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• Initiate with OW, Mar-12 PT of Rs740: Reliance Capital, which runs
India's largest MF and a top-5 lifeco, is a quintessential bull-market
stock. Valuations have now turned reasonable and the individual
businesses are turning profitable. The recent Nippon Life deal validates
the model and relieves balance sheet stress.
• Insurance – the worst is over. The post-September meltdown affected
RCAP asymmetrically, but we see the internal restructuring efforts and
fresh product focus bearing fruit in FY12. Margins will probably
stabilize at ~12% and growth should turn positive in 2HFY12. The
Nippon Life deal raises credibility and could provide a critical capital
buffer.
• Peripheral businesses turning around. The turnaround is proceeding
well, and we expect consolidated PAT CAGR growth of 27% FY10-13.
Growth opportunities in the niche businesses are a bit constrained, but
this isn’t a near term issue given the low base. There are regulatory
upsides too - the AMC has seen the worst on regulatory pressures, and
there could be positive movement on bank licensing too.
• Key catalysts: a) Consummation of the Nippon Life deal in 1HFY12, b)
RBI announcements on bank licenses in 1QFY12, c) sales momentum
returning to insurance in 2HFY12 and mutual funds in 2QFY12.
• Valuation, key risks: Our SOTP valuation of Rs 740/share – Our
lifeco valuation is significantly below Nippon Life’s, adjusting
downward for the strategic premium. The other businesses are pegged at
peer or acquisition valuations, and implies a reasonable 12.6x PER on
FY13(ex-insurance).We estimate (page 26) the option value of a bank
licence at Rs 153/share, but have not captured that in valuations. A key
risk is that the story and valuation rests to a degree on strong
markets. 55% of RCap’s value comes from businesses (life and mutual
fund) that depend on buoyant stock markets, raising its beta. The opaque
structure of the lifeco holding and the large investment book are the other
risks. The holdco structure, necessitating SOTP valuations, also deters
many investors.
Investment Summary
We initiate coverage on Reliance Capital with Overweight rating and a sum-ofparts
price target of Rs 740 (Mar-12). Our key arguments are:
SOTP value of Rs 740/share
Our lifeco valuation is significantly below Nippon Life’s, adjusting downward for
the strategic premium. The other businesses are pegged at peer or deal valuations,
and implies a reasonably 12.6x PER on FY13. The complex structure is a deterrent,
but the underlying valuations are quite attractive.
Insurance – the worst is over
• We expect the monthly WRP sales to contract (oya) through to September, before
a sharp turnaround as the base effect kicks in. The high base for Apr-Sep drives
our flat volumes estimate (FY12) – well below the 15% management target.
• RCap’s internal restructuring on costs and processes should start paying off in
FY12. Its focus on traditional products (~50% of sales, Oct-Feb) should put
pressure on ticket sizes and overall volumes. We think this strategy will pay off
for RCap, given its focus on smaller towns and lack of access to banking
distribution channels.
• Our NBAP margin assumption, at 13%, is more conservative than RCap’s current
run-rate of 18.0%. Our haircuts are driven by a higher tax rate, incremental
pricing pressure and concerns on persistency.
• The Nippon Life deal brings a few positives - a) much-needed capital and the
operating company and holdco levels b) validation of the business model c) some
levels of technical support in product structuring and agency management, given
Nippon Life’s skills in the traditional business. We are not using the deal value
for our price estimate, given the strategic premium involved.
Peripheral businesses turning around
The recovery is proceeding well, and we expect consolidated PAT CAGR growth of
23% FY10-13. Growth opportunities in the niche businesses are a bit constrained,
but this isn’t a near term issue given the low base. There are regulatory upsides too -
the AMC has seen the worst on regulatory pressures, and there could be positive
movement on bank licensing too.
Retail assets
The retail assets business is benefiting from greater discipline enforced in the last
two years. The cornerstones of this business are:
• The book has been significantly derisked. Loan growth has been curtailed to
~30% (allowing it to exit businesses that overheat) and unsecured lending totally
eliminated.
