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Credit Analysis & Research Ltd IPO Review By Naman Sec (Apply)

Review By Naman Securities and Finance Pvt. Ltd on December 8, 2012

Rating agency Credit Analysis and Research Ltd. (CARE), proposes to sell 7.19 million shares through its Initial Public Offer (IPO) to raise ~Rs 500-550 crs for providing partial exit to existing shareholders. The deal is therefore an offer for sale (OFS) and the company will not be issuing fresh equity as part of the issue. The issue opens tomorrow with a price band of Rs 700 to Rs 750 per share. In this post, I evaluate the attractiveness of the CARE issue.

CARE is the second largest rating agency in India, next to CRISIL. While it ranks second in terms of market share in the credit rating business, it is the leader in IPO grading services in India. CARE is promoted by major banks and financial institutions and the three largest shareholders are IDBI Bank holding 26%, Canara Bank with 23% and State Bank of India holding 9%.

Pertinent points to consider:

  • CRISIL is the largest player in the credit rating space; far ahead of ICRA and CARE, the next 2 nearly equal sized players by revenues. CARE however, is substantially more profitable than its listed peers CRISIL and ICRA.
    1. CARE has a larger presence (over 80% of revenues) in the ratings business which enjoys higher margins as against CRISIL's roughly equal presence in both ratings and lower-margin research businesses.
    2. CARE has lower presence in the low-margin SME ratings business as compared to peers
    3. ICRA enjoys substantially higher revenue and profit per employee due to its presence (through wholly owned subsidiaries) in high-margin analytics and business intelligence software businesses.
  • In July, 2009, the RBI advised banks that they may move to an internal rating based approach (IRB) using own internal estimates for some or all of the credit risk components in determining the capital requirement for a given credit exposure. RBI may allow applicant banks to move to this system by March 31, 2014. If banks increasingly opt for internal credit assessments, the rating services business of credit rating agencies, especially CARE since it derives 85% revenues from that segment, will be affected. Based on the conversations I had with industry sources however, I tend to believe that this issue does not pose a very serious risk as yet as most banks are not in a state of preparedness to conduct this activity in-house in the near term.
  • A bigger concern however, is India's slowing growth rate. CARE's revenues and earnings show nearly zero y-o-y growth if we annualize its H1FY13 numbers, a worrying trend. It would be wise to expect a lower growth over the next 2 years due to the slowing investment and capex cycle in the country and the resulting slowdown in debt issuances. I have estimated a 5% y-o-y growth in revenues and stable margins in estimating the FY13 earnings.

Conclusion / Investment Strategy

Issue attractively priced, expect 10-15% upside

CRISIL and ICRA have traded at three year average trailing PE multiples of 28.3x and 21.2x respectively. At the upper end of the price band, i.e. Rs 750, the implied trailing PE multiple is 18.5x for CARE. This is despite its higher profitability and growth rates compared to its listed peers.

To make a fair comparison of forward multiples based on FY13 estimated earnings, I have used the average daily stock prices of CRISIL and ICRA over the last 3 months to adjust for the recent sharp run-up in the prices of both the rating stocks.

Based on FY13E estimated earnings, CRISIL and ICRA are trading at forward PE multiples of 28.8X and 23.7X respectively, implying over 30% discount to CARE's 17.7X FY13E earnings. Even if we apply a conservative forward multiple of 20X, considering CARE's risk of concentration to the ratings business and slowing growth, the fair value estimate comes to Rs. 845 implying a 13% upside from the upper end of the price band.

Data sources: CARE RHP, annual reports and company presentations of CRISIL and ICRA

Reviewer recommends Subscribing to the issue.

Review By Naman Securities and Finance Pvt. Ltd on December 8, 2012