CREDIT ANALYSIS AND RESEARCH LTD : HAS A GOOD POTENTIAL !!!

Scrip Code: 534804 / CARERATING

CMP:  Rs. 1,389.35; Market Cap: Rs. 4,029.12 Cr; 52 Week High/Low: Rs. 1,590.00 / Rs. 666.00.

Total Shares: 2,89,99,122 shares; Promoters : Not Defined – 00.00 %; Total Public holding 5 % or more : 84,96,066 shares – 29.30 %; Total Public holding 1 % or more : 1,76,25,415 shares – 60.78 %; Public holding : 28,77,641 shares – 9.92 %; Book Value: Rs. 167.01; Face Value: Rs. 10.00; EPS: Rs. 45.16; Dividend: 280.00 % ; P/E: 30.76 times; Ind. P/E: 43.38; EV/EBITDA: 19.31.

Total Debt: ZERO; Enterprise Value: Rs. 4,005.70 Cr.

CREDIT ANALYSIS AND RESEARCH LTD: The Company was founded on 21st April, 1993 and is based in Mumbai, India. Credit Analysis and Research Limited is a credit rating agency, providing rating and grading services for various sectors in India. The company came with an IPO of 71,99,700 equity shares of Rs. 10 each at Rs. 750.00 to the general public in December, 2012. Its rating services include corporate rating services, such as corporate debt, bank loan, issuer, corporate governance, and recovery rating services; financial sector rating services, which cover banks, mutual funds, capital protection oriented schemes, insurance, NBFCs, securitization, and housing finance companies; and public finance ratings that cover ratings of state government entities and urban local bodies, as well as project finance, infrastructure sector, and small and medium enterprises rating services. The company also offers grading services for educational institutes, IPOs, construction companies, shipyard companies, maritime training institutes, renewable energy service companies and system integrators, micro finance institutions, and energy audit, as well as real estate star rating services. CARE has entered into collaboration with four credit rating agencies from emerging markets like in Brazil, Portugal, Malaysia, and South Africa each to provide ratings in those countries, set up ARC ratings in those countries. CARE also provides research services and it has been expanding its product portfolio to include newer services. The company is exploring opportunities to provide risk management solutions and acquired 75.1 % stake in Kalypto, a firm providing risk management software solutions in Nigeria in Nov 2011. Credit Analysis and Research Ltd is locally compared with CRISIL INDIA LTD, ICRA and Globally with Asukanet Company Ltd of Japan, Eprint Group Ltd of Hong Kong, ZWEI Co Ltd of Japan, McGraw Hill Financial Inc of USA, Standards & Poors of USA, Moody's of UK.

Investment Rationale:

Credit Analysis and Research Ltd (CARE) is a leading credit rating company in India offering rating and grading services. It also provides research services and risk management solutions through its subsidiaries. CARE is the second largest rating company in India and it enjoys a strong parentage of marquee banks and large financial institutions like SBI, Canara Bank, IDBI Bank and IL&FS. CARE has over 19 years of experience in this business and has a significant rating coverage of Indian banks and financial institutions. Its experience and knowledge has enabled it to rate a wide range of instruments and has created a strong customer base of 7,754 clients as on March 2014. CARE has rated debt instruments of entities in various sectors like manufacturing, services, banks and infrastructure. It also has provided debt and issuer ratings to corporates, banks, financial institutions, public sector undertakings, state government undertakings, sub-sovereign entities, NBFCs, SMEs and microfinance institutions. In FY14 CARE reported completed assignments of 7,865 nos as compared to 7439 no.s last year. CARE has also launched ARC Ratings in London on 16th January 2014 while it has commenced operations in Advisory Services through its subsidiary company CARE Kalypto Risk and Advisory Services Private Limited. Credit rating business is a niche segment in the financial services arena. In the post-reforms era, with increased activity in the Indian Financial sector both existing and new companies are opting for finance from the capital market. Presently, the India can claim to be one of the world's most vibrant capital markets. In spite of the challenges that are still there, the future of this sector's looks good. The market size of banking assets in India have reached US$ 1.8 trillion in FY 13 and is projected to touch US$ 28.5 trillion by FY 2025. According to the data provided by SEBI, during FY 14, Foreign Institutional Investors (FIIs) invested a net amount of about Rs. 80,000 Cr (US$ 13.31 billion) in Indian equity market. Association of Mutual Funds in India (AMFI) has reported that the mutual fund industry's assets under management (AUM) have gone past the Rs. 10 trillion (US$ 166.37 billion) mark in May, 2014. The AUM of the Indian mutual fund industry rose to Rs. 10.11 trillion (US$ 168.19 billion) in May from Rs. 9.45 trillion (US$ 157.21 billion) in April. A strong capex cycle in Indian economy, lower penetration of corporate bond market and regulatory push due to implementation of Basel II norms are likely to help credit rating agencies ahead. Also Credit Agencies are likely to benefit from increased penetration by pension funds and insurance companies and multiple initiatives taken by the Government of India to develop the bond market. In India, Rating is a more recent phenomenon, but the changing global perspectives on the subject do impact the financial system. India was perhaps the first amongst developing countries to set up a credit rating agency in 1988. The function of credit rating was to institutionalized when RBI made it mandatory for the issue of Commercial Paper (CP) and subsequently by SEBI, when it made credit rating compulsory for certain categories of debentures and debt instruments. In June 1994, RBI made it mandatory for Non- Banking Financial Companies (NBFCs) to be rated. Also earlier there was severe under-cutting in the BLR (Bank Loan Rating), which impacted the margins of credit rating business, however, over the past six months, SEBI has came out with its guidelines under which a credit rating agency (CRA) has to disclose its minimum rating fees on a new BLR assignment. Around 50 % to 60 % is surveillance income and 70 % to 80 % of the business comes from existing clients with the balance coming from new clients. Therefore, this provides a hedge against a downturn even if CARE does not get any new client. However, old clients are still enjoying discounted fees in the BLR segment. Consequently, the full impact of SEBI guidelines on minimum rating fees is also not visible. CARE is trying to gradually increase its fees going forward, which is expected to improve the margins of the BLR segment and partially negate the effect of lower margins in SME rating business. CARE has also started increasing its presence in the SME segment. For this, CARE has expanded its reach to 60-70 locations, the results of which will be visible in the coming years. This should surely benefit CARE.

