions and organic growth initiatives since 2006, supported by a capital and
brand-boosting IPO in 2007, Religare now offers a comprehensive suite of financial
products and services across the retail, institutional and high net worth spectrum.
Through its subsidiaries, Religare offers equity and commodity broking, asset
financing/lending, investment banking, asset management, wealth management and
insurance. Current revenue streams are almost wholly from the domestic market,
supported by an extensive national network of 2,163 branches across 566 cities, with
the total group employee count now exceeding 10,000
We believe Religare has pulled together the necessary products, distribution and
branding muscle to substantially exploit the attractive growth opportunities presented
by a rapidly growing Indian economy and the relative under-penetration of broad
financial services. With an entrenched domestic profit pool supporting it (internally and
promoter support) and looking to take advantage of growth opportunities stemming
from the global credit crisis, Religare, in our view, looks ready to accelerate a
synergistic global expansion strategy:
Focused on establishing a niche global emerging market-led investment bank that
can fully intermediate between the capital pools of the developed world and
investment opportunities in the rapidly growing emerging markets; and
Grounded by management’s view that each of the BRIC countries will support
development of 1-2 global investment banks to create the world’s first truly
integrated platform for emerging market investment banking and institutional
securities.
Retail equity broking via Religare Securities (RSL) and lending operations via Religare
Finvest (RFL) currently dominate revenue, together accounting for just over 80% of
Religare’s consolidated revenues over 1H FY11. However, heavy investments in and
rapid growth from new operating subsidiaries such as insurance (via AEGON Religare
Life Insurance; ARLI), asset management (via Religare AMC; RAMC) and investment
banking (via Religare Capital Markets; RCML) have steadily diluted this dominance. In
particular, we believe the global growth ambitions of the asset management and
investment banking operations should translate into growing revenue shares for these
divisions going forward, hence delivering an increasingly diversified (by both product
and geography), synergistic and stable revenue base with a well-balanced risk profile.
In our opinion, Religare has assembled a well-balanced and highly experienced
management team from a variety of backgrounds, both at the holding company level
as well as at the individual operating subsidiary levels, to deliver on its growth
ambitions. With each subsidiary having its own CEO and dedicated management team,
the broad depth of experience across the group has allowed for a rapid scaling-up of
the various businesses.
We believe the effectiveness of management is further supported by the following:
Governance: in our view, the board has an optimum combination of executive and
non-executive directors that balance efficient, nimble decision making with the need
for continuous, independent oversight. Currently, the board of the company
consists of 10 directors comprising a chairman and managing director, a group
CEO, a group CFO and seven non-executive directors, of which six are
independent directors. In April 2010, the promoter directors – Mr Malvinder Singh
(chairman) and Mr Shivinder Singh – resigned from directorships, with Mr Sunil
Godhwani taking over as chairman.
Incentivisation: a substantial portion of senior management compensation is via
an equity grant scheme that covers Religare and then individual business
subsidiaries which they are steering. By creating co-ownership in the respective
businesses and allowing employees to only realise the value of their grants when
Religare itself crystallises the value embedded in the business via sale or IPO,
alignment of management interests with those of shareholders in generating growth,
profits and long-term value should be entrenched, we believe.
In our view, management’s capacity to leverage nimble decision making and
innovative structuring (as per equity incentivisation above) to build an integrated
financial services platform while working within existing capital constraints is
exemplified by the following (elaborated upon later in this report):
securing a guaranteed minimum IRR of 12% on capital investments in the life
insurance joint venture with AEGON, and simultaneously using the guarantee to
secure funding for additional capital contributions to the JV;
structuring acquisition of asset management companies such that potential
management and client attrition is minimised even as synergy potential with and
EPS accretion to the broader Religare group is clear from the start; and
executing and integrating a series of niche acquisitions and high-profile hires in the
emerging market investment banking space that is rapidly establishing a highimpact, scalable platform for operations across BRICs and ASEAN.
Core operations: equity broking, NBFC
lending
As at 1H FY11, the broking and lending operations accounted for the bulk of group
revenues (81%) and almost all of its earnings.
Broking operations (Religare Securities Ltd; RSL)
The brokerage business employs more than half the total group workforce and is a
core source of group income, comprising primarily commissions earned from equities,
derivatives and commodities traded on the exchanges for clients, and distribution of
third-party products such as mutual funds and insurance. RSL is currently ranked
among the top 3 brokers in the country by market share, with a leadership position in
retail broking (according to company data and BSE/NSE released numbers). Note that
only retail equity broking is now housed under RSL – institutional broking as well as
investment banking licence have been transferred to Religare Capital Markets (RCML).
