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CRISIL – Initiating Coverage
Angel Broking Initiates Coverage on CRISIL with a Buy recommendation and Target Price of Rs7,584
CRISIL is the largest credit rating agency with a market share of around 65% and is
one of the biggest research houses in India. With the recent acquisition of Pipal
Research Corp. (Pipal), robust credit demand and strong infrastructure-spend, we
expect strong growth across all the segments of the company. The company has
also recently finished a buyback of 1.3lakh shares worth `80cr at an average price
of `6,200. We Initiate Coverage on the stock with a Buy rating.
Acquisition of Pipal to boost research revenue: Pipal is a strong player providing
offshore research services to the corporate sector, while CRISIL's Irevna is a leading
offshore research provider to the financial sector. The synergy between the two
firms will help CRISIL to service its clients better and further expand its client base,
resulting in strong growth going ahead. Post the acquisition with the combined
strength of the two firms we expect a 22% CAGR in the research segment's revenue
over CY2010–12.
Robust growth in credit ratings to continue on strong credit demand: We believe
credit demand will continue to grow at a faster rate than India's nominal GDP as
financial depth continues to increase. The need for large capital formation of 30–
35% of GDP for sustaining 8%+ GDP growth in India is well acknowledged;
hence, we expect credit demand to witness 20% CAGR over CY2010–14,
considering the actual and latent credit demand in India. CRISIL has been growing
at ~2x India's credit growth since CY2005. Further, the company will continue to
benefit from Basel-II norms, as a large number of entities are still to be rated.
CRISIL, being the market leader with 65% market share in credit rating and 50%
share in bank loan rating (BLR), will continue to benefit greatly from India's strong
credit growth. We conservatively expect the segment to register 21% revenue CAGR
over CY2010–12.
Outlook and valuation: We expect CRISIL to post 21.5% CAGR in revenues over
CY2010–12 and continue to maintain its leadership position. CRISIL benefits from
its asset-light business model, which is high on intellectual assets (employee costto-
sales is around 40%). Further, the company is debt free and has 40% plus RoE.
Additionally, CRISIL enjoys strong parentage (Standard and Poor's). Currently, the
stock is available at 17.3x CY2012E earnings, which is at the lower end of its
historical range of 16.4–29.9x one-year forward EPS. We Initiate Coverage on the
stock with a Buy rating and a Target Price of `7,584, valuing it at its five-year
median of 22x CY2012E earnings and implying an upside of 27%.
Investment arguments
CRISIL witnessed robust growth in the first three quarters of CY2010 on the back of
strong credit growth and global economic recovery, which going ahead is
expected to further improve. The company recently acquired Pipal Research, which
will lend to a boost to their research portfolio and result in robust growth in the
ensuing years. The advisory segment is expected to revert to high growth
tracjectory on the back of the strong infra spends. Overall, we expect all the
segments of the company to register high growth and conservatively expect total
revenues to register 21.5% CAGR over CY2010-12.
Strong growth to continue on the back of acquisition Pipal
CRISIL has a history of acquiring small companies and scaling their operations by
leveraging their strong clientele, skills and processes. CRISIL acquired Irevna in
CY2005 for `73.1cr, which was valued at ~2.2x EV/Sales (`33.1cr sales). Post the
acquisition, CRISIL’s research segment’s revenue increased from `41cr in CY2005
to `238cr in CY2009, witnessing a 55.7% CAGR in revenue over CY2005–09,
contributing nearly 45% to the total revenue in CY2009 from 29% in CY2005.
In CY2009, Datamonitor’s The Black Book of Outsourcing for Financial Research
ranked Irevna as the number one research house in the country.
CRISIL recently acquired Chicago-based Pipal Research Corp., one of the leading
players in the knowledge process outsourcing (KPO) industry, from First Source
Solution for US $12.75mn (around `58cr), at 1.6x EV/Sales . Pipal has a strong
presence in the corporate sector mainly in North America and Europe and
reported revenue of US $8.1mn (around `37cr) in FY2010. Pipal’s client base
includes leading telecommunications, technology, consumer packaged goods and
industrial companies.
