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After giving stupendous returns, stock prices of broking companies took a sharp U-turn since the markets crashed in mid-January 2008.
Within three months of touching their respective 52-week highs, stock prices of broking firms such as Motilal Oswal, Edelweiss Capital and IL&FS Investsmart touched their 52-week lows in the last week of March.
While companies such as India Infoline [Get Quote] and IL&FS Investsmart are down by 55 per cent and 33 per cent, respectively in 2008 till date, newly listed companies such as Motilal Oswal, Edelweiss Capital and Religare are not far behind with their stock having tanked by 52 per cent, 49 per cent and 26 per cent, respectively from the closing price of their listing day (between September and December 2007).
Oodles of bad news
There has been bad news on the domestic as well as global front. Globally, factors like the credit crisis, weakening US dollar, rising inflation and economic slowdown, have been playing negatively on the market sentiment.
In India, growth in corporate earnings, industrial production and credit offtake have been slowing down, while concerns over high inflation and foreign currency derivative exposure of India Inc have been looming large.
It's not surprising that the stock markets fell and volumes plunged. To give some examples, the combined (BSE and NSE) cash turnover declined by 36.5 per cent from Rs 632,117 crore (Rs 6,321.17 billion) in January 2008 to Rs 401,404 crore (Rs 4,014.04 billion) in February and by a further 10.3 per cent in March to Rs 360,048 crore (Rs 3,600.48 billion), though it recovered a bit in April (up by 6.8 per cent). Even till May 12, 2008, the figures are not exciting enough.
Among other factors that have added to the woes include the proposals announced in the Union Budget 2008-09, in February 2008.
The short term capital gains tax rate was increased from 10 per cent to 15 per cent, commodities transaction tax was introduced and there was a change in the treatment of securities transaction tax (to deductible expenditure against business income rather than a set off against income tax earlier) that will likely increase the tax burden for equity traders.
Notably, the flow of foreign institutional investors' money has also been poor. FIIs have pulled out about $3 billion in 2008 till date after being huge buyers in the past two years�around $8 billion in 2006 and over $10 billion in 2007. This has kept the retail investors at bay and led the domestic institutional players tread cautiously.
All these factors added to the uncertainties, raising questions about the prospects and growth sustainability of the business of broking companies.
Q4 results reflecting the concerns
The above fears have partly come out to be true given the sequential decline in operating income (revenues) and net profit for most broking companies. The operating incomes have declined in the range of 10-25 per cent quarter-on-quarter (q-o-q) except in the case of India Infoline (which saw a rise of 25 per cent).
Interestingly, the numbers indicates that companies such as India Infoline and IL&FS Investsmart, which have a fairly diversified portfolio as compared to others, have seen a lesser impact on revenue growth.
Profitability though, for majority of the companies declined due to a rise in major costs like employee, administrative, interest and depreciation (largely due to expansions undertaken by companies) on one hand, and declining to flat top line growth.
While on a year on year basis the performance of many companies has been strong for March quarter as well as FY08, growth rates could slip for some companies if trading volumes continue at current levels.
The markets are expected to remain stable and volumes are likely to be volatile in the short-term (next three-four months).
Says Anup Maheshwari, fund manager, DSP Merrill Lynch, "Markets are likely to be in a consolidation phase in calendar year 2008. We are more positive for calendar year 2009."
Most experts feel that the scenario does not look all that bad on a longer term horizon (12 months and more) and the impact of the budgetary measures will be neutral.
They believe that volumes and markets will pick up over the next year. Even at current volume levels, some companies should manage to show reasonable growth (helped by diverse revenue streams) in their bottom line.
Overall, the outlook for broking companies is good and valuations appear reasonable for the sector after the deep correction, say fund managers. However, having broking stocks is not everybody's cup of tea. The business is competitive and cyclical in nature besides, it is getting linked with global factors.
Sandeep Neema, fund manager, J M Financial Mutual, also prefers to be stock specific and is comfortable with companies having a well diversified revenue mix and established presence, and available at reasonable valuations. Read on to know more about individual companies.
1. India Infoline
India Infoline has the most de-risked revenue model with a little over 55 per cent of the total revenues coming from the equity brokerage business--the least among listed broking companies. This is probably one reason for the company being the best pick among most mutual fund managers.