Retail equity broking: According to company data, steady investments in branch
network, sales manpower and customer acquisition have increased the equity client
base from less than 420,000 as at end-FY08, to almost 690,000 as at March 2010
(+64% expansion). RSL’s model combines a dedicated relationship and dealing team
for each client – the latter handles all the existing business needs of the client while
the relationship team will look to cross-sell / up-sell newer products (both in-house and
third party) and services. We believe such cross-selling efforts, including availability of
share margin financing funded by the lending subsidiary RFL (see below), are
essential to mitigate yield pressure stemming from an increasing share of overall
market turnover coming from lower-margin options trading. Still, RSL now holds an
estimated 8% market share in the cash segment
Leveraging on a national branch network (409 own branches and 1,482 franchisee
branches as at Sept 2010), a comprehensive technology backbone (which includes an
integrated, end-to-end online investment portal called R-ACE that which currently
accounts for an average 7% of total internet trading volume on the National Stock
Exchange [NSE]), and a rising number of relationships with private and public sector
banking groups, Religare has been able to maintain an equity broking market share of
around 3.5%. While the competitive landscape – the top 25 brokers control 40% of the
market – weighs against any further significant organic traction for market share, we
think the underlying market itself is poised to expand substantially as the low rate of
retail penetration – India has less than 15mn equity trading account holders at present
(source: SEBI,NSDL) – rises and delivers secular growth in market turnover.
With strong distribution being the cornerstone of the group’s aim to maintain market
share and at the same time enhance cross-selling by building reach and customer
base, RSL has continued to build-out its national network. Over the past three years,
its broking branch network has expanded from 1,273 to 1,891, comprising 409 owned
branches and 1,482 franchises. To maintain cost efficiency and cap incremental
distribution costs, management’s focus is now on bringing more franchisees on board
to penetrate Tier-II and Tier-III cities. The franchisees work on a revenue-sharing
model whereby, in return for bearing the operating costs, they are entitled to two-thirds
of revenue generated. RSL has also secured partnerships with public and private
banks to further facilitate client acquisition.
Commodities broking: This business is carried out under Religare Commodities Ltd.
(RCL), which is structured as a wholly owned subsidiary of RSL. With 435 dedicated
commodity dealers and 305 commodity RMs, RCL is the clear leader in the sector and
targets equity trading customers for investment in globally traded commodities such as
agricultural products, bullion and oil & gas. RCL grew its client base by 91% over FY10,
to 107,000 and is now present in 600 locations across the country, including more than
80 operational Mandi (rural market) locations which provide on-the-ground takes on
developments in the agricultural sector.
While a relatively small contributor to group revenues and profit at this juncture, growth
prospects are appealing, we believe, given the nascent stage of the industry. In more
advanced markets, trading in commodity derivatives is 30-40x that of the physical
commodities market – this compares to just 3-4x for India currently. We see early signs
that the Indian commodity derivatives market is starting to catch up, with RCL reporting
the best quarter in terms of revenue in 2Q FY11
Lending operations (Religare Finvest Ltd; RFL)
RFL is an NBFC (non-banking financial company) and has rapidly grown its lending
operations since 2008, discontinuing the delinquency-plagued personal loans product
(significant write-offs taken over FY09 and FY10) and focusing instead on commercial
assets, loans against property and small and medium enterprise (SME) financing. RSL
has also transferred its share margin financing (loan against shares) book to RFL,
adding to the strong growth momentum as per the 28% CQGR notched since 2Q FY10
(up to 2Q FY11). As of September 2010, RFL’s book value was Rs16bn while the loan
book had expanded to Rs72.5bn, giving a comfortable leverage ratio of c.4.5x
compared with the regulatory maximum of 6.66x (based on a capital adequacy ratio
minimum of 15%, of which at least two-thirds must be core equity).
Commercial assets: This product was started in December 2008 and
encompasses loans for commercial vehicles (new or used) and construction
equipment (heavy or light) with tenures averaging 3-4 years. Commercial asset
funding is extended to both priority sector small operators and high-end retail and
strategic operators. As at 2Q FY11, lending outstanding amounted to Rs9.3bn, or
13% of the total loan book.
Mortgage/loan against property (LAP): The LAP product, offered from December
2008, enables customers to obtain loan facilities against their residential or
commercial property. The term loans offered under this product have an average
duration of 7 years and may be utilised towards different purposes, including
business expansion and purchase of plant and machinery. As at 2Q FY11, lending
outstanding amounted to Rs23.8bn, or 33% of the total loan book.
