Motilal Oswal Financial Services (MOFS.BO) Downgrade to Sell; Industry Outlook Remains Weak Citi

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Motilal Oswal Financial Services
(MOFS.BO)
Downgrade to Sell; Industry Outlook Remains Weak
 Downgrading to Sell, reducing Target Price to Rs77 — We downgrade MOFS
to Sell (3M) with a lower target price of Rs77. Our revised target price factors in
58%-59% lower earnings over FY12-13E (lower industry volumes, market share
and sharp reduction in profitability) and lower valuation multiples (10x 1 Yr Fwd
PE, 15x earlier). We believe that the industry level challenges (market
fragmentation, falling yields and market volumes) will pressure MOFS’ business
medium term and will drag down growth and profitability.
 Business Prospects to Remain Muted — MOFS is highly leveraged to the
capital markets across all its businesses - broking, investment banking,
discretionary portfolio management and third party product distribution. While
each of these industries is facing declining profitability due to volatile macro
conditions, MOFS itself has also been losing market share in the broking
segment (2% market share now). While MOFS’s investments in developing its
retail franchise could turn into a longer term positive, any gains would only be
gradual. Overall, recovery prospects look weak in the near to medium term.


Motilal Oswal Financial Services
Company description
Motilal Oswal Securities, incorporated in 1994, was started by entrepreneurs
Raamdeo Agrawal and Motilal Oswal. It began business as a retail broker and has
broadened to include institutional equity broking and commodity broking, investment
banking, discretionary portfolio management, venture capital management, and
third party product distribution. The company's predominant business lines are
institutional and retail broking; it has expanded into the areas of investment banking
and asset management recently. In addition, it is seeking to build on its equity and
retail market businesses, and it is establishing a wealth management platform.
Investment strategy
We rate MOFS Sell/Medium Risk (3M). MOFS is one of the few direct and
diversified plays on the Indian capital markets opportunity, with a strong
management. However, it has been losing market share - from being one of the
larger domestic brokers in India, it now has about 2% market share. Indian
brokerage industry continues to face challenges on a) Market fragmentation
(increasing competition); b) Lower commission yields (changing product mix); and
c) Muted outlook on financial product distribution (regulatory changes). The current
market environment is volatile, and turnover levels are also down from last year.
While MOFS’s strong investment in developing its retail franchise is likely to be a
longer term positive for its market positioning, we believe gains will likely deferred
as volumes in the retail segment have been declining and prospects of a near term
recovery appear low.
Valuation
Our target price for MOFS is Rs77, which is set at 10x one-year forward earnings,
and is at a 20-30% discount to the broader market (Sensex) P/E multiple. This is
consistent with our approach for other players in the industry. We value
brokerages/related businesses at a discount to broader market earnings multiples in
the current environment given structural challenges in a cyclical business.
Risks
We rate MOFS Medium Risk, in line with our quantitative risk-rating system, which
tracks 260-day historical share price volatility. While MOFS has a broad and
diversified business revenue mix, and is well balanced between the retail and
institutional segments, its business fundamentally remains leveraged to the capital
market environment, which we believe increases operating risk. Key upside risks to
our target price include: a) higher-than-expected trading volumes; b) market share
gains; and c) positive regulatory changes.