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Sell
Religare Enterprises (RELG.BO)
Return Potential: 3% Equity Research
Long-term potential offset by immediate challenges; Initiate at Sell
Source of opportunity
We initiate on Religare Enterprises (RELG.BO) with a Sell (12-m price target of
Rs500, about 3% potential upside) for three reasons: (1) we believe the riskreward is more favorable in other banking stocks, (2) we see a lack of catalysts
in RELG’s traditional businesses – retail broking and lending business given
rising interest rates. (3) The new businesses (investment banking, institutional
broking, global asset mgmt.) are likely to see a revenue lag as they are in
investment mode. Our blue-sky scenario analysis indicates potential upside
could be 65%, with valuation rising to Rs800/ share, but this is: a) subject to
high execution risk; and b) unlikely to be realized within three years.
Catalyst
(1) Lower equity market volumes (RELG market share in cash is 4.5%): Jan
2011 market volumes down to US$3.7 bn a day from US$4.5 bn in
September 2010; (2) Further hike in interest rates, which could impact
growth potential and spreads in the lending business. Our ECS team
expects RBI to raise interest rates by another 75 bps in 2011, over and
above the 150 bps in 2010.
Valuation
Using CAMELOT and sum-of-the-parts, our 12-m price target for RELG is
Rs500/share, which implies around 3% upside from here. We initiate
coverage on RELG with a Sell rating given limited upside to target price vs.
other stocks in our coverage (27%-44% for Buys and 21%-32% for Neutralrated stocks). RELG is trading at 2.6X P/B FY2012E on a consolidated basis.
Key risks
1) Buoyant capital markets could lead to higher profit in broking/
investment banking; (2) lower inflation and easing rates will be positive for
growth and spreads in lending business; and (3) better-than-expected
execution, specifically in the lending and investment banking/ institutional
broking businesses, could translate into stronger earnings.
Overview: Traditional businesses face near-term headwinds; new
businesses in investment mode
While still in its nascent stage, Religare Enterprises (‘RELG’ or ‘Religare’) offers exposure
to India’s under-penetrated financial services industry. Religare’s businesses span across
most financial services products, including lending, brokerage and insurance products.
The company’s traditional businesses of retail broking and lending are generating profit
and will likely benefit long term from growing equity market volumes and lower
penetration in the mortgages business. However, these businesses face the challenge of
volatile and weak capital markets and rising lending rates in the near term. The new
businesses – investment banking, institutional broking, asset management (India and
overseas), and health insurance – are in investment mode and would require 2-4 years in
our view to be EPS-accretive, given the lack of scale, execution challenges, limited brand
resonance and the current unfavorable macro-economic environment. We estimate an
incremental capital requirement of about Rs25 bn across subsidiaries (40% of current
market cap, 97% of FY10 net worth) in order to meet the company’s expansion plans.
Our CAMELOT and SOTP-based price target is Rs500, which implies 3% upside from
current levels. On a relative basis this is lower than the 27%-44% potential upside in our
Buy-rated stocks and around 21%-32% potential upside in our Neutral-rated stocks. We
thus find investment in Religare relatively less attractive vs. our coverage universe and
initiate coverage on RELG with a Sell rating. A key risk to our estimate could arise from
successful execution of its lending and institutional brokerage business, which could
surprise on the upside. Our blue-sky scenario extrapolating revenues for lending/
institutional broking businesses beyond FY13 indicates a valuation 65% higher than
current price, for investors with a longer investment horizon and/or much higher risk
appetite. But given the headwinds of a higher interest rate environment/ muted trading
volumes over our 1 year price target horizon we believe there is better value in our Buyrated stocks (IndusInd Bank, Yes Bank, Bank of Baroda, Punjab National Bank and ICICI
Bank).
Better risk reward in other stocks
We initiate coverage on RELG with a Sell rating and a 12-month target price of Rs500,
indicating limited potential upside of about 3% from current levels. Key reasons:
Traditional businesses – lack near-term catalysts: While we believe that the longterm prospects for the lending and brokerage (4% market share) businesses are strong,
we believe Religare will face near-term challenges that could subdue stock price
performance. In brokerage, industry volumes are down 20%-26% in 1HFY2011 and will
likely remain subdued/down given the rising interest rate environment. In the lending
business too, we think Religare will face challenges: (1) We believe Finvest will find it
difficult to lever up significantly given the newness of its businesses, and will need to
infuse about Rs12 bn capital in FY12 to maintain a leverage ratio below 6X. (2) Banks are
better positioned in the lending business given access to low-cost deposits and large
network, (3) Rising interest rates over the last year (CP/CD rates up 300bp-500bp) could
pressure on lending spreads – we forecast 5% in FY13 vs. 6.5% in FY10. Our ECS team
expects at least another 75bps rate hike during 2011. This could impact the company’s
ability to achieve its 14%-15% RoE target over the next two years.
Revenues to lag in new businesses: Religare has recently started expanding into new
businesses including insurance, institutional brokerage, and investment banking. The
build-out phase across subsidiaries has led to employee strength increasing 1.9X to
around 8,500 over FY07-H1FY11, including key senior management across the
subsidiaries. While the dedicated management teams bring the requisite experience to
these nascent companies, we believe revenues would accrue gradually, given the
gestation period, lack of scale and execution risk (limited brand resonance, people
retention, likely culture conflicts on inorganic growth). However, cost ratios would remain
high given the build-out. We estimate total cost/ net income rising to 91% in FY11 vs. 81%
in FY10, before trending down to 81% by FY13.