• It remains a niche lender, focusing on vehicle financing, mortgages to the selfemployed
and various SME sub-categories. The key competitive advantage is
skills in assessing credit for small businesses and the self-employed. It’s a timeconsuming
and labor-intensive process, which we believe will work only if
growth is kept under control (hence not scalable). Under those circumstances,
risk-adjusted returns are high.
Asset Management
The last leg of adverse regulation is done, with the closing out of tax arbitrage
headwinds in the Budget. We think AUM will now start to growth, with the
upheavals in the distribution business now over. We expect Equity AUMs to grow at
20-25% (including market action) over the next 2-3 years, and a PAT growth of 24%
to match.
Reliance Money
The key driver of Reliance Money’s growth will be third-party distribution of
products - gold coin sales through India Post, NPS origination as well as insurance
and MFs. The retail brokerage business is consolidating – the upside from recent
technology investments should be visible in FY12. We expect PAT to grow by ~80%
FY10-13E.
This, again, is a niche business – picking out areas with significant entry barriers.
The main competitive advantage of Reliance is the ability to build low-cost and
sticky distribution, as well as the India Post distribution tie-up which supports the
overall business.
Valuation and share price analysis
Our SOP based Mar-12 price target is Rs740/share, implying a 27% upside from
current levels. Life insurance, AMC and retail assets contribute >70% of the total
valuations. Our PT implies ~13.0x FY13 profits ex life insurance business.
Valuation based on SOP: We have valued Reliance Capital on a sum-of-the-parts
basis as most of the businesses have different operating metrics. Some of the
subsidiaries would break even over FY13-14 and hence earnings and cashflow would
not adequately reflect the business potential. Based on our SOP, Insurance and AMC
business contribute ~52% of the total valuation for Reliance Capital. On a
consolidated basis there is strictly no comparable for Reliance capital but our
valuation for many other businesses are based on relative valuation of peers in the
industry and are more conservative.
Valuation without any holding company discount: We have not applied a holdco
discount to RCap, as these businesses are an integral part of RCap’s overall business
strategy, with operating control at the parentco level. They are structured into
subsidiaries largely for regulatory reasons. This is not the case for ICICI and
HDFC’s lifecos, which operate as independent board-run firms. Our treatment of
RCap is similar to that of Kotak and IDFC, which we value on consolidated earnings
and implicitly ignore holdco discounts.
Reliance Capital: Investment in subsidiaries and excess capital (In Rsbn)
FY11E Networth 80.9
Investment in subsidiaries
Life insurance for 74% stake (adjusted for stake sale to Nippon Life) 22.9
General Insurance 11.0
Reliance Money 8.0
Others 4.0
Lending business at 16% CAR 18.7
Total capital required 64.6
Excess Capital 16.3
Source: Company, J.P.Morgan estimates
Key risks
RCap directly holds only 16% of the lifeco and the rest through a web of
subsidiaries. The opaque structure is the key risk – others are a) 55% of RCap’s value
comes from market-dependent businesses (life and mutual fund) b) the large
investment book and c) the holdco structure and varying businesses.
Opacity of insurance holding
RCap holds only 16% of Reliance Life directly – the rest is held via a complex web
of subsidiaries. We operate on the assumption that RCap has 100% beneficial interest
in the lifeco, based on management assurances. There is a risk of tax incidence on
unwinding the structure, which we have not captured.
Dependence on markets
55% of RCap’s value comes from businesses (life and mutual fund) that depend on
buoyant stock markets. Both the life and mutual fund see increased sales when
markets accelerate, and the history of broking stocks in India suggest that multiple
expands at the same time. This significantly increases the beta of the stock, and it
tends to outperform rising markets and underperform falling ones.
Diverse business structure
The diverse business mix, necessitating a holdco structure, is a deterrent for many
investors. This may create a permanent holds’ discount, and cap the rerating of the
stock beyond a point.