Currently, CRISIL is a leader in the high-end KPO space. With this acquisition,
CRISIL, which provides services from Chennai, Mumbai, Buenos Aires and
Wroclaw (Poland), will now have presence in Gurgaon, Noida, Bangalore and
Chicago. The acquisition will also strengthen its position in the market. Pipal has
strong presence in the corporate sector, while Irevna’s strong presence lies in the
financial sector. The synergy between the two firms will help the company to
service clients better and expand its client base, which will result in a strong
platform for growth in the coming years.
Going ahead, we expect CRISIL’s research segment to grow further, as it did post
the acquisition of Irevna, registering a 22% CAGR over CY2010–12E.
Robust growth in credit ratings to continue on strong credit demand
The Indian economy is on the cusp of an upturn in its capex cycle, and early signs
of a pronounced capex upswing are already emerging. GDP growth has averaged
at about 8% over the last five years and is expected to grow at 8–9% over the next
few years.
We believe macro indicators such as huge project announcements, improving
utilisation levels, improved business confidence, increasing end-product prices and
expectation of significant demand improvement will lead to growth in the capex
cycle. Funds raised by companies grew by 20.5% in FY2010 compared to 18% in
FY2009. The capex cycle, which started in 2004, took a breather between 2008
and 2009 as the world faced liquidity constraints.
After the interruption seen over the last two years, the capex cycle has resumed
and is expected to further improve going ahead. Rising economic growth
momentum, improving domestic demand prospects and growing capacity
utilisation since FY2009 have translated into recent growth in capacity expansion
plans as well as in actual project implementation. Moreover, the continuous flow of
investment announcements reflects the confidence of industries in sustaining the
current upsurge in demand. More importantly, the current investment boom is not
triggered by the government but by companies that are optimistic about the
economy’s growth potential and are investing willingly. This is evident from the fact
that the share of private sector in outstanding investment has been rising steadily
from 39% in 2004 to 58% in 2010.
We believe credit demand will continue to grow at a faster rate than India's
nominal GDP as financial depth continues to increase. The need for large capital
formation of 30–35% of GDP for sustaining 8%+ GDP growth in India is well
acknowledged; hence, we expect credit demand to witness a 20% CAGR over
CY2010–14, considering the actual and latent credit demand in India.
CRISIL has been growing at ~2x India's credit growth since CY2005. Further, the
company will continue to benefit from Basel II norms, as the number of entities to
be rated will increase further. CRISIL, being the market leader with 65% market
share in credit rating, will continue to benefit greatly from India's strong credit
growth. As of September 30, 2010, CRISIL had more than 10,941 ratings
(including 6030 SMEs) outstanding. We conservatively expect the rating business to
register 21% revenue CAGR over CY2010–12.
Robust growth in BLR to continue post Basel II
Post Basel II, CRISIL has seen strong growth in its credit rating segment due to a
boost in bank loan rating (BLR). The company’s credit rating segment witnessed a
38.2% CAGR in revenue over CY2006–09. Till 3QCY2010, CRISIL had 5,017
BLRs, making it the market leader with a market share of 50%.
The BLR market is a much larger market compared to the bond market given the
wide reach of banks and large funds at their disposal vis-à-vis the capital market
participants. There are several incentives for entities to get rated, as they can avail
loans at cheaper rates based on their ratings. On the other hand, banks also stand
to benefit, as they now only need to hold capital reserves to the extent of the risks
they are exposed to, in turn freeing vital capital and reducing costs. Thus, given the
large size of the SME sector and high number of unrated entities under Base II
norms, we believe that the BLR market presents a strong growth opportunity.
Post 2014, the RBI may shift to the advanced internal ratings methodology under
Basel II norms, where banks can themselves rate entities. However, it is better for
an entity to get rated from a single, well-accepted external agency than getting
rated by multiple banks and increase its cost of rating. Hence, CRISIL being the
market leader will benefit the most from the growing BLR market.
India’s bond issuance growth to fuel further growth in ratings
Bond rating is one of the major contributors to the company’s ratings segment.
India’s corporate bond market is relatively underpenetrated compared to major
developed countries and emerging markets, as corporates in India prefer bank
credit over bonds. However, with the growing capex cycle and infra spends in the
recent years, corporate bond issuance has increased, as it is a cheaper way to
raise money compared to bank loans or equity dilution.
For India to expand at 8–9% in the coming decade, huge capex and infra spends
are required. As per the XIIth Five-Year Plan, the government has announced
US $1tn infrastructure spending. Accordingly, we expect bonds to become a major
source for corporates to raise money to fuel such a huge amount of spending.