Capital infusion estimated at Rs25 bn (around 38% of current market cap): So far,
RELG has infused Rs26 bn (about US$545 mn) of capital over FY07-FY10 (around 98% of
FY10 net worth; around 38% of market cap) across subsidiaries. As per our estimates,
additional capital requirement over H1FY11- FY13 would be similar at about Rs25 bn
(about US$540 mn) – around 97% of FY10 net worth; 38% of current market cap).Of the
total capital requirement, we estimate about 46% will be needed in the lending business
(to avoid constraining growth) and another 24% and 12% by the life insurance and
investment banking/institutional broking businesses, respectively. As we do not build
capital issuance into our estimates at the RELG level, our consolidated earnings are
subdued by higher interest expenses. We estimate RELG to deliver a 26% CAGR in
consolidated earnings over FY10-13 and RoE of 6.9% by FY13.
Relatively more upside in banking stocks: Our SOTP-based price target for RELG is
Rs500, which implies about 3% upside from current levels. On a relative basis this is lower
than the current 27%- 44% potential upside in our Buy-rated stocks and 21%-32% potential
upside in our Neutral-rated stocks. We thus find investment in Religare relatively less
attractive vs. our coverage universe and initiate coverage on RELG with a Sell rating. In
addition to seeing better value propositions elsewhere, we believe RELG’s value
unlocking will take time given that the company has to demonstrate a successful
execution of its strategy, with a number of its key businesses still in the evolution phase,
lack of strong brand, and challenges arising from the integration of several acquisitions in
a short span (including cultural differences). In addition, the recent strategic difficulties of
Reliance Capital and Anand Rathi’s institutional businesses could mean the market will
prefer to assign a higher value for RELG as and when there is more earnings visibility.
Valuation
RELG was listed in November 2007, and is currently trading at 2.6X FY12E P/B. Its average
trading band has been between 1.8X and 2.4X P/BV since listing. Our 12-month CAMELOT
and SOTP-based price target is Rs500, which implies a 2.7X FY12E P/B. As RoEs improve
and management delivers on expected lines, the stock has potential to re-rate. However,
given the several challenges involved we think the stock is likely to remain range-bound,
as confidence in the management’s strategy and execution ability are only likely to
emerge gradually.
Blue-sky scenario – Upside risk
A better-than-expected execution, a turnaround in the macro-economic environment and
buoyancy in capital markets can lead to upside risk to our estimates and valuation.
Despite the company’s management past credentials, we would prefer to be reactive to
stronger traction/ execution on the nascent business – specifically investment banking/
institutional broking – given the experience with other new entrants who have failed with
similar strategies, and also given that 90%+ of RELG’s investment banking fees are
currently from Group transactions. Nonetheless, for investors with horizon beyond 2-3
years and higher risk appetite, RELG could potentially offer structural exposure to India’s
under-penetrated financial services segment.
Within this context we have projected a blue-sky scenario, wherein the swing factor is
valuation for the investment banking/ institutional broking business. Potentially strong
capital markets and execution could likely impute into a step change in earnings beyond
FY13 for the currently loss-making investment banking/ institutional broking businesses
(RCML), resulting in a value of Rs223 per share based on the present value of 15X FY15E
EPS. Our blue-sky SOTP-based valuation for Religare is Rs800per share, which implies
65% potential upside from current levels.
Significant industry potential, will RELG manage to capitalize?
RELG has historically been a retail broker. Since FY07, the company has been adding
businesses through both organic and inorganic routes. Over the period, about Rs26 bn
(US$540 mn; 37% of current market capitalization) has been invested across subsidiaries,
with the Indian promoters (Malvinder Singh and Shivinder Singh, better known as the
promoters of Ranbaxy Laboratories) having added about Rs22.5 bn additional capital over
FY2007-FY2010. As of December 2010, the promoters own a 66% stake in Religare, with
FIIs holding <2% (approved limit of 40%).
Diversified exposure to Indian financial services industry: Over FY06-FY10,
Religare Enterprises (RELG) has diversified from its prior focus on retail broking to asset
lending, asset management, life insurance, investment banking, institutional broking and
alternative assets. Broking-related income has declined from about 60% of consolidated
revenue in FY07 to about 40% in FY10.
Strong growth potential
Penetration levels across financial service segments in India remain low, translating into a
huge opportunity for Religare as it builds out operations across segments. We forecast
robust CAGR of 9%-75% across key growth drivers over FY11-13 for RELG’s subsidiaries
in the context of strong economic activity, low penetration levels and a low base effect.
We expect growth will be driven by the lending business with loan CAGR of 48% over
FY11-13. The other key businesses – retail broking and capital markets – are likely to
experience some cyclicality given volatile capital markets. On the other hand, life
insurance and asset management face regulatory constraints at an industry level, while
we expect Religare to show traction from its current low base
Stock options (ESOPs) issued to attract/incentivize/retain employees:
To align and incentivize management interests, over September 2010-December 2010,
RELG has issued ESOPs to employees across businesses. Further, to align interests of
subsidiary business heads to Religare as a whole, 50% of each employee’s ESOPs is
cross-linked to Religare Enterprises – the holding company. Investment
banking/institutional broking (Religare Capital markets) has the highest percentage of
ESOPs among the subsidiaries at 25% of outstanding share capital (Exhibit 23). The
vesting schedule is one-third over three years for all subsidiaries except Religare AMC,
with a longer vesting schedule of 20%/30% and 50% and Religare Capital markets, which
remains to be finalized.
Investment mode to keep a lid on returns generated over the next
few years
Given Religare’s current build-out, we expect a lag between revenues and expenses over
FY11-FY13. We estimate Religare Capital Markets (investment banking/ institutional
broking) will break-even beyond FY13, with consolidated return ratios remaining subdued,
before improving to an RoA of 0.8% and RoE of 6.9% by FY13. Importantly, our estimates
do not factor equity issuance at REL level, resulting in higher interest expenses/ lower
RoEs.
