Mumbai: Indian brokerage stocks are trading at an unjustifiably high level, unlike their global peers that are valued at a significant discount to their respective market multiples, says a report by Deutsche Bank AG.
The report — authored by the bank’s analysts Suresh Ganapathy and Dipankar Choudhury and sent out to its clients last week — recommended selling shares in two large local brokerage firms, Edelweiss Capital Ltd and India Infoline Ltd.
“Despite a strong correction of 50-60% year-to-date, we believe it is still not too late to sell these brokerage stocks,” the report said.
Deutsche Bank, which initiated coverage on the brokerage segment with the these stocks, said it has a negative view on the entire sector.
Local brokerage stocks are trading at 29% premium to the average price-earnings, or P-E, multiples of the Indian market, the report says. These stocks command prices some 19 times their earnings, compared with the market’s P-E multiples at 14.6.
This is not the case in other markets. Chinese brokerage firms are trading at 25% discount to the average market P-E. China’s average market P-E is now 12.4, while its brokerage stocks are valued 9.3 times their earnings.
Similarly, in Korea, brokerage stocks trade at an 8% discount to the broader market and Malaysian brokerages at 65% discount to the average market valuation.
In the US, 10 large brokerage stocks now trade at a 58% discount, compared with the P-E multiple of the Standard and Poor’s 500 index.
P-E multiples are arrived at by dividing stock price with earnings per share. Normally, a high P-E multiple suggests investors are expecting higher earnings growth in the future compared with companies with a lower P-E multiple, but it could also indicate that the stocks are overvalued.
Indian brokerages trading at market premiums higher than their counterparts in the US and Korea put them at a greater risk of market corrections, the analysts said.
India’s bellwether Sensex index is now trading 27% below its early-January levels. Before the markets turned bearish, some brokerage stocks were trading at more than 100% premium to the market multiples.
The brokerage sector in India is thinly covered by analysts. As a result, high valuations of brokerage stocks and their business outlook do not often come under the scanner.
Deutsche Bank’s target price for India Infoline is Rs110 and for Edelweiss Rs480, both 20% below current market prices.
One of the key worries for Indian brokerage stocks, according to the report, is the highly fragmented industry.
The report also notes that increasing competition from large players in both retail and institutional broking is likely to exert pressure on broking houses’ ability to maintain market share, margins, and consequently, return ratios.
Edelweiss, which was a pure institutional brokerage, had announced plans to start retail operations. It has also entered into mutual funds business. India Infoline, a retail broker and distributor of financial products, now has a strong institutional equities business and is strengthening its investment banking business.
Deutsche Bank, however, said diversification among Indian brokerages is a myth.
Indeed, India Infoline earns 70% of its revenue from broking and investment banking operations, 5% from trading or investing, 13% from consumer finance and 10% from insurance distribution.
Edelweiss gains 41% from broking and investment banking, a hefty 39% from trading or investing and about 20% from its consumer finance business.
India has huge untapped base of high net-worth individuals but wealth management is currently dominated by foreign banks and this business.
Institutional equities brokerage business, too, was dominated by foreign firms but local brokerages are now building muscle in this business.
With the participatory note (PN) business being phased out at the initiative of the capital market regulator, local brokerages could see a 20% recovery in volumes in fiscal 2010, said Deutsche Bank analysts.
PNs are offshore contracts, with underlying Indian securities, issued by foreign brokerages in India to their clients who are not registered here.
Other listed brokerage firms in India include Motilal Oswal Financial Services Ltd, Religare Enterprises Ltd, IL&FS Investsmart Ltd and Geojit Financial Services Ltd.