Infra & advisory services to benefit from huge infra spend
CRISIL’s infrastructure advisory segment provides practical and innovative solutions
to governments, donor-funded agencies and leading organisations, where the
company helps to improve infrastructure service delivery, transform performance of
public institutions and design and strengthen reform programs to catalyse private
sector participation.
Over CY2007–09, CRISIL’s infra and risk advisory segment took a hit due to the
ongoing liquidity crisis. Consequently, the segment’s revenue declined from `107cr
in CY2007 to `60cr in CY2009. However, post the crisis, we expect the segment to
recover at a fast pace and register revenue close to its CY2007 revenue.
CRISIL is set to benefit from the estimated US $800bn spend on infrastructure from
FY2010–14E (US $1tn in the XIIth Five-Year Plan), as it will provide a huge
opportunity to the company to expand its infra and risk advisory services segment.
Accordingly, CRISIL has undertaken aggressive hiring across hierarchy and will
expand its customer base going ahead.
Hence, we expect CRISIL's infra and risk advisory services segment to conservatively
report a 21.7% CAGR over CY2010–12E on account of low revenue base. Despite
such strong growth, the advisory segment is expected to report revenue of `75cr in
CY2012, which will be less than its CY2007 revenue of `107cr. Thus, there could
be significant upside to our estimates.
Strong cash reserves to result in buyback, acquisitions and
higher dividends
CRISIL, with its strong cash reserves of `158cr, initiated a buyback of ~1.3lakh
shares worth `80cr for an average price of `6,200/share in CY2010. The
company also purchased Pipal for `58cr. In CY2010, apart from the `75/share
dividend, CRISIL gave a special dividend of `100/share.
Going ahead, we expect this trend to continue with the company paying higher
dividend with payout ratio above 50% in CY2011–12. Also, the company can
initiate another round of buyback in CY2011, as it will have `142cr of cash
reserve post an estimated dividend payout of `150/share in CY2011. CRISIL has
historically taken up many inorganic growth opportunities to fuel its growth and
can easily accept another inorganic growth prospect, given its strong cash reserve
of `242cr by CY2012E.
Outlook and valuation
We expect CRISIL to register a 21.5% CAGR in revenue over CY2010–12E and
continue to maintain its leadership position, with robust growth across all its
segments. The company benefits from its asset-light business model, which is high
on intellectual assets (employee cost-to-sales is around 40%). Further, the company
is debt free and has 40% plus RoE. Additionally, the company enjoys strong
parentage (Standard and Poor's).
Currently, the stock is available 17.3x CY2012E earnings, which is at the lower
end of its historical range of 16.4–29.9x one-year forward EPS, which makes it
attractive. We Initiate Coverage on the stock with a Buy rating and a Target Price
of `7,584, valuing it at its five-year median of 22x CY2012E earnings and
implying an upside of 27%.
Concerns
Slowdown in economic growth
CRISIL’s rating business depends on growth in credit demand, which is closely
linked to the economy’s growth. A major part of research revenue is generated
through outsourcing research services to foreign corporate and institution, which
may be affected if economic crisis continues in the near future.
Competition from other players
CRISIL enjoys the highest market share in industry. However, growing competition
from players such as ICRA, CARE, Fitch Rating and Brickwork has seen erosion in
its market share as seen in the case of BLR where CRISIL’s market share has
dipped to 50% in 3QCY2010 from 55% in CY2009. Going forward, this could
result in declining growth and have negative impact on the company’s profitability.
Nonetheless, CRISIL being the market leader since inception is well-placed to fend
off such competition, which we believe is there to stay.
Margins at risk due to fluctuations in forex
CRISIL derives ~53% of its revenue from foreign clients. Thus, the company has a
large exposure to foreign currency and any major fluctuation in forex can lead to
losses, thus affecting margins and profitability.
Wage inflation and attrition rate cause of concern
CRISIL has been facing attrition in excess of 15% over the years. In the face of it,
the company has been incurring significant costs towards acquiring and training
qualified manpower. Also, in its efforts to retain talent, CRISIL has seen an increase
in cost per employee due to inflationary effects. However, it may be noted that it
has been able to increase its profit and revenue per employee over the years
exhibiting strong capability to pass on additional expenses. Overall, we believe
that being a market leader with a strong brand, the company will be able to
manage such pressures and sustain its margins going ahead.