SME loans: The SME business loan product was launched in December 2008 and
caters to working capital and other financial requirements of SMEs, self-employed
businessmen and professionals. As at 2Q FY11, lending outstanding amounted to
Rs5.5bn, or 8% of the total loan book.
Loan against shares (LAS): The LAS business primarily involves offering loans
secured by shares held by its retail customers, which frees up clients’ capital yet
provides RFL with highly liquid security to cover the loans. Recently, this business
has expanded to provide wholesale lending, ie, promoter and corporate lending
services, supported by an institutional research team. As at 2Q FY11, lending
outstanding amounted to Rs27.3bn, or 38% of the total loan book.
While the lending operations are relatively new and in a very competitive space, we
believe strong management and good processes underpin profitability, with net profit
over 1H FY11 almost doubling y-y. Management will consider inorganic opportunities
to grow when available – RFL acquired part of Citigroup India’s home loan portfolio,
with a book size of Rs4.7bn, in 2Q FY11 – underscoring a target growth in the asset
finance book to Rs100bn by FY12F, from Rs31bn currently. Organic growth is
facilitated by branch presence in 23 cities, as well as the use of direct selling agents
and sales teams that have passed a due diligence process. Referrals are also sourced
from the broader Religare group, particularly via the extensive branch network and
client base of RSL. Service differentiation is key – compared to bank peers, RFL can
be more flexible in terms of product solutions and more personal and expeditious in
overall servicing. Further, RFL is not subject to bank specific issues, such as required
lending to priority sectors and restrictive liquidity frameworks.
A pan-India presence and dedicated distribution, operations and risk management
teams ensure credit assessment processes are robust, in our opinion. At the macro
level, credit database checks (similar resource used by other NBFCs and Indian banks)
and document verification are ingrained. The typical loan to value (LTV) ratio at
origination for mortgage loans is 65% (FY10: average LTV for portfolio was below
50%), while that for commercial assets is 75%. While current NPL ratios are biased
lower by rapid and unseasoned asset growth, we think slippage as the portfolio
matures should be tempered by a largely secured book (c.85% of total) and low LTVs.
At the operating level, rapidly rising operating scale is also bringing down cost per unit,
partially mitigating sustained yield pressure across all loan categories.
RFL is targeting to triple its current loan book by end-FY14F (ie, to around Rs 250bn,
from Rs72.5bn currently) according to management. Currently, given it holds no bank
licence, RFL cannot take deposits and instead needs to source funding from the debt
markets and capital to support loan growth. We believe that securing a banking licence
would not only significantly reduce RFL’s funding costs, allowing it to compete better
and raise its medium-term profitability (current target is to raise ROA towards 2.5%,
from 2% currently, by reducing the equity bias in the funding mix), but also complete
the broader Religare financial services product platform. The chances of securing a
banking license are explored in Section 3 of this report. The current dependence of the
funding on the debt market is highlighted in the following exhibit. Adverse movements
in the yield curve could see the cost of funds increasing
Parallels to thriving CIMB
Religare’s strategy of building on a strong domestic revenue pool while pursuing niche,
high-growth opportunities in the emerging markets space has parallels with the
strategic direction taken by Malaysian universal banking group CIMB upon the entry of
new management in early 2006, in our view. Group CEO Nazir Razak, previously head
of the group’s successful investment banking subsidiary, assembled an aggressive
and capable management team and then leveraged on the group’s strong domestic
investment banking franchise to both provide earnings “cover” for the underperforming
commercial banking unit while it was restructured and, at the same time pursuing niche
acquisitions across the ASEAN region with the aim of creating the most successful
pan-ASEAN universal banking franchise, in our view. We think CIMB now has a highly
integrated, universal banking platform across Malaysia, Indonesia, Singapore and
Thailand, collectively the same size as the Indian economy – as growth targets were
met and synergies delivered, CIMB’s earnings more than quadrupled in four years,
from less than RM1bn in FY05, to RM3.7bn in FY10F, while its share price has tripled.
As highlighted in the exhibit below, Religare has a similarly potent mix to CIMB of
capable management, entrenched domestic earnings base, supportive major
shareholder and targeted domestic and offshore growth ambitions to be pursued both
organically and via acquisitions, in our view. While we think Religare has a larger
share of businesses in their investment phase as opposed to CIMB in 2006, it also has
a much more lucrative domestic growth market at its back when compared with the
relatively mature Malaysian financial services industry. In sum, given proper execution
and noting the earnings momentum inflection that would occur when currently lossmaking but high-growth divisions like insurance (ARLI), asset management (RAMC)
and investment banking (RCML) turn profitable over the next three-seven years, on
our estimates, we believe Religare could deliver similar outperformance if its strategy
is properly executed.