Key challenges
While the potential across the financial services industry is substantial, whether Religare
will manage to capitalize on this potential remains to be seen. We believe RELG faces
several execution challenges in delivering profitable growth across subsidiaries, such as:
In the inception phase: Most of RELG’s businesses (such as institutional broking,
investment banking, and life insurance) are 2-3 years old, implying a long gestation
period and also lack of scale.
No significant unique proposition/ limited brand franchise: While we expect the
financial services pie to grow, the commoditized nature of the businesses magnifies
challenges for RELG from its either being a late entrant, or seeing high competition from
incumbents and/or having limited ability to innovate/ carve a niche.
Required capital investment to postpone returns: Continued need for capital infusion
as some businesses are capital heavy (for example –lending) while others such as
investment banking/institutional broking may take 3-4 years to turn profitable.
Too much too soon: While each of these businesses has its own management team,
Religare runs the risk of diluting focus/returns by venturing into multiple business
segments in a short span.
Potential synergies would take time to accrue: While some strategic challenges remain
at each subsidiary’s level, RELG’s integrated approach should result in synergies primarily
through cost advantages and cross-selling benefits.
Regulatory risk: Financial reforms/ changing regulations have had a significant impact,
specifically for the asset management and life insurance industry. Marginal industry
participants such as Religare may face consolidation pressures in the context of
suppressed profitability and near-term growth.
Religare Finvest – Strong growth but spreads could see pressure
Opportunity: India’s loan to GDP ratio remains low relative to developing/developed
markets. Thus, the banking sector has delivered 22% CAGR over FY00-FY10 (Exhibit
27). Religare Finvest (‘Finvest’) primarily provides loans to the self-employed segment,
typically with a 2-3 year track record. During FY08-10, the loan book CAGR has been
strong at 96% from a low base. From a previous focus on loans against shares to the
retail segment, the product mix has been diversified with about 50% from assetbacked lending (mortgages, commercial assets and SME loans) as of September 2010.
During Q2FY11, Finvest re-organized to decentralize operations (collections, credit
appraisal and marketing) region-wise to shorten turnaround time. Management has
guided loan book to grow to Rs250 bn over the next four-five years (driven by
secured business), buoyed by expansion from the current 23 locations to 36 by May
2011 and doubling the sales force from 1,200 to 2,500. We are building in loan CAGR
of about 50% over FY11-FY13 in Finvest.
Key risks/ challenges – profitability to be delayed given economic environment:
(1) Wholesale-funded, spike in interest rates: We believe Finvest could see pressure
on spreads (assumed at 5% in FY13 vs. 6.5% in FY10), marginally offset by
improvement in credit rating (from LA+ as of March 2010 to LAA- as of Sept 2010),
given the sharp 400-500 bp rise in short-term rates, and the inherent disadvantage
when competing with banks with their strong low-cost liability franchises. (2) Gross
NPLs declined from 1.1% in FY09 to 0.22% as of September 2010 (due to unsecured
personal loans). High growth in loan book and rising rates may lead to a rise in NPLs
given new systems and processes.
Valuation: We have valued Finvest using our CAMELOT-based model at Rs261/ share
(52% of our RELG target price), implying 1.4X FY12E P/B, and assuming an ROE of
15% in the high-growth stage.
Religare Securities – Well-poised but trading volumes a key vector
Opportunity: Religare Securities (‘RSL’ - a 100% subsidiary of RELG), started off as
the primary business of RELG focusing on the retail segment. RSL’s peak market
share was about 4% in FY08. Management has indicated current market share of
around 5% in the retail segment and 8% in the retail cash segment, which we were
unable to verify given limited available data. After adopting an aggressive price entry
strategy to offer broking services to all clients since November 2010, the new
management intends to focus on sourcing profitable customers, and have thus raised
brokerage rates. While the owned branch network contributes about 88% of total
business for RSL, going forward, management has guided share of franchisees/
banks would rise to 18%-20%. Management also appears focused on reducing costs –
both acquisition and administration. The company is attempting to differentiate its
proposition through research on mid-cap and small companies, while also crossselling life insurance and mutual funds.
Catalysts/ risks: In our view, there are no near-term catalysts for RELG’s relatively
mature retail broking business, given the competitive environment and muted cash
volumes. Industry cash turnover fell 20%-26% in Q1FY11-Q2FY11, and we estimate
11% yoy decline in FY11 and 8% yoy growth in FY12. The share of cash volumes has
consistently declined from around 40% in FY05 to 14% as of Q3FY11. Also, retail
participation on NSE is now at 50% of total vs. 60% in FY08. Nonetheless, growth
potential remains strong given the low household ownership in equities at 2.6%,
despite the high savings ratio of 20%. However, the Indian broking industry is
competitive with the top 25 brokers having 40% of the market share (Exhibit 42).
Valuation: Based on comparative valuation multiples (Exhibit 7), we have valued the
business at 15X FY12E P/E to Rs79/ share, which contributes 16% of RELG’s GSe
target price.
Key risks: (1) Continued low trading volumes, specifically in the high-yield cash
segment, (2) Capital market volatility/correction.
Religare Capital Markets – conceptually good, but EPS-accretive?
The journey so far: Subsequent to the acquisition of Hichens Harrison in 2008, Religare
Capital markets (RCML) was incorporated with a merchant banking license. So far, the
bulk (about 90%) of the revenue has been generated through in-house/ group transactions.
RELG plans to set up an emerging markets investment bank, with India continuing to hold
about 70% of the revenue pie. To expedite rollout in terms of research footprint and
client-empanelments, three more entities have been acquired over Q3FY11 (Exhibit 49).
RCML intends to roll out operations in 7 countries: Brazil, Russia, South Africa, Hong
Kong, Thailand, Malaysia and Indonesia.
