Credit Rating - Sector Initiation - "A credit-able proposition" :: Centrum

“A credit-able proposition”



We initiate coverage on Credit Rating Agencies (CRA) with a positive
bias – CARE (Buy) and CRISIL (Hold). Elevated interest rates, policy
lapses and moderation in GDP growth impacted the investment cycle
during FY11-14 and in turn the ratings business. With stable
government, prospects have emerged of policy reforms across core
sectors of growth which will push corporate capex plans. This, in
addition to initiatives on reviving the corporate bond market will
result in a surge in the rating business and lead to improved
profitability for CRAs. CRISIL and CARE stand to gain given their
leadership positions and superior returns profile.

$ Green shoots emerging; but it will be a gradual process: The period
between FY11-14 was characterised by weak investment activities
following policy lapses, sticky interest rates and moderation in GDP
growth. This, in addition to excess leveraging by the corporates and
higher levels of delinquencies (NPAs) led to moderation in funds
raised by corporates to 15.2% CAGR vs 21.4% CAGR in the preceding
period (FY08-11). Green shoots have emerged following early signs of
progress in reforms across core growth sectors. With a stable
government and the need to accelerate growth, leading corporates,
lenders and associations expect gradual recovery beginning H2FY15.

$ Efforts to revive corporate bond market; SME, the next business
opportunity:  The Indian corporate bond market remains
under-penetrated (~3% of GDP), partially due to the financial
structures and regulatory intervention in the past. Efforts have been
made towards reviving the corporate bond market by encouraging
participation of various investors. With huge capex pipeline and
constrains on bank funding, the growth in corporate bond market though
gradual, will improve steadily. SME is the backbone of large
industries (contributing 45% to manufacturing) and with immense
benefits of rating, is the next business opportunity for rating
agencies.

$ Asset light model; credibility of utmost importance: CRAs deal with
the capital requirement of corporates and reflect the health of
investment activities in the economy. These agencies operate on asset
light models that generate healthy EBIDTA margins and superior return
ratios. Judicious utilisation of cash is vital from the shareholders’
perspective and hence these agencies have resorted to payback or taken
up in-organic growth. Default study / stability reports play a vital
role in assessing the health of corporates and quality of ratings by
the agencies, but it can affect their credibility if they fail to
recognise early signs of stress. Though CRISIL and ICRA have done
well, CARE’s performance was equally good. (exhibit 36-39).

$ Outlook and recommendation: CRISIL commands premium to its peers
given its strong parentage, well diversified revenue mix and superior
return ratio profile. Valuations at 31.1x CY15E EPS is on the higher
band and limits upside. Initiate with HOLD (TP of Rs1,340). CARE
trades at 34% / 48% discount to ICRA and CRISIL respectively. While
the discount to CRISIL is justified given the superior profile of the
latter, we believe the valuation gap to ICRA is on the higher side and
should narrow as CARE scores well on all ratios when compared to ICRA.
Initiate with Buy and target price at Rs1,150.



Thanks & Regards

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