Sum-of-the-parts (SOTP) valuation
We use a sum-of-the-parts valuation method to arrive at our price target for Religare
Enterprises. The main business segments of Religare have been classified into:
Religare Securities (retail broking), Finvest (commercial lending), Religare Capital
Markets (domestic and overseas), Religare Asset Management (domestic and global),
AEGON Religare Insurance and Religare Macquaire Wealth Management.
Valuation parameters
The RSL broking operation is valued at a FY12F P/E of 10x. While peer brokers are
trading on a lower 8x FY12F P/E, we believe RSL deserves a premium, given its
top-three market share position, strong growth prospects for its market-leading
commodity broking business, and looming and increasingly tangible synergies with
the broader Religare group.
The lending business (RFL) is valued at FY12F P/BV of 1.8x, which is comparable
to market multiples for peers operating in India’s commercial lending space. We
stress the positives of a relatively young operation unburdened by fall-out from the
credit crisis and with the potential to tap into synergies available from the broader
Religare group.
For RCML, its Indian investment banking division is valued at a FY12F P/E of 10x
while the international business, currently in loss-making investment mode, is
conservatively valued on the basis of the invested capital in the division.
The asset management division is valued on a % of AUM basis with the domestic
arm (RAMC) being valued at 4% of AUM (a slight premium to global peers to reflect
country-specific demographics/growth potential; note some recent acquisitions in
the Indian space have been valued as high as 5% of AUM). The Indian asset
management landscape has seen deals ranging from IDFC’s acquisition of
Standard Chartered business at 5.7% of AUM to around 3% of AUM for Nomura’s
stake acquisition in LIC (source: company data). The recently acquired global AUM
portfolio (RGAM) is valued at a lower 2% of AUM to reflect relatively greater
maturity and execution risk.
The AEGON Religare Insurance business (ARLI) is valued on the basis of the
invested capital (a conservative measure to take into account the long gestation
period involved, although we have imputed value uptick from the 12% IRR
guarantee) while the rapidly expanding Religare Macquaire Wealth Management is
valued at 4% of AUM (along the same lines as domestic asset management).
Where could we go wrong?
Risks to our investment view
As a human capital-dependent financial services group investing heavily, organically
and inorganically, in expanding outside of a relatively familiar domestic market into
offshore investment banking and asset management, capacity to execute is key – in
particular, ability to retain and motivate key management as well as to build and
integrate offshore operations with the core domestic franchise could be a challenge.
Add to this intense competition across all business lines and a potentially volatile
regulatory environment and you have the potential that key divisions such as
insurance, asset management and investment banking could take longer than
expected to turn profitable, potentially necessitating further capital support in our view.
Finally, despite increasing diversification, a majority share of group revenues and
earnings are still directly dependent on the performance of the potentially volatile
equity market.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Buy Religare Enterprises- -Emergent financial supermarket
Action
Religare is rapidly building out a financial services platform infused with capable
management and significant synergies well-positioned to tap into the broad growth
opportunities in Indian financial services. If well-executed, its strategy to create an
emerging market-focused investment bank and global asset management platform
should be a key differentiator and structural value creator. Initiating at BUY.
Catalysts
Securing a commercial bank licence, demonstrating a growing flow of investment
banking mandates, and macro delivery on financial services growth potential.
Anchor themes
Deep relative under-penetration across the entire spectrum of financial services in
India gives integrated financial services platforms significant scope for structural
growth, especially if cross-platform synergies can be tapped. Ability to intermediate
capital flows into the investment-hungry economy is another lucrative opportunity.
Emergent financial supermarket
Core operations: equity broking, NBFC lending
Religare Securities is among the top-three equity brokers in India, with
a market share of c.3.5%. To mitigate sustained yield pressure, the
operating model stresses cross-selling supported by a cost-efficient
national network of more than 2,000 branches. Religare Finvest is
growing rapidly, with a focus on property and share margin financing –
85% of the book is secured, with an average LTV below 50%.