Challenges/ catalysts: Evidently, RCML is in an investment phase and the new teams
still have to start delivering, which, along with the company’s inorganic growth strategy,
makes it difficult to estimate the likely profit trajectory. Religare’s limited brand franchise
would make it more challenging to source investment banking deals/ gain traction with
institutional clients in the competitive industry. While about 25% of outstanding share
capital in the company has been doled out in stock options (ESOPs) to attract and
incentivize employees, retaining key people after the lock-in expires would be a key
determinant of the company’s success. RELG has adopted an inorganic growth strategy,
which poses additional integration/culture challenges, in our view. Management is
confident of no conflicts arising, given the small size of teams in the acquired entities. Of
the recent new entrants, Reliance Capital and Anand Rathi adopted a similar strategy of
hiring experienced people from bulge bracket banks/brokers, but failed to retain them,
while India Infoline appears to have been successful in gaining business traction. Despite
the execution challenges and limited track record, we are building comparable
income/expenses for RCML vs. more established peers.
Valuation: RCML is likely to remain in investment mode and not generate profits over the
next few years. We have valued the business at 1X FY12E P/B (vs. 1X-1.5X FY12E for the
listed/ more established peers) to arrive at Rs56 per share (11% of RELG’s GS target price).
AEGON Religare Life Insurance – Downside protected
The journey so far: AEGON Religare Life Insurance (ARLI) started operations in July 2008
and has a market share in APE (annualized premium equivalent) of 0.4%. Religare owns
44% stake in the life insurance business with the balance 26% held by AEGON
(headquartered in Netherlands) and another 30% by Bennett and Coleman (part of India’s
Times Group). ARLI is in its inception phase, and is building up its distribution network
(currently around 120 branches and 9,000 agents). Given the lack of a banc-assurance tieup, ARLI is focusing on distributing through agents, group network (specifically in Tier-II
cities) and alternative channels such as the Internet. Management intends to focus on the
unit-linked segment and has indicated new business (NBAP) margins to be 10%-11%, post
the new guidelines for life insurers. So far, Rs2.5 bn capital has been invested in the
subsidiary. Based on terms negotiated with AEGON, Religare has downside protection in
the business, with 12% guaranteed return per annum on its capital invested. Going
forward, in the event of a listing, Religare will get the higher of 12% or market determined
return. Thus, Religare currently writes back its share of the surplus/deficit in the life
insurance business in the consolidated profit and loss account.
Catalysts/challenges: We believe that the industry insurance premium will likely grow at
around 15-18% over the next couple of years on the back of GDP growth of 12%-14%, a
demographic profile that will attract more savers, and increasing awareness. A strong
brand, distribution network (preferably banks) and scale are key success factors for
companies in this segment. At present, about 50% of Aegon Religare’s business is driven
by agents/corporate agents. Religare does not have a tie-up with banks as most banks
have tied up with large companies and it is difficult to dislodge existing contracts.
Religare is focusing on cross-selling the insurance products through its retail securities
and lending arm. Regulatory changes on traditional product could be an added risk.
Valuation: We value AEGON Religare at Rs39 per share, using the appraisal value
method, which is embedded value (EV) + 16X new business value (NBV). This is higher
than the 14X NBV we assume for the larger/established life insurers, while assuming
ARLI’s new business (NBAP) margins at par with these peers at 12%.
Religare Asset Management – Sound strategy, challenges galore
In October 2008, Religare AMC bought Lotus AMC (with AUM of around Rs35 bn, of which
60% was in debt) facing huge redemption pressures, which shrank by 70%+ by Feb ‘2009.
Of the total current AUM, 92% is in debt funds. Religare AMC is attempting to differentiate
its business model by sharper focus on profitability versus growth by (1) focusing on
independent financial advisors (IFAs) contributing 70% of volumes vs. 40% at the industry
level, (2) paying lower upfront commissions versus trail payouts to discourage churn, and
(3) focusing on the Tier-II and III cities. The execution of this strategy remains challenging
for Religare AMC given (1) abolition of entry load by the regulator SEBI from August 2009
hurting growth due to cut in distributor commissions, (2) relatively higher commissions
paid by larger industry participants, (3) lower brand visibility and, (4) limited track record.
The peak capital commitment is Rs1 bn, of which Rs100 mn-Rs120 mn remains to be
drawn down (likely in April 2011). Management expects to achieve break-even by FY12E
and is also looking to garner off-shore AUM and offer portfolio management services to
the HNI segment to supplement income. We have valued RAMC at 3.5% of FY11E AUM (in
recent transaction, LIC Mutual Fund was valued at about 2%).
Religare Global Asset Management – Too early to say
The journey so far: Religare Global Asset Management (RGAM) intends to
opportunistically acquire strategic stakes in asset managers across products/geographies.
Subsequently, RGAM would provide a common distribution platform for these asset
managers, while giving complete autonomy to the existing professionals to continue
managing the Fund (s). During FY09-FY10, RGAM has acquired strategic stake in two
investments managers – Northgate (70%) and Landmark (c.55%). The aggregate
investment made is US$258 mn (about Rs12.2 bn – 17% of RELG’s current market cap), of
which US$78 mn (about Rs3.5 bn) is equity investment, implying a gearing level of 2.3X
for RGAM. Significant cost synergies or growth in AUM would be crucial for the business
to turn profitable, which may be further delayed by new alliances/acquisitions.
Catalysts/challenges: Religare's ability to provide value-add to these specialist asset
managers is constrained by its nascent franchise and limited resonance as a global &
financial services brand. In addition, extracting any cost synergies across funds through
the common distribution platform would take time to accrue, if successful. Further,
incentivizing the investment professionals to continue running the fund may pose a
challenge, if they have encashed a significant portion of their stake. RGAM indicated it has
long-term lock-in contracts with the professionals ranging from 10-12 years.