Thanks to its diversified portfolio, the company bucked the trend and reported a sequential rise of about 25 per cent in its operating income and a marginal one per cent increase in net profit in the March 2008 quarter.
The growth in FY08 was largely driven by its institutional broking business, financing income and better utilisation of its branch network, which has grown rapidly in the past few years.
Going ahead, its institutional broking and lending businesses are expected to gain more scale and will be the revenue drivers.
The company hired four high profile professionals from CLSA a few months earlier to spearhead its foray in institutional broking. Plus, its partnership with New York-based brokerage firm, Auerbach Grayson and Co will increase its access to institutional clients in the US and offer them access to Indian capital markets.
Also, its lending portfolio comprising of margin finance and consumer finance products (mortgages, personal loans, business loans and loans against shares) should grow at a higher rate.
The company's newly set up subsidiary for wealth management and its move to set up an asset management company should lead to positive results in the respective businesses. The stock looks reasonably priced at 25 times FY09 estimated earnings, but looks more attractively priced (PE of 18.7 times) based on FY10 estimated earnings.
2. Indiabulls [Get Quote] Securities
Indiabulls Securities got listed on April 2, 2008 after the de-merger of the stock broking business from Indiabulls Financial Services, which now operates the financial services business. Since its listing, the stock has bucked the overall trend and has gained about 12 per cent.
After closing at Rs 99 on listing day, the stock is currently quoting at Rs 111. One reason could be its reasonable valuation of about 11 times for FY08 earnings as compared with Motilal Oswal and Religare Securities (which have similar size of business).
However, the profitability of Indiabulls is much higher than Motilal's and Religare's-net profit margins of 42 per cent in FY08 as compared with 25 per cent and 17 per cent respectively, partly due to lower operational costs.
Analysts expect roughly a minimum 20 per cent growth each in operating income and net profit over the next two years. Its valuation of 9 times and 7.7 times based on estimated earnings for FY09 and FY10, respectively looks attractive. A higher-than-expected performance could translate into significant upside in the stock performance.
3. IL&FS Investsmart
IL&FS Investsmart, held by strategic investors like IL&FS (30 per cent) and USA-based, E*Trade (about 44 per cent), provides a variety of products such as retail broking, online trading, distribution of financial products, portfolio management services, commodity trading, insurance broking, institutional equity, loan syndication and investment banking through its 300-odd offices across the country.
Excluding India Infoline, the company witnessed least downside in its operating income on a sequential basis compared to other broking players, which reinforces its advantage of having a well diversified portfolio of products and services.
The company has recently been in the news due to market talks that its strategic investor, E*Trade, a leading provider of brokerage and banking products and services to retail, corporate and institutional clients in the US, is looking to divest its investments including its stake in IL&FS Investsmart to private equity players, banks or strategic investors as it is facing liquidity crunch in the US, thanks to the sub-prime crisis.
The impact of this on IL&FS Investsmart will depend on the new buyer and what benefits it brings to IL&FS Investsmart's growth prospects.
4. Motilal Oswal Financial Services
Motilal Oswal, started by entrepreneurs Motilal Oswal and Raamdeo Agrawal as a retail broker, has broadened its product portfolio to include institutional equity broking and commodity broking, investment banking, discretionary portfolio management, venture capital management, and third party product distribution.
The company has rapidly expanded its network with presence in 432 cities through 1,430 outlets followed by growing customer base.
While institutional and retail broking contribute significantly to the revenues currently, its share is coming down -- equity brokerage as a percentage to total income came down from 88.5 per cent in FY07 to 84.7 per cent in FY08.
Moreover, its recently formed investment banking and venture capital management businesses are gaining traction. Its investment banking business closed 23 deals aggregating to approximately $1.8 billion in its first full year of operation and 33 deals for about $2.5 billion since inception in 2006.
The VC business achieved a final closure of "India Business Excellence Fund" at $125 million. While it deployed $31 million across six deals, another $30 million worth of deals are in advanced stages of closing.
On the retail side, the company aims to move up the value chain by offering wealth management and asset management services; it also plans to scale up its margin finance and third-party product distribution businesses.
Strong management, diversification in revenues and superior research capabilities instil confidence in the company's growth prospects. The stock trades at an attractive valuation of 7 times and 6 times based on estimated FY09 and FY10 earnings, respectively.