Large prop book
RCap has historically run a large prop-book of investments, including in group
companies. Management has addressed this and the dependence of prop book profits
has reduced from 95% in FY08 to ~28% in FY11. This does raise the risk profile,
especially given the large capital needs of the operating businesses
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
• Initiate with OW, Mar-12 PT of Rs740: Reliance Capital, which runs
India's largest MF and a top-5 lifeco, is a quintessential bull-market
stock. Valuations have now turned reasonable and the individual
businesses are turning profitable. The recent Nippon Life deal validates
the model and relieves balance sheet stress.
• Insurance – the worst is over. The post-September meltdown affected
RCAP asymmetrically, but we see the internal restructuring efforts and
fresh product focus bearing fruit in FY12. Margins will probably
stabilize at ~12% and growth should turn positive in 2HFY12. The
Nippon Life deal raises credibility and could provide a critical capital
buffer.
• Peripheral businesses turning around. The turnaround is proceeding
well, and we expect consolidated PAT CAGR growth of 27% FY10-13.
Growth opportunities in the niche businesses are a bit constrained, but
this isn’t a near term issue given the low base. There are regulatory
upsides too - the AMC has seen the worst on regulatory pressures, and
there could be positive movement on bank licensing too.
• Key catalysts: a) Consummation of the Nippon Life deal in 1HFY12, b)
RBI announcements on bank licenses in 1QFY12, c) sales momentum
returning to insurance in 2HFY12 and mutual funds in 2QFY12.
• Valuation, key risks: Our SOTP valuation of Rs 740/share – Our
lifeco valuation is significantly below Nippon Life’s, adjusting
downward for the strategic premium. The other businesses are pegged at
peer or acquisition valuations, and implies a reasonable 12.6x PER on
FY13(ex-insurance).We estimate (page 26) the option value of a bank
licence at Rs 153/share, but have not captured that in valuations. A key
risk is that the story and valuation rests to a degree on strong
markets. 55% of RCap’s value comes from businesses (life and mutual
fund) that depend on buoyant stock markets, raising its beta. The opaque
structure of the lifeco holding and the large investment book are the other
risks. The holdco structure, necessitating SOTP valuations, also deters
many investors.
Investment Summary
We initiate coverage on Reliance Capital with Overweight rating and a sum-ofparts
price target of Rs 740 (Mar-12). Our key arguments are:
SOTP value of Rs 740/share
Our lifeco valuation is significantly below Nippon Life’s, adjusting downward for
the strategic premium. The other businesses are pegged at peer or deal valuations,
and implies a reasonably 12.6x PER on FY13. The complex structure is a deterrent,
but the underlying valuations are quite attractive.
Insurance – the worst is over
• We expect the monthly WRP sales to contract (oya) through to September, before
a sharp turnaround as the base effect kicks in. The high base for Apr-Sep drives
our flat volumes estimate (FY12) – well below the 15% management target.
• RCap’s internal restructuring on costs and processes should start paying off in
FY12. Its focus on traditional products (~50% of sales, Oct-Feb) should put
pressure on ticket sizes and overall volumes. We think this strategy will pay off
for RCap, given its focus on smaller towns and lack of access to banking
distribution channels.
• Our NBAP margin assumption, at 13%, is more conservative than RCap’s current
run-rate of 18.0%. Our haircuts are driven by a higher tax rate, incremental
pricing pressure and concerns on persistency.
• The Nippon Life deal brings a few positives - a) much-needed capital and the
operating company and holdco levels b) validation of the business model c) some
levels of technical support in product structuring and agency management, given
Nippon Life’s skills in the traditional business. We are not using the deal value
for our price estimate, given the strategic premium involved.
Peripheral businesses turning around
The recovery is proceeding well, and we expect consolidated PAT CAGR growth of
23% FY10-13. Growth opportunities in the niche businesses are a bit constrained,
but this isn’t a near term issue given the low base. There are regulatory upsides too -
the AMC has seen the worst on regulatory pressures, and there could be positive
movement on bank licensing too.
Retail assets
The retail assets business is benefiting from greater discipline enforced in the last
two years. The cornerstones of this business are:
• The book has been significantly derisked. Loan growth has been curtailed to
~30% (allowing it to exit businesses that overheat) and unsecured lending totally
eliminated.