Valuation: Given the nascent and investment stage of the business, we have valued
RGAM at equity investment made, amounting to Rs22 per share (4% of GS target price)
India Equity Research Reports, IPO and Stock News
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Sell
Religare Enterprises (RELG.BO)
Return Potential: 3% Equity Research
Long-term potential offset by immediate challenges; Initiate at Sell
Source of opportunity
We initiate on Religare Enterprises (RELG.BO) with a Sell (12-m price target of
Rs500, about 3% potential upside) for three reasons: (1) we believe the riskreward is more favorable in other banking stocks, (2) we see a lack of catalysts
in RELG’s traditional businesses – retail broking and lending business given
rising interest rates. (3) The new businesses (investment banking, institutional
broking, global asset mgmt.) are likely to see a revenue lag as they are in
investment mode. Our blue-sky scenario analysis indicates potential upside
could be 65%, with valuation rising to Rs800/ share, but this is: a) subject to
high execution risk; and b) unlikely to be realized within three years.
Catalyst
(1) Lower equity market volumes (RELG market share in cash is 4.5%): Jan
2011 market volumes down to US$3.7 bn a day from US$4.5 bn in
September 2010; (2) Further hike in interest rates, which could impact
growth potential and spreads in the lending business. Our ECS team
expects RBI to raise interest rates by another 75 bps in 2011, over and
above the 150 bps in 2010.
Valuation
Using CAMELOT and sum-of-the-parts, our 12-m price target for RELG is
Rs500/share, which implies around 3% upside from here. We initiate
coverage on RELG with a Sell rating given limited upside to target price vs.
other stocks in our coverage (27%-44% for Buys and 21%-32% for Neutralrated stocks). RELG is trading at 2.6X P/B FY2012E on a consolidated basis.
Key risks
1) Buoyant capital markets could lead to higher profit in broking/
investment banking; (2) lower inflation and easing rates will be positive for
growth and spreads in lending business; and (3) better-than-expected
execution, specifically in the lending and investment banking/ institutional
broking businesses, could translate into stronger earnings.
Overview: Traditional businesses face near-term headwinds; new
businesses in investment mode
While still in its nascent stage, Religare Enterprises (‘RELG’ or ‘Religare’) offers exposure
to India’s under-penetrated financial services industry. Religare’s businesses span across
most financial services products, including lending, brokerage and insurance products.
The company’s traditional businesses of retail broking and lending are generating profit
and will likely benefit long term from growing equity market volumes and lower
penetration in the mortgages business. However, these businesses face the challenge of
volatile and weak capital markets and rising lending rates in the near term. The new
businesses – investment banking, institutional broking, asset management (India and
overseas), and health insurance – are in investment mode and would require 2-4 years in
our view to be EPS-accretive, given the lack of scale, execution challenges, limited brand
resonance and the current unfavorable macro-economic environment. We estimate an
incremental capital requirement of about Rs25 bn across subsidiaries (40% of current
market cap, 97% of FY10 net worth) in order to meet the company’s expansion plans.
Our CAMELOT and SOTP-based price target is Rs500, which implies 3% upside from
current levels. On a relative basis this is lower than the 27%-44% potential upside in our
Buy-rated stocks and around 21%-32% potential upside in our Neutral-rated stocks. We
thus find investment in Religare relatively less attractive vs. our coverage universe and
initiate coverage on RELG with a Sell rating. A key risk to our estimate could arise from
successful execution of its lending and institutional brokerage business, which could
surprise on the upside. Our blue-sky scenario extrapolating revenues for lending/
institutional broking businesses beyond FY13 indicates a valuation 65% higher than
current price, for investors with a longer investment horizon and/or much higher risk
appetite. But given the headwinds of a higher interest rate environment/ muted trading
volumes over our 1 year price target horizon we believe there is better value in our Buyrated stocks (IndusInd Bank, Yes Bank, Bank of Baroda, Punjab National Bank and ICICI
Bank).
Better risk reward in other stocks
We initiate coverage on RELG with a Sell rating and a 12-month target price of Rs500,
indicating limited potential upside of about 3% from current levels. Key reasons:
Traditional businesses – lack near-term catalysts: While we believe that the longterm prospects for the lending and brokerage (4% market share) businesses are strong,
we believe Religare will face near-term challenges that could subdue stock price
performance. In brokerage, industry volumes are down 20%-26% in 1HFY2011 and will
likely remain subdued/down given the rising interest rate environment. In the lending
business too, we think Religare will face challenges: (1) We believe Finvest will find it
difficult to lever up significantly given the newness of its businesses, and will need to
infuse about Rs12 bn capital in FY12 to maintain a leverage ratio below 6X. (2) Banks are
better positioned in the lending business given access to low-cost deposits and large
network, (3) Rising interest rates over the last year (CP/CD rates up 300bp-500bp) could
pressure on lending spreads – we forecast 5% in FY13 vs. 6.5% in FY10. Our ECS team
expects at least another 75bps rate hike during 2011. This could impact the company’s
ability to achieve its 14%-15% RoE target over the next two years.
Revenues to lag in new businesses: Religare has recently started expanding into new
businesses including insurance, institutional brokerage, and investment banking. The
build-out phase across subsidiaries has led to employee strength increasing 1.9X to
around 8,500 over FY07-H1FY11, including key senior management across the
subsidiaries. While the dedicated management teams bring the requisite experience to
these nascent companies, we believe revenues would accrue gradually, given the
gestation period, lack of scale and execution risk (limited brand resonance, people
retention, likely culture conflicts on inorganic growth). However, cost ratios would remain
high given the build-out. We estimate total cost/ net income rising to 91% in FY11 vs. 81%
in FY10, before trending down to 81% by FY13.