Financial overview
In CY2009, CRISIL registered mediocre growth of 4.4% yoy in revenue, largely due
to the slowdown in capital expenditure during the economic downturn. However,
on the back of a revival in the economy, the company registered robust 16% yoy
growth in revenue for 9MCY2009 to `453.7cr from `391.7cr, aided by strong
growth in the credit rating and research segments.
For 4QCY2010E, we expect strong growth across all segments as the economy is
back on track, with an estimated GDP growth of around 8.5%. For CY2010, we
expect strong top-line growth of `91cr (17%) yoy to `629cr compared to `537cr in
CY2009, largely due to strong growth in the credit rating and research segments,
which are expected to post 22% and 20% yoy growth, respectively. Further, we
expect all segments to register strong growth on the back of robust credit demand,
acquisition of Pipal and strong infrastructure spend in the coming years.
Going ahead, we expect the company's top line to register a 21.5% CAGR over
CY2010–12E, increasing to `767cr in CY2011 and `927cr in CY2012.
EBITDA margins to remain in line
During CY2009, CRISIL’s operating margin improved to 37.1% (34.8%), largely on
the back of cost cutting, which resulted in other expenses coming down to 14% of
revenue in CY2009 versus 18% in CY2008. However, for 9MCY2010, the
operating margin reduced marginally by 4.3% to 32.8% yoy due to higher
employee cost and other expenses, which included forex losses of `7.3cr for
9MCY2010.
CRISIL’s margins, which took a hit in the first two quarters of CY2010, improved to
35.3% in 3QCY2010 due to lower other expenses. For 4QCY2010E, we believe
the company’s EBITDA margin will be at around 34.4%. For CY2010E, we
estimate EBITDA margin of 33.3%, which is expected to come back to its CY2008
levels going ahead and gradually increase to 34.3% and 34.8% in CY2011E and
CY2012E, respectively. EBITDA is estimated to increase from `199cr in CY2009 to
`323cr in FY2012E on the back of strong revenue growth.
Net profit to register 15% CAGR over CY2009–12E
In CY2009 CRISIL's net profit margin increased by 261bp to 29.9% (27.3%),
primarily because of higher operating margins. For CY2010, we estimate net profit
margin to increase substantially to 32.1% (29.9%) on the back of higher other
income arising from sale of property and investments. For 9MCY2010, net profit
surged 32.6% yoy to `155cr from `117cr due to the 306% yoy spike in other
income. Thus, in CY2010 net profit is expected to increase to `202cr from `161cr
in CY2009.
CRISIL derives a major part of its revenue from exports, which is tax-exempted till
FY2011 under the Software Technology Parks of India’s (STPI) regulations. Going
ahead, this exemption will seize and, thus, the company has started taking
necessary steps such as transferring business to its existing SEZ units, where the
company can continue to avail tax exemption. Management has guided that tax
exemption may be extended till FY2012 under the STPI. If tax exemptions under the
STPI are not extended till FY2012, we expect the company’s tax rate to increase by
~2% in CY2012. For CY2011 and CY2012, we estimate net profit margin to
decline to 26.1% and 26.4% to `200cr and `245cr, respectively, due to lower
other income in CY2011 and CY2012 and higher tax rate in CY2012.
Company background
CRISIL was incorporated in 1987 as India’s first credit rating agency. Over the
years, the company has evolved to become the industry leader with a market share
of around 65% and has diversified into research and infrastructure risk and policy
advisory services. The company is currently one of the largest research houses in
the country, providing research to over 65 industries and 150 corporates in India.
The company also provides high-end offshore research and analytical services
mainly to top financial institutions (including six of the world’s top 10 investment
banks), insurance companies and asset management firms.
Credit rating segment
CRISIL is the largest credit rating agency in India. CRISIL pioneered ratings in India
more than 20 years ago and is today the undisputed business leader, with the
largest number of rated entities and products. Over the years, CRISIL has also
developed several structured ratings for multinational entities based on guarantees
from the parent as well as standby letter of credit arrangements from bankers. The
rating agency has also developed a methodology for credit enhancement of
corporate borrowing programmes through the use of partial guarantees. CRISIL is
uniquely placed in its experience in understanding the extent of credit
enhancement arising out of such structures. CRISIL’s comprehensive offerings
include ratings for long-term instruments such as debentures/bonds and
preference shares, structured obligations (including asset-backed securities) and
fixed deposits. The company also rates short-term instruments such as commercial
paper programmes and short-term deposits.