New growth areas: IB, asset management, insurance
Religare is investing heavily in creating an India-anchored, emerging
market investment banking platform, with targeted acquisitions and
hiring of top-tier bankers expediting operational scaling-up. A similarly
market-differentiated strategy is being pursued in establishing a global,
multi-boutique asset management platform with scalable skill sets and
relationships. Capital committed to life insurance is recyclable and has
a minimum 12% IRR as guaranteed by joint venture partner AEGON.
Macro attraction, bank license bid, shareholder support
Religare’s expanding product platform dovetails with low penetration of
financial services within the high-growth, demographically friendly
Indian economy. Clinching a bank licence would have a far-reaching
positive impact on the franchise, we believe, with concerns about
related capital demands mitigated by a supportive majority shareholder.
Parallels to thriving CIMB MK; SOTP PT of Rs545
We find parallels in the management style and growth strategy of
Religare and Malaysian universal banking group CIMB, where
successful execution of a similar strategy from 2006 has since seen
earnings grow by 4.5x and the share price triple. Noting a significant
short-term earnings drag due to a loss-making investment phase at
key subsidiaries, we use SOTP valuation to derive our Rs545 PT
Religare: the big picture
Starting operations as a retail-oriented equity and commodities broker in 2002 and
spending the next few years building up infrastructure and reach, the company
changed its name to Religare Enterprises (Religare) in 2006. Religare is a Latin word
that translates as “to bind together”, and this effectively underscores the group’s aim to
build a diversified and synergistic financial services platform. Following a spate of
acquisitions and organic growth initiatives since 2006, supported by a capital and
brand-boosting IPO in 2007, Religare now offers a comprehensive suite of financial
products and services across the retail, institutional and high net worth spectrum.
Through its subsidiaries, Religare offers equity and commodity broking, asset
financing/lending, investment banking, asset management, wealth management and
insurance. Current revenue streams are almost wholly from the domestic market,
supported by an extensive national network of 2,163 branches across 566 cities, with
the total group employee count now exceeding 10,000
We believe Religare has pulled together the necessary products, distribution and
branding muscle to substantially exploit the attractive growth opportunities presented
by a rapidly growing Indian economy and the relative under-penetration of broad
financial services. With an entrenched domestic profit pool supporting it (internally and
promoter support) and looking to take advantage of growth opportunities stemming
from the global credit crisis, Religare, in our view, looks ready to accelerate a
synergistic global expansion strategy:
Focused on establishing a niche global emerging market-led investment bank that
can fully intermediate between the capital pools of the developed world and
investment opportunities in the rapidly growing emerging markets; and
Grounded by management’s view that each of the BRIC countries will support
development of 1-2 global investment banks to create the world’s first truly
integrated platform for emerging market investment banking and institutional
securities.
Retail equity broking via Religare Securities (RSL) and lending operations via Religare
Finvest (RFL) currently dominate revenue, together accounting for just over 80% of
Religare’s consolidated revenues over 1H FY11. However, heavy investments in and
rapid growth from new operating subsidiaries such as insurance (via AEGON Religare
Life Insurance; ARLI), asset management (via Religare AMC; RAMC) and investment
banking (via Religare Capital Markets; RCML) have steadily diluted this dominance. In
particular, we believe the global growth ambitions of the asset management and
investment banking operations should translate into growing revenue shares for these
divisions going forward, hence delivering an increasingly diversified (by both product
and geography), synergistic and stable revenue base with a well-balanced risk profile.
In our opinion, Religare has assembled a well-balanced and highly experienced
management team from a variety of backgrounds, both at the holding company level
as well as at the individual operating subsidiary levels, to deliver on its growth
ambitions. With each subsidiary having its own CEO and dedicated management team,
the broad depth of experience across the group has allowed for a rapid scaling-up of
the various businesses.
We believe the effectiveness of management is further supported by the following:
Governance: in our view, the board has an optimum combination of executive and
non-executive directors that balance efficient, nimble decision making with the need
for continuous, independent oversight. Currently, the board of the company
consists of 10 directors comprising a chairman and managing director, a group
CEO, a group CFO and seven non-executive directors, of which six are
independent directors. In April 2010, the promoter directors – Mr Malvinder Singh
(chairman) and Mr Shivinder Singh – resigned from directorships, with Mr Sunil
Godhwani taking over as chairman.
Incentivisation: a substantial portion of senior management compensation is via
an equity grant scheme that covers Religare and then individual business
subsidiaries which they are steering. By creating co-ownership in the respective
businesses and allowing employees to only realise the value of their grants when
Religare itself crystallises the value embedded in the business via sale or IPO,
alignment of management interests with those of shareholders in generating growth,
profits and long-term value should be entrenched, we believe.