Capital infusion estimated at Rs25 bn (around 38% of current market cap): So far,
RELG has infused Rs26 bn (about US$545 mn) of capital over FY07-FY10 (around 98% of
FY10 net worth; around 38% of market cap) across subsidiaries. As per our estimates,
additional capital requirement over H1FY11- FY13 would be similar at about Rs25 bn
(about US$540 mn) – around 97% of FY10 net worth; 38% of current market cap).Of the
total capital requirement, we estimate about 46% will be needed in the lending business
(to avoid constraining growth) and another 24% and 12% by the life insurance and
investment banking/institutional broking businesses, respectively. As we do not build
capital issuance into our estimates at the RELG level, our consolidated earnings are
subdued by higher interest expenses. We estimate RELG to deliver a 26% CAGR in
consolidated earnings over FY10-13 and RoE of 6.9% by FY13.
Relatively more upside in banking stocks: Our SOTP-based price target for RELG is
Rs500, which implies about 3% upside from current levels. On a relative basis this is lower
than the current 27%- 44% potential upside in our Buy-rated stocks and 21%-32% potential
upside in our Neutral-rated stocks. We thus find investment in Religare relatively less
attractive vs. our coverage universe and initiate coverage on RELG with a Sell rating. In
addition to seeing better value propositions elsewhere, we believe RELG’s value
unlocking will take time given that the company has to demonstrate a successful
execution of its strategy, with a number of its key businesses still in the evolution phase,
lack of strong brand, and challenges arising from the integration of several acquisitions in
a short span (including cultural differences). In addition, the recent strategic difficulties of
Reliance Capital and Anand Rathi’s institutional businesses could mean the market will
prefer to assign a higher value for RELG as and when there is more earnings visibility.
Valuation
RELG was listed in November 2007, and is currently trading at 2.6X FY12E P/B. Its average
trading band has been between 1.8X and 2.4X P/BV since listing. Our 12-month CAMELOT
and SOTP-based price target is Rs500, which implies a 2.7X FY12E P/B. As RoEs improve
and management delivers on expected lines, the stock has potential to re-rate. However,
given the several challenges involved we think the stock is likely to remain range-bound,
as confidence in the management’s strategy and execution ability are only likely to
emerge gradually.
Blue-sky scenario – Upside risk
A better-than-expected execution, a turnaround in the macro-economic environment and
buoyancy in capital markets can lead to upside risk to our estimates and valuation.
Despite the company’s management past credentials, we would prefer to be reactive to
stronger traction/ execution on the nascent business – specifically investment banking/
institutional broking – given the experience with other new entrants who have failed with
similar strategies, and also given that 90%+ of RELG’s investment banking fees are
currently from Group transactions. Nonetheless, for investors with horizon beyond 2-3
years and higher risk appetite, RELG could potentially offer structural exposure to India’s
under-penetrated financial services segment.
Within this context we have projected a blue-sky scenario, wherein the swing factor is
valuation for the investment banking/ institutional broking business. Potentially strong
capital markets and execution could likely impute into a step change in earnings beyond
FY13 for the currently loss-making investment banking/ institutional broking businesses
(RCML), resulting in a value of Rs223 per share based on the present value of 15X FY15E
EPS. Our blue-sky SOTP-based valuation for Religare is Rs800per share, which implies
65% potential upside from current levels.
Significant industry potential, will RELG manage to capitalize?
RELG has historically been a retail broker. Since FY07, the company has been adding
businesses through both organic and inorganic routes. Over the period, about Rs26 bn
(US$540 mn; 37% of current market capitalization) has been invested across subsidiaries,
with the Indian promoters (Malvinder Singh and Shivinder Singh, better known as the
promoters of Ranbaxy Laboratories) having added about Rs22.5 bn additional capital over
FY2007-FY2010. As of December 2010, the promoters own a 66% stake in Religare, with
FIIs holding <2% (approved limit of 40%).
Diversified exposure to Indian financial services industry: Over FY06-FY10,
Religare Enterprises (RELG) has diversified from its prior focus on retail broking to asset
lending, asset management, life insurance, investment banking, institutional broking and
alternative assets. Broking-related income has declined from about 60% of consolidated
revenue in FY07 to about 40% in FY10.
Strong growth potential
Penetration levels across financial service segments in India remain low, translating into a
huge opportunity for Religare as it builds out operations across segments. We forecast
robust CAGR of 9%-75% across key growth drivers over FY11-13 for RELG’s subsidiaries
in the context of strong economic activity, low penetration levels and a low base effect.
We expect growth will be driven by the lending business with loan CAGR of 48% over
FY11-13. The other key businesses – retail broking and capital markets – are likely to
experience some cyclicality given volatile capital markets. On the other hand, life
insurance and asset management face regulatory constraints at an industry level, while
we expect Religare to show traction from its current low base
Stock options (ESOPs) issued to attract/incentivize/retain employees:
To align and incentivize management interests, over September 2010-December 2010,
RELG has issued ESOPs to employees across businesses. Further, to align interests of
subsidiary business heads to Religare as a whole, 50% of each employee’s ESOPs is
cross-linked to Religare Enterprises – the holding company. Investment
banking/institutional broking (Religare Capital markets) has the highest percentage of
ESOPs among the subsidiaries at 25% of outstanding share capital (Exhibit 23). The
vesting schedule is one-third over three years for all subsidiaries except Religare AMC,
with a longer vesting schedule of 20%/30% and 50% and Religare Capital markets, which
remains to be finalized.
Investment mode to keep a lid on returns generated over the next
few years
Given Religare’s current build-out, we expect a lag between revenues and expenses over
FY11-FY13. We estimate Religare Capital Markets (investment banking/ institutional
broking) will break-even beyond FY13, with consolidated return ratios remaining subdued,
before improving to an RoA of 0.8% and RoE of 6.9% by FY13. Importantly, our estimates
do not factor equity issuance at REL level, resulting in higher interest expenses/ lower
RoEs.