Outlook and Valuation:

CARE is the second largest rating company in India in terms of rating turnover. CARE also enjoys a strong parentage of marquee banks and large financial institutions of India like SBI, Canara Bank, IDBI Bank and IL&FS. CARE has over 19 years of experience in this business and has a significant rating coverage of Indian banks and financial institutions and financial instruments. CARE is primarily engaged in rating services which accounts for around 98 % of the total revenue of the company as of FY13. CARE has achieved a steady growth in its ratings business having rating relationships with 7,754 clients and with number of assignments of 7,865 and it has cumulatively rated around Rs. 7.7 lakh Crs of debt in FY14. In the last few years, the company has begun expanding itself internationally and is now providing technical assistance services to countries like Maldives, Hong Kong, Nepal and Mauritius. Globally and in India also Credit Rating business will continue to be an niche business making existing players in India thrive on the upturn expected in the economy over the medium term. This is because credit rating agencies all across the globe are a business based on trust, long relationships and hence from the market point of view also there is unlikely to be any excess supply of paper in this space. Also one important and noteworthy aspect in the Indian Ratings space is that global rating players have shown strong interest in the Indian ratings players with S&P holding 75 % in CRISL and Moodys holding 50.8 % in ICRA which has resulted in a sharp rise in credit rating counters. After CRISL and ICRA, CARE is now the second largest player in the rating space which is now available going ahead. While any kind of strategic tie up cannot be ruled out, it is quite clear that in future such a development cannot be ruled out. Added to this CARE is atleast twice as large and more profitable to ICRA and enjoys better financials and return ratios but still trades at 20x FY15E as compared to 34x FY15E for ICRA. From performance side, CARE’s income from operations increased 14 % yoy to Rs. 74.3 Cr in Q2FY15 despite sluggish growth in bank credit. This higher income came mainly from surveillance cases. The sequential strong growth was seen mainly due to cyclical nature of rating business. Total operating expenditure increased to 28 % yoy to Rs. 22.70 Cr mainly due to 43 % yoy increase in the staff cost which was Rs. 16.70 Cr. Higher staff cost was due provision for ESOP cost and also increase in the staff count on account of continued focus on building the business team especially in the SME space. CARE’s EBITDA increased 8 % YoY to Rs. 51.5 Cr, and its EBITDA margin reduced to 69.4 % from 72.9 % in Q2FY15. However, it was much ahead than EBITDA margins of its listed peers ICRA which has EBITDA margin of 40.1 % in Q2FY15 and CRISIL with 33.3 % in Q2FY15. As CARE declared special dividend of Rs. 65.00 per share in the last quarter, the company had to sell its some of the investments and booked the gain on investments to P&L a/c. As a result, the company’s net profit increased 50 % YoY to Rs. 52.40 Cr and its Net Profit margin increased to 54.1 % from 49.6 % in Q2FY15. Modified credit ratio (MCR) has increased from 1.0 in Q1FY15 to 1.3 in Q2FY15 which is a good sign for the economy and it also suggests improvement in credit environment during the recent quarters. It was 1.1 in Q2FY14. MCR is the ratio of upgrades against downgrades in ratings of the companies. An increase in MCR means stable and improving financials of the rated companies. CARE continued with its liberal dividend pay-out policy and the company had announced a special dividend of 650 % in Q2FY15 with the purpose of sharing the cash surpluses with the shareholders. Combining this with the interim dividend announced in Q1 of 60 %, the total dividend paid so far is 710 % or Rs. 71. In Feburary 2014, the stake holders of CARE namely IDBI holding 16.62 %, Canara Bank holding 11.95 % & SBI holding 5.19 % invited bids for selling their 33.76 % or approx 97,88,041 Cr shares of their holding in CARE. However the bids did not went through at that time due to valuation issues. It is now heard that CARE is likely to revive the stake sale of its investors again, now it should be noted here that if at all this stake went through, will also trigger an open offer for an additional 26 % shares facilitating the new investor to corner over 70 % in CARE. So if this stake sale goes successful then there would be a very good upside for the stock. CARE’s Q2FY15 performance was better and one can have a positive view on the huge long term opportunities for the credit rating sector on the back of development in debt market over next two to three years and CARE should be a good pick among the listed credit rating agencies. CARE is the best placed for cyclical recovery in corporate capex and bank credit growth. It is expected that with the company’s surplus scenario is likely to continue for the next three years & will keep its growth story intact for the coming quarters also. 

KEY FINANCIALS	FY13	FY14	FY15E	FY16E
SALES (₹ Crs)	198.80	229.50	265.80	319.00
NET PROFIT (₹ Cr)	113.00	128.70	148.20	179.10
EPS (₹)	40.80	44.00	51.00	62.00
PE (x)	18.90	30.70	26.60	22.00
P/BV (x)	5.10	8.10	12.10	9.80
EV/EBITDA (x)	15.80	26.70	22.80	18.60
ROE (%)	28.30	27.70	36.50	49.00
ROCE (%)	167.30	164.50	101.50	111.60

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