In our view, management’s capacity to leverage nimble decision making and
innovative structuring (as per equity incentivisation above) to build an integrated
financial services platform while working within existing capital constraints is
exemplified by the following (elaborated upon later in this report):
securing a guaranteed minimum IRR of 12% on capital investments in the life
insurance joint venture with AEGON, and simultaneously using the guarantee to
secure funding for additional capital contributions to the JV;
structuring acquisition of asset management companies such that potential
management and client attrition is minimised even as synergy potential with and
EPS accretion to the broader Religare group is clear from the start; and
executing and integrating a series of niche acquisitions and high-profile hires in the
emerging market investment banking space that is rapidly establishing a highimpact, scalable platform for operations across BRICs and ASEAN.
Core operations: equity broking, NBFC
lending
As at 1H FY11, the broking and lending operations accounted for the bulk of group
revenues (81%) and almost all of its earnings.
Broking operations (Religare Securities Ltd; RSL)
The brokerage business employs more than half the total group workforce and is a
core source of group income, comprising primarily commissions earned from equities,
derivatives and commodities traded on the exchanges for clients, and distribution of
third-party products such as mutual funds and insurance. RSL is currently ranked
among the top 3 brokers in the country by market share, with a leadership position in
retail broking (according to company data and BSE/NSE released numbers). Note that
only retail equity broking is now housed under RSL – institutional broking as well as
investment banking licence have been transferred to Religare Capital Markets (RCML).
Retail equity broking: According to company data, steady investments in branch
network, sales manpower and customer acquisition have increased the equity client
base from less than 420,000 as at end-FY08, to almost 690,000 as at March 2010
(+64% expansion). RSL’s model combines a dedicated relationship and dealing team
for each client – the latter handles all the existing business needs of the client while
the relationship team will look to cross-sell / up-sell newer products (both in-house and
third party) and services. We believe such cross-selling efforts, including availability of
share margin financing funded by the lending subsidiary RFL (see below), are
essential to mitigate yield pressure stemming from an increasing share of overall
market turnover coming from lower-margin options trading. Still, RSL now holds an
estimated 8% market share in the cash segment
Leveraging on a national branch network (409 own branches and 1,482 franchisee
branches as at Sept 2010), a comprehensive technology backbone (which includes an
integrated, end-to-end online investment portal called R-ACE that which currently
accounts for an average 7% of total internet trading volume on the National Stock
Exchange [NSE]), and a rising number of relationships with private and public sector
banking groups, Religare has been able to maintain an equity broking market share of
around 3.5%. While the competitive landscape – the top 25 brokers control 40% of the
market – weighs against any further significant organic traction for market share, we
think the underlying market itself is poised to expand substantially as the low rate of
retail penetration – India has less than 15mn equity trading account holders at present
(source: SEBI,NSDL) – rises and delivers secular growth in market turnover.
With strong distribution being the cornerstone of the group’s aim to maintain market
share and at the same time enhance cross-selling by building reach and customer
base, RSL has continued to build-out its national network. Over the past three years,
its broking branch network has expanded from 1,273 to 1,891, comprising 409 owned
branches and 1,482 franchises. To maintain cost efficiency and cap incremental
distribution costs, management’s focus is now on bringing more franchisees on board
to penetrate Tier-II and Tier-III cities. The franchisees work on a revenue-sharing
model whereby, in return for bearing the operating costs, they are entitled to two-thirds
of revenue generated. RSL has also secured partnerships with public and private
banks to further facilitate client acquisition.
Commodities broking: This business is carried out under Religare Commodities Ltd.
(RCL), which is structured as a wholly owned subsidiary of RSL. With 435 dedicated
commodity dealers and 305 commodity RMs, RCL is the clear leader in the sector and
targets equity trading customers for investment in globally traded commodities such as
agricultural products, bullion and oil & gas. RCL grew its client base by 91% over FY10,
to 107,000 and is now present in 600 locations across the country, including more than
80 operational Mandi (rural market) locations which provide on-the-ground takes on
developments in the agricultural sector.