Key challenges
While the potential across the financial services industry is substantial, whether Religare
will manage to capitalize on this potential remains to be seen. We believe RELG faces
several execution challenges in delivering profitable growth across subsidiaries, such as:
In the inception phase: Most of RELG’s businesses (such as institutional broking,
investment banking, and life insurance) are 2-3 years old, implying a long gestation
period and also lack of scale.
No significant unique proposition/ limited brand franchise: While we expect the
financial services pie to grow, the commoditized nature of the businesses magnifies
challenges for RELG from its either being a late entrant, or seeing high competition from
incumbents and/or having limited ability to innovate/ carve a niche.
Required capital investment to postpone returns: Continued need for capital infusion
as some businesses are capital heavy (for example –lending) while others such as
investment banking/institutional broking may take 3-4 years to turn profitable.
Too much too soon: While each of these businesses has its own management team,
Religare runs the risk of diluting focus/returns by venturing into multiple business
segments in a short span.
Potential synergies would take time to accrue: While some strategic challenges remain
at each subsidiary’s level, RELG’s integrated approach should result in synergies primarily
through cost advantages and cross-selling benefits.
Regulatory risk: Financial reforms/ changing regulations have had a significant impact,
specifically for the asset management and life insurance industry. Marginal industry
participants such as Religare may face consolidation pressures in the context of
suppressed profitability and near-term growth.
Religare Finvest – Strong growth but spreads could see pressure
Opportunity: India’s loan to GDP ratio remains low relative to developing/developed
markets. Thus, the banking sector has delivered 22% CAGR over FY00-FY10 (Exhibit
27). Religare Finvest (‘Finvest’) primarily provides loans to the self-employed segment,
typically with a 2-3 year track record. During FY08-10, the loan book CAGR has been
strong at 96% from a low base. From a previous focus on loans against shares to the
retail segment, the product mix has been diversified with about 50% from assetbacked lending (mortgages, commercial assets and SME loans) as of September 2010.
During Q2FY11, Finvest re-organized to decentralize operations (collections, credit
appraisal and marketing) region-wise to shorten turnaround time. Management has
guided loan book to grow to Rs250 bn over the next four-five years (driven by
secured business), buoyed by expansion from the current 23 locations to 36 by May
2011 and doubling the sales force from 1,200 to 2,500. We are building in loan CAGR
of about 50% over FY11-FY13 in Finvest.
Key risks/ challenges – profitability to be delayed given economic environment:
(1) Wholesale-funded, spike in interest rates: We believe Finvest could see pressure
on spreads (assumed at 5% in FY13 vs. 6.5% in FY10), marginally offset by
improvement in credit rating (from LA+ as of March 2010 to LAA- as of Sept 2010),
given the sharp 400-500 bp rise in short-term rates, and the inherent disadvantage
when competing with banks with their strong low-cost liability franchises. (2) Gross
NPLs declined from 1.1% in FY09 to 0.22% as of September 2010 (due to unsecured
personal loans). High growth in loan book and rising rates may lead to a rise in NPLs
given new systems and processes.
Valuation: We have valued Finvest using our CAMELOT-based model at Rs261/ share
(52% of our RELG target price), implying 1.4X FY12E P/B, and assuming an ROE of
15% in the high-growth stage.
Religare Securities – Well-poised but trading volumes a key vector
Opportunity: Religare Securities (‘RSL’ - a 100% subsidiary of RELG), started off as
the primary business of RELG focusing on the retail segment. RSL’s peak market
share was about 4% in FY08. Management has indicated current market share of
around 5% in the retail segment and 8% in the retail cash segment, which we were
unable to verify given limited available data. After adopting an aggressive price entry
strategy to offer broking services to all clients since November 2010, the new
management intends to focus on sourcing profitable customers, and have thus raised
brokerage rates. While the owned branch network contributes about 88% of total
business for RSL, going forward, management has guided share of franchisees/
banks would rise to 18%-20%. Management also appears focused on reducing costs –
both acquisition and administration. The company is attempting to differentiate its
proposition through research on mid-cap and small companies, while also crossselling life insurance and mutual funds.
Catalysts/ risks: In our view, there are no near-term catalysts for RELG’s relatively
mature retail broking business, given the competitive environment and muted cash
volumes. Industry cash turnover fell 20%-26% in Q1FY11-Q2FY11, and we estimate
11% yoy decline in FY11 and 8% yoy growth in FY12. The share of cash volumes has
consistently declined from around 40% in FY05 to 14% as of Q3FY11. Also, retail
participation on NSE is now at 50% of total vs. 60% in FY08. Nonetheless, growth
potential remains strong given the low household ownership in equities at 2.6%,
despite the high savings ratio of 20%. However, the Indian broking industry is
competitive with the top 25 brokers having 40% of the market share (Exhibit 42).
Valuation: Based on comparative valuation multiples (Exhibit 7), we have valued the
business at 15X FY12E P/E to Rs79/ share, which contributes 16% of RELG’s GSe
target price.
Key risks: (1) Continued low trading volumes, specifically in the high-yield cash
segment, (2) Capital market volatility/correction.
Religare Capital Markets – conceptually good, but EPS-accretive?
The journey so far: Subsequent to the acquisition of Hichens Harrison in 2008, Religare
Capital markets (RCML) was incorporated with a merchant banking license. So far, the
bulk (about 90%) of the revenue has been generated through in-house/ group transactions.
RELG plans to set up an emerging markets investment bank, with India continuing to hold
about 70% of the revenue pie. To expedite rollout in terms of research footprint and
client-empanelments, three more entities have been acquired over Q3FY11 (Exhibit 49).
RCML intends to roll out operations in 7 countries: Brazil, Russia, South Africa, Hong
Kong, Thailand, Malaysia and Indonesia.