Bank Loan Ratings (Basel II)
CRISIL commenced rating bank loans post the RBI’s guidelines on capital
adequacy for banks in 2007. Basel II guidelines, as they are called, require banks
to provide capital on credit exposure as per credit ratings assigned by approved
external credit assessment institutions (ECAIs), such as CRISIL. Basel II is a
recommendatory framework for banking supervision issued by the Basel
Committee on Banking Supervision in June 2004. The objective of Basel II is to
bring about international convergence of capital measurement and standards in
the banking system. The revised framework for capital adequacy has been effective
from March 31, 2008, for all Indian banks with an operational presence outside
India (12 public sector banks and five private sector banks) and for all foreign
banks operating in India. It has been applicable to all other commercial banks
(except local area banks and regional rural banks) from March 31, 2009.
CRISIL rates the maximum number of companies for their bank loans in India. As
of September 30, 2010, CRISIL had rated 5,017 entities, representing over 50% of
all the companies, which have their bank loans rated in India; CRISIL has rated
bank facilities of all types: term loans, project loans, corporate loans, general
purpose loans, working capital demand loans, cash credit facilities and non-fundbased
facilities, such as letters of credit and bank guarantees.
SME Ratings
CRISIL pioneered the concept of ratings for the SME sector in India and, presently,
within a span of just five years, has the largest number of ratings on the SME sector
in the world. As of September 30, 2010, CRISIL had assigned ratings to over
14,500 SMEs. CRISIL's SME ratings are affordable and tailor-made services
designed for SMEs.
Real Estate Ratings
Housing and real estate form the backbone of the country's infrastructure and are
critical drivers of economic development. With government policies emphasising
faster economic growth, the real estate sector is attracting large investments from
both domestic and foreign investors. Investors and customers, however, need to
exercise caution in their exposure, as the sector is largely unorganised.
Given the risk factors and volatility inherent in the real estate business, it is critical
to judge the performance ability of developers to deliver good quality projects.
Towards this end, CRISIL provides third-party opinion through two specialised
products: National Developer Ratings and Real Estate Star Ratings.
Research
CRISIL Research: CRISIL’s research segment is India’s leading independent,
integrated research house. Through constant innovation and comprehensive
research offerings covering the economy, industry and companies, CRISIL Research
meets the requirements of more than 750 Indian and global clients. Apart from
off-the-shelf research reports, CRISIL provides incisive, customised research.
Through its IPO grading initiative, CRISIL Research has also established a presence
in the equity research domain and is poised to significantly expand its presence in
this area.
Outsourcing (Irevna and Pipal): CRISIL’s outsourcing department consists of Irevna
and the recently acquired Pipal. Irevna was one of the pioneers of offshore
investment research for some of the world’s leading investment banks and
financial institutions. It is one of the most experienced and diversified provider of
analytical services to the financial services industry, supporting equity research,
equity strategy, credit research, securitisation research, and derivatives IT and
structuring. Irevna has offices across the world in the US, the UK, Poland,
Argentina and Hong Kong and its Indian offices are at Mumbai and Chennai.
Pipal is a leading custom research firm, delivering financial and business research
and quantitative analytics to organisations worldwide. Founded in 2001 by a team
of management professionals, Pipal created a name for itself as a knowledge
vendor of choice.
Advisory
CRISIL Infrastructure Advisory: CRISIL’s infrastructure advisory segment provides
practical and innovative solutions to governments, donor-funded agencies and
leading organisations in over 20 emerging economies across the world. It has
widely acknowledged policy advisory expertise and specialises in commercial and
contractual issues in the areas of energy, urban infrastructure and public-private
partnerships. CRISIL Infrastructure Advisory has built a unique position for itself in
these domains and is the preferred consultant to governments, multilateral lending
agencies and private sector clients.
CRISIL Risk: This segment provides risk solutions for banks, financial institutions,
mutual funds and corporates. It also provides risk management services,
consulting and software products in the areas of credit, market and operational
risk. It partners closely with leading public and private sector banks and entities in
the financial services and insurance sectors, implementing enterprise-wide risk
management solutions.
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