While a relatively small contributor to group revenues and profit at this juncture, growth
prospects are appealing, we believe, given the nascent stage of the industry. In more
advanced markets, trading in commodity derivatives is 30-40x that of the physical
commodities market – this compares to just 3-4x for India currently. We see early signs
that the Indian commodity derivatives market is starting to catch up, with RCL reporting
the best quarter in terms of revenue in 2Q FY11
Lending operations (Religare Finvest Ltd; RFL)
RFL is an NBFC (non-banking financial company) and has rapidly grown its lending
operations since 2008, discontinuing the delinquency-plagued personal loans product
(significant write-offs taken over FY09 and FY10) and focusing instead on commercial
assets, loans against property and small and medium enterprise (SME) financing. RSL
has also transferred its share margin financing (loan against shares) book to RFL,
adding to the strong growth momentum as per the 28% CQGR notched since 2Q FY10
(up to 2Q FY11). As of September 2010, RFL’s book value was Rs16bn while the loan
book had expanded to Rs72.5bn, giving a comfortable leverage ratio of c.4.5x
compared with the regulatory maximum of 6.66x (based on a capital adequacy ratio
minimum of 15%, of which at least two-thirds must be core equity).
Commercial assets: This product was started in December 2008 and
encompasses loans for commercial vehicles (new or used) and construction
equipment (heavy or light) with tenures averaging 3-4 years. Commercial asset
funding is extended to both priority sector small operators and high-end retail and
strategic operators. As at 2Q FY11, lending outstanding amounted to Rs9.3bn, or
13% of the total loan book.
Mortgage/loan against property (LAP): The LAP product, offered from December
2008, enables customers to obtain loan facilities against their residential or
commercial property. The term loans offered under this product have an average
duration of 7 years and may be utilised towards different purposes, including
business expansion and purchase of plant and machinery. As at 2Q FY11, lending
outstanding amounted to Rs23.8bn, or 33% of the total loan book.
SME loans: The SME business loan product was launched in December 2008 and
caters to working capital and other financial requirements of SMEs, self-employed
businessmen and professionals. As at 2Q FY11, lending outstanding amounted to
Rs5.5bn, or 8% of the total loan book.
Loan against shares (LAS): The LAS business primarily involves offering loans
secured by shares held by its retail customers, which frees up clients’ capital yet
provides RFL with highly liquid security to cover the loans. Recently, this business
has expanded to provide wholesale lending, ie, promoter and corporate lending
services, supported by an institutional research team. As at 2Q FY11, lending
outstanding amounted to Rs27.3bn, or 38% of the total loan book.
While the lending operations are relatively new and in a very competitive space, we
believe strong management and good processes underpin profitability, with net profit
over 1H FY11 almost doubling y-y. Management will consider inorganic opportunities
to grow when available – RFL acquired part of Citigroup India’s home loan portfolio,
with a book size of Rs4.7bn, in 2Q FY11 – underscoring a target growth in the asset
finance book to Rs100bn by FY12F, from Rs31bn currently. Organic growth is
facilitated by branch presence in 23 cities, as well as the use of direct selling agents
and sales teams that have passed a due diligence process. Referrals are also sourced
from the broader Religare group, particularly via the extensive branch network and
client base of RSL. Service differentiation is key – compared to bank peers, RFL can
be more flexible in terms of product solutions and more personal and expeditious in
overall servicing. Further, RFL is not subject to bank specific issues, such as required
lending to priority sectors and restrictive liquidity frameworks.
A pan-India presence and dedicated distribution, operations and risk management
teams ensure credit assessment processes are robust, in our opinion. At the macro
level, credit database checks (similar resource used by other NBFCs and Indian banks)
and document verification are ingrained. The typical loan to value (LTV) ratio at
origination for mortgage loans is 65% (FY10: average LTV for portfolio was below
50%), while that for commercial assets is 75%. While current NPL ratios are biased
lower by rapid and unseasoned asset growth, we think slippage as the portfolio
matures should be tempered by a largely secured book (c.85% of total) and low LTVs.
At the operating level, rapidly rising operating scale is also bringing down cost per unit,
partially mitigating sustained yield pressure across all loan categories.