Challenges/ catalysts: Evidently, RCML is in an investment phase and the new teams
still have to start delivering, which, along with the company’s inorganic growth strategy,
makes it difficult to estimate the likely profit trajectory. Religare’s limited brand franchise
would make it more challenging to source investment banking deals/ gain traction with
institutional clients in the competitive industry. While about 25% of outstanding share
capital in the company has been doled out in stock options (ESOPs) to attract and
incentivize employees, retaining key people after the lock-in expires would be a key
determinant of the company’s success. RELG has adopted an inorganic growth strategy,
which poses additional integration/culture challenges, in our view. Management is
confident of no conflicts arising, given the small size of teams in the acquired entities. Of
the recent new entrants, Reliance Capital and Anand Rathi adopted a similar strategy of
hiring experienced people from bulge bracket banks/brokers, but failed to retain them,
while India Infoline appears to have been successful in gaining business traction. Despite
the execution challenges and limited track record, we are building comparable
income/expenses for RCML vs. more established peers.
Valuation: RCML is likely to remain in investment mode and not generate profits over the
next few years. We have valued the business at 1X FY12E P/B (vs. 1X-1.5X FY12E for the
listed/ more established peers) to arrive at Rs56 per share (11% of RELG’s GS target price).
AEGON Religare Life Insurance – Downside protected
The journey so far: AEGON Religare Life Insurance (ARLI) started operations in July 2008
and has a market share in APE (annualized premium equivalent) of 0.4%. Religare owns
44% stake in the life insurance business with the balance 26% held by AEGON
(headquartered in Netherlands) and another 30% by Bennett and Coleman (part of India’s
Times Group). ARLI is in its inception phase, and is building up its distribution network
(currently around 120 branches and 9,000 agents). Given the lack of a banc-assurance tieup, ARLI is focusing on distributing through agents, group network (specifically in Tier-II
cities) and alternative channels such as the Internet. Management intends to focus on the
unit-linked segment and has indicated new business (NBAP) margins to be 10%-11%, post
the new guidelines for life insurers. So far, Rs2.5 bn capital has been invested in the
subsidiary. Based on terms negotiated with AEGON, Religare has downside protection in
the business, with 12% guaranteed return per annum on its capital invested. Going
forward, in the event of a listing, Religare will get the higher of 12% or market determined
return. Thus, Religare currently writes back its share of the surplus/deficit in the life
insurance business in the consolidated profit and loss account.
Catalysts/challenges: We believe that the industry insurance premium will likely grow at
around 15-18% over the next couple of years on the back of GDP growth of 12%-14%, a
demographic profile that will attract more savers, and increasing awareness. A strong
brand, distribution network (preferably banks) and scale are key success factors for
companies in this segment. At present, about 50% of Aegon Religare’s business is driven
by agents/corporate agents. Religare does not have a tie-up with banks as most banks
have tied up with large companies and it is difficult to dislodge existing contracts.
Religare is focusing on cross-selling the insurance products through its retail securities
and lending arm. Regulatory changes on traditional product could be an added risk.
Valuation: We value AEGON Religare at Rs39 per share, using the appraisal value
method, which is embedded value (EV) + 16X new business value (NBV). This is higher
than the 14X NBV we assume for the larger/established life insurers, while assuming
ARLI’s new business (NBAP) margins at par with these peers at 12%.
Religare Asset Management – Sound strategy, challenges galore
In October 2008, Religare AMC bought Lotus AMC (with AUM of around Rs35 bn, of which
60% was in debt) facing huge redemption pressures, which shrank by 70%+ by Feb ‘2009.
Of the total current AUM, 92% is in debt funds. Religare AMC is attempting to differentiate
its business model by sharper focus on profitability versus growth by (1) focusing on
independent financial advisors (IFAs) contributing 70% of volumes vs. 40% at the industry
level, (2) paying lower upfront commissions versus trail payouts to discourage churn, and
(3) focusing on the Tier-II and III cities. The execution of this strategy remains challenging
for Religare AMC given (1) abolition of entry load by the regulator SEBI from August 2009
hurting growth due to cut in distributor commissions, (2) relatively higher commissions
paid by larger industry participants, (3) lower brand visibility and, (4) limited track record.
The peak capital commitment is Rs1 bn, of which Rs100 mn-Rs120 mn remains to be
drawn down (likely in April 2011). Management expects to achieve break-even by FY12E
and is also looking to garner off-shore AUM and offer portfolio management services to
the HNI segment to supplement income. We have valued RAMC at 3.5% of FY11E AUM (in
recent transaction, LIC Mutual Fund was valued at about 2%).
Religare Global Asset Management – Too early to say
The journey so far: Religare Global Asset Management (RGAM) intends to
opportunistically acquire strategic stakes in asset managers across products/geographies.
Subsequently, RGAM would provide a common distribution platform for these asset
managers, while giving complete autonomy to the existing professionals to continue
managing the Fund (s). During FY09-FY10, RGAM has acquired strategic stake in two
investments managers – Northgate (70%) and Landmark (c.55%). The aggregate
investment made is US$258 mn (about Rs12.2 bn – 17% of RELG’s current market cap), of
which US$78 mn (about Rs3.5 bn) is equity investment, implying a gearing level of 2.3X
for RGAM. Significant cost synergies or growth in AUM would be crucial for the business
to turn profitable, which may be further delayed by new alliances/acquisitions.
Catalysts/challenges: Religare's ability to provide value-add to these specialist asset
managers is constrained by its nascent franchise and limited resonance as a global &
financial services brand. In addition, extracting any cost synergies across funds through
the common distribution platform would take time to accrue, if successful. Further,
incentivizing the investment professionals to continue running the fund may pose a
challenge, if they have encashed a significant portion of their stake. RGAM indicated it has
long-term lock-in contracts with the professionals ranging from 10-12 years.
Valuation: Given the nascent and investment stage of the business, we have valued
RGAM at equity investment made, amounting to Rs22 per share (4% of GS target price)
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