CARE - Attractive valuations.. Recommend SUBSCRIBE.. - IndiaNivesh

Care ratings, incorporated in 1993, is the leading credit rating company in India. It is the second largest rating company in India based on rating volumes and holds ~30% market share. It provides wide range of rating services for the instruments like short, medium and long-term debt instruments (which includes commercial paper, bonds, debentures, preference shares and structured debt instruments), bank loans and facilities (which includes both fund-based and non fund-based), deposit obligations instruments (inter-corporate deposits, fixed deposits and certificates of deposit), Initial Public Offering (IPO) ratings and research services (which includes industry, economy and customized research). It has a client base of 4644 as on September 2012 which includes Banks and Financial Institutions, Private sector companies, Public sector undertakings, Small and Medium Enterprises (SMEs) and Micro Finance Institutions (MFI). IDBI bank (25.8%), Canara bank (22.8%), State Bank of India (9.6%), ILFS (9%), Federal bank (6.2%) and Bajaj Holdings (6%) are the major shareholder of the company.

Investment Rationale

Healthy growth in debt instruments rating:

CARE is well positioned to take the advantage of increasing penetration of rating business by delivering 21% CAGR in debt volumes to Rs 9269 bn and 39% CAGR in number of debt instruments rated in FY08-12. As on September 2012, it has rated debt instruments worth Rs 3571 bn and total number of debt contracts increased to 17237. New assignments completed during FY12 stood at 5980 as against 2187 in FY11. On research front, company has delivered a consistent increase in count to 205 in industry research and 73 in economy research as against 167 and 60 in FY11.

...revenues grew by 38% CAGR since FY08...

Healthy volumes growth backed by increasing number of contracts resulted in impressive growth in revenues of 38% CAGR since FY08 to Rs 1890 mn. This is much ahead of peer group CAGR of 16% by CRISIL in CY08-11 and 15% by ICRA in FY08-12. Despite significant slowdown across the industry due to lower capex, revenues increased by 14% yoy in FY12 which is higher than its closest peer ICRA of 8% yoy and lower than largest peer CRISIL of 28% yoy.

Highest margins in the industry:

EBITDA of CARE has improved by 38% CAGR to Rs 1353 mn over FY08-12 led by healthy business growth. While EBITDA margins have come down to 66% in H1FY13 from 72% for FY12, it remains highest in industry. EBITDA margins of CRISIL were 33% in CY11 and 30% of ICRA in FY12.

... is due to lower expense ratio:

CARE's healthy EBITDA margin is a result of lower Expense ratio of 28% for FY12. Though it has moved up from 24% in FY11 yet it remains lowest amongst peers. Further chunk of expense are employee cost which was 22% in FY12 vs 51% for ICRA in FY12 and 44% for CRISIL in CY11.

Superior ROE... backed by 44% CAGR in Net profit:

ROE of CARE remains superior at 35% for FY12 backed by 44% CAGR in Net profits in FY08-12. Net profit margins were 56% as against 61% in FY12 and 53% in FY11. ROE of CARE is lower than 51% of CRISIL and higher than 19% of ICRA. However it beats peers on Net profits margins front with healthy margins of 61% as compared to 26% of CRISIL in CY11 and 26% of ICRA in FY12.

Future strategy:

The company's future strategy is to 1) expand its foot prints of ratings business in other countries like Nepal and Mauritius 2) explore the other opportunities in existing joint ventures with international rating agencies in Brazil, Portugal, Malaysia and South Africa and 3) diversify its service offerings to Knowledge process outsourcing (KPO), risk management and any other support services to derisk its business model.

Risk and Concerns

Shrink in new issue of debt instruments or bank loans:

CARE's business will get impact if there is any shrink in rating volumes and new issuance of debt instruments and bank loans. This is because company's income from rating constitutes 86% of total revenues in FY12 as against 96% in FY11. Due to continuous hike in interest rates, demand for debt instruments have come down due to lower investments and capital expenditure. Debt volumes excluding banking facility has come down by 14% yoy to Rs 2480 bn in FY12. Hence higher interest rates for longer term could post threat on company's business.

Competition from existing and new players:

Currently CARE enjoys higher margins due to lower employee and other operating expense. However increasing competition from existing players like CRISIL and ICRA along with new entrants like Fitch and SMERA might result in increase in cost and hence lower margins.

Valuation and Recommendation

CARE has emerged as one of the fastest growing rating company in the industry with increasing market share in debt and bank loan ratings. We are impressed by its above industry growth rate, highest margins, superior efficiency and return profile. At higher side of the price band, it is trading at P/E of 21.4x for FY13 annualised EPS which lower than peers of CRISIL at 33.4x for CY12 annualised EPS and ICRA at 31.3x for FY13 annualised EPS. Hence we recommend SUBSCRIBE to the issue.

Source : Equity Bulls

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