RFL is targeting to triple its current loan book by end-FY14F (ie, to around Rs 250bn,
from Rs72.5bn currently) according to management. Currently, given it holds no bank
licence, RFL cannot take deposits and instead needs to source funding from the debt
markets and capital to support loan growth. We believe that securing a banking licence
would not only significantly reduce RFL’s funding costs, allowing it to compete better
and raise its medium-term profitability (current target is to raise ROA towards 2.5%,
from 2% currently, by reducing the equity bias in the funding mix), but also complete
the broader Religare financial services product platform. The chances of securing a
banking license are explored in Section 3 of this report. The current dependence of the
funding on the debt market is highlighted in the following exhibit. Adverse movements
in the yield curve could see the cost of funds increasing
Parallels to thriving CIMB
Religare’s strategy of building on a strong domestic revenue pool while pursuing niche,
high-growth opportunities in the emerging markets space has parallels with the
strategic direction taken by Malaysian universal banking group CIMB upon the entry of
new management in early 2006, in our view. Group CEO Nazir Razak, previously head
of the group’s successful investment banking subsidiary, assembled an aggressive
and capable management team and then leveraged on the group’s strong domestic
investment banking franchise to both provide earnings “cover” for the underperforming
commercial banking unit while it was restructured and, at the same time pursuing niche
acquisitions across the ASEAN region with the aim of creating the most successful
pan-ASEAN universal banking franchise, in our view. We think CIMB now has a highly
integrated, universal banking platform across Malaysia, Indonesia, Singapore and
Thailand, collectively the same size as the Indian economy – as growth targets were
met and synergies delivered, CIMB’s earnings more than quadrupled in four years,
from less than RM1bn in FY05, to RM3.7bn in FY10F, while its share price has tripled.
As highlighted in the exhibit below, Religare has a similarly potent mix to CIMB of
capable management, entrenched domestic earnings base, supportive major
shareholder and targeted domestic and offshore growth ambitions to be pursued both
organically and via acquisitions, in our view. While we think Religare has a larger
share of businesses in their investment phase as opposed to CIMB in 2006, it also has
a much more lucrative domestic growth market at its back when compared with the
relatively mature Malaysian financial services industry. In sum, given proper execution
and noting the earnings momentum inflection that would occur when currently lossmaking but high-growth divisions like insurance (ARLI), asset management (RAMC)
and investment banking (RCML) turn profitable over the next three-seven years, on
our estimates, we believe Religare could deliver similar outperformance if its strategy
is properly executed.
Sum-of-the-parts (SOTP) valuation
We use a sum-of-the-parts valuation method to arrive at our price target for Religare
Enterprises. The main business segments of Religare have been classified into:
Religare Securities (retail broking), Finvest (commercial lending), Religare Capital
Markets (domestic and overseas), Religare Asset Management (domestic and global),
AEGON Religare Insurance and Religare Macquaire Wealth Management.
Valuation parameters
The RSL broking operation is valued at a FY12F P/E of 10x. While peer brokers are
trading on a lower 8x FY12F P/E, we believe RSL deserves a premium, given its
top-three market share position, strong growth prospects for its market-leading
commodity broking business, and looming and increasingly tangible synergies with
the broader Religare group.
The lending business (RFL) is valued at FY12F P/BV of 1.8x, which is comparable
to market multiples for peers operating in India’s commercial lending space. We
stress the positives of a relatively young operation unburdened by fall-out from the
credit crisis and with the potential to tap into synergies available from the broader
Religare group.
For RCML, its Indian investment banking division is valued at a FY12F P/E of 10x
while the international business, currently in loss-making investment mode, is
conservatively valued on the basis of the invested capital in the division.
The asset management division is valued on a % of AUM basis with the domestic
arm (RAMC) being valued at 4% of AUM (a slight premium to global peers to reflect
country-specific demographics/growth potential; note some recent acquisitions in
the Indian space have been valued as high as 5% of AUM). The Indian asset
management landscape has seen deals ranging from IDFC’s acquisition of
Standard Chartered business at 5.7% of AUM to around 3% of AUM for Nomura’s
stake acquisition in LIC (source: company data). The recently acquired global AUM
portfolio (RGAM) is valued at a lower 2% of AUM to reflect relatively greater
maturity and execution risk.
The AEGON Religare Insurance business (ARLI) is valued on the basis of the
invested capital (a conservative measure to take into account the long gestation
period involved, although we have imputed value uptick from the 12% IRR
guarantee) while the rapidly expanding Religare Macquaire Wealth Management is
valued at 4% of AUM (along the same lines as domestic asset management).
Where could we go wrong?
Risks to our investment view
As a human capital-dependent financial services group investing heavily, organically
and inorganically, in expanding outside of a relatively familiar domestic market into
offshore investment banking and asset management, capacity to execute is key – in
particular, ability to retain and motivate key management as well as to build and
integrate offshore operations with the core domestic franchise could be a challenge.
Add to this intense competition across all business lines and a potentially volatile
regulatory environment and you have the potential that key divisions such as
insurance, asset management and investment banking could take longer than
expected to turn profitable, potentially necessitating further capital support in our view.
Finally, despite increasing diversification, a majority share of group revenues and
earnings are still directly dependent on the performance of the potentially volatile
equity market.
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