• It remains a niche lender, focusing on vehicle financing, mortgages to the selfemployed
and various SME sub-categories. The key competitive advantage is
skills in assessing credit for small businesses and the self-employed. It’s a timeconsuming
and labor-intensive process, which we believe will work only if
growth is kept under control (hence not scalable). Under those circumstances,
risk-adjusted returns are high.
Asset Management
The last leg of adverse regulation is done, with the closing out of tax arbitrage
headwinds in the Budget. We think AUM will now start to growth, with the
upheavals in the distribution business now over. We expect Equity AUMs to grow at
20-25% (including market action) over the next 2-3 years, and a PAT growth of 24%
to match.
Reliance Money
The key driver of Reliance Money’s growth will be third-party distribution of
products - gold coin sales through India Post, NPS origination as well as insurance
and MFs. The retail brokerage business is consolidating – the upside from recent
technology investments should be visible in FY12. We expect PAT to grow by ~80%
FY10-13E.
This, again, is a niche business – picking out areas with significant entry barriers.
The main competitive advantage of Reliance is the ability to build low-cost and
sticky distribution, as well as the India Post distribution tie-up which supports the
overall business.
Valuation and share price analysis
Our SOP based Mar-12 price target is Rs740/share, implying a 27% upside from
current levels. Life insurance, AMC and retail assets contribute >70% of the total
valuations. Our PT implies ~13.0x FY13 profits ex life insurance business.
Valuation based on SOP: We have valued Reliance Capital on a sum-of-the-parts
basis as most of the businesses have different operating metrics. Some of the
subsidiaries would break even over FY13-14 and hence earnings and cashflow would
not adequately reflect the business potential. Based on our SOP, Insurance and AMC
business contribute ~52% of the total valuation for Reliance Capital. On a
consolidated basis there is strictly no comparable for Reliance capital but our
valuation for many other businesses are based on relative valuation of peers in the
industry and are more conservative.
Valuation without any holding company discount: We have not applied a holdco
discount to RCap, as these businesses are an integral part of RCap’s overall business
strategy, with operating control at the parentco level. They are structured into
subsidiaries largely for regulatory reasons. This is not the case for ICICI and
HDFC’s lifecos, which operate as independent board-run firms. Our treatment of
RCap is similar to that of Kotak and IDFC, which we value on consolidated earnings
and implicitly ignore holdco discounts.
Reliance Capital: Investment in subsidiaries and excess capital (In Rsbn)
FY11E Networth 80.9
Investment in subsidiaries
Life insurance for 74% stake (adjusted for stake sale to Nippon Life) 22.9
General Insurance 11.0
Reliance Money 8.0
Others 4.0
Lending business at 16% CAR 18.7
Total capital required 64.6
Excess Capital 16.3
Source: Company, J.P.Morgan estimates
Key risks
RCap directly holds only 16% of the lifeco and the rest through a web of
subsidiaries. The opaque structure is the key risk – others are a) 55% of RCap’s value
comes from market-dependent businesses (life and mutual fund) b) the large
investment book and c) the holdco structure and varying businesses.
Opacity of insurance holding
RCap holds only 16% of Reliance Life directly – the rest is held via a complex web
of subsidiaries. We operate on the assumption that RCap has 100% beneficial interest
in the lifeco, based on management assurances. There is a risk of tax incidence on
unwinding the structure, which we have not captured.
55% of RCap’s value comes from businesses (life and mutual fund) that depend on
buoyant stock markets. Both the life and mutual fund see increased sales when
markets accelerate, and the history of broking stocks in India suggest that multiple
expands at the same time. This significantly increases the beta of the stock, and it
tends to outperform rising markets and underperform falling ones.
Diverse business structure
The diverse business mix, necessitating a holdco structure, is a deterrent for many
investors. This may create a permanent holds’ discount, and cap the rerating of the
stock beyond a point.
Large prop book
RCap has historically run a large prop-book of investments, including in group
companies. Management has addressed this and the dependence of prop book profits
has reduced from 95% in FY08 to ~28% in FY11. This does raise the risk profile,
especially given the large capital needs of the operating businesses
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