However, investors will have to be patient as contribution of equity broking business in the total income will be substantial for the next few years.
5. Edelweiss Capital
Like Motilal Oswal, Edelweiss Capital is also a large broking company with strong presence in institutional broking and superior research capability.
The company is among the largest in the institutional broking segment with 9 per cent market share and is a leader in the derivatives segment with more than a 13 per cent market share.
It also has strong domestic investment-banking business and one of the highest operating margins of more than 30 per cent in the industry.
Like Motilal Oswal, Edelweiss is making attempts to have a well-diversified portfolio to include finance against shares, asset and wealth management, insurance and third party distribution from the current brokerage and arbitrage activities.
Amid this scenario and compared to its closest peer in terms of size, India Infoline, Edelweiss stock looks rightly priced, and will look attractive on some declines.
6. Religare Enterprises
Religare Enterprises is the holding company of various subsidiaries, whose businesses are classified into three main verticals�retail, institutional and wealth spectrums and is among the larger retail brokerages in India. It has one of the biggest networks with presence in more than 1,300 locations across over 400 cities and towns.
The company also offers a diverse bouquet of services ranging from equities, commodities and insurance broking to wealth management, portfolio management services, personal financial services, investment banking and institutional broking services.
As a part of its strategy to become a globally trusted brand in the financial services domain, the company has started taking initiatives on this front. Its UK subsidiary recently got an approval from the Financial Services Authority (FSA) for acquiring Hichens, Harrison & Co, London's oldest broking firm.
Hichens, Harrison has been in the business for over 200 years, and offers services like corporate broking, institutional broking and sales.
The deal, which is valued at more than $100 million, will allow the UK subsidiary to create an international distribution network for Religare's domestic institutional business and provide an opportunity to service the needs of Indian corporates through its large global network besides, providing small and medium Indian companies with much needed access to capital.
For the domestic market, the company has partnered with one of the global leaders, Aegon, to launch life insurance and mutual fund products in India and has also entered into a joint venture with Macquarie for wealth management services.
Though the company is increasingly diversifying its revenue profile, it will continue to significantly depend on retail broking (about 90 per cent of total revenues) and margin finance (broking volumes are backed by its large margin finance book) business for growth and earnings for the next few years.
Thus, taking these factors into consideration, the company's valuation of about 20.5 times and 17 times its estimated FY09 and FY10 earnings, respectively looks stretched.
7. Emkay Share and Stock Brokers
Emkay Share and Stock Brokers, which is soon to be rechristened Emkay Global Financial Services, is the smallest player among the listed broking companies with a consolidated turnover of Rs 102.6 crore (Rs 1.026 billion) in nine months ended December 2007.
The company provides advisory services such as investing, trading, research, financial planning and portfolio management in both cash and derivatives market to a mix of clients (institutional, high net worth and retail investors).
It also distributes savings or investment instruments such as mutual fund schemes, saving bonds and initial public offers besides, insurance and commodity broking through its 100 per cent subsidiaries.
However, the company is currently predominantly dependent on its brokerage business (85.7 per cent of consolidated revenues in nine months ended December 2007) and scaling up of insurance and commodity broking businesses will take some time. This makes the stock relatively risky given the competitive nature of brokerage industry and Emkay's smaller scale of operations.
8. Geojit Financial Services [Get Quote]
Geojit Financial Services, a leading player in south India is spreading its reach not only in the other domestic regions but also overseas. The company, which is partly owned by BNP Paribas, plans to expand its presence in northern and western regions.
Further, the company has signed two joint ventures each in Dubai and Saudi Arabia and entered into an exclusive agreement with Bank of Bahrain and Kuwait (BBK), one of the largest retail banks in Bahrain and Kuwait, in order to tap the growing NRI (non-resident Indian) population in the region, besides the local population which may be looking to diversify their investment portfolio.
Geojit is also making attempts to diversify its revenue mix by venturing into newer product offerings, besides its current retail broking business.
The company recently formed 50:50 joint venture with BNP Paribas Securities Asia for the institutional broking business. The company plans to leverage its network and NRI client base for distribution of third party products and also take advantage of fund management expertise of BNP Paribas to scale up its PMS services.
All these efforts should lead to a successful de-risking of revenues and greater profitability. However, as compared to its peers and size of operations, the stock looks a little overpriced.
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