Brokerage house Kotak Institutional Equities believes credit rating agencies (CRAs) are well-placed to benefit from credit expansion in the medium term, however, it noted that the valuations for these firms are misplaced.
It has initiated coverage on CRISIL with a ‘sell’ call and ICRA with a ‘reduce’ call and sees 21 percent and 8 percent downside, respectively.
"While we are positive on ratings, we are cautious about the non-ratings businesses of both CRISIL (85 percent/70 percent of revenues/EBIT) and ICRA (45 percent/55 percent of revenues/EBIT), which have global market linkage. Reasonable valuations and more confidence in the profitable growth of non-ratings businesses could make us revisit our stance," it said.
Kotak explained that the credit rating agencies (CRAs) are well-placed to benefit from the broad-based credit expansion in the next 3-5 years, resulting from (1) increased supply of credit from all sources (banks, NBFCs, credit funds, etc.); (2) deleveraged corporate balance sheets that are well-placed for the next investment cycle; and (3) potential growth optionalities (ESG ratings, corporate bond market and secondary loan market).
It forecasts a 13-15 percent ratings revenue CAGR in the next 3-4 years. Rating revenues have shown a strong correlation with credit growth in the past two decades, which augurs well given the high operating margins as well as stronger guardrails of regulation and reputation after the IL&FS saga, it added.
CRISIL has jumped 43 percent in the last 1 year and 38 percent in 2023 YTD, giving positive returns in 8 of the 10 months completed this year. It declined in only 2 months - September, down 1.17 percent and March, down 5 percent. Meanwhile, it surged the most in April, up 12 percent.
The stock hit its record high of ₹4,284.30 last month on October 20, 2023. Currently, trading at ₹4,212.45, it has rallied over 54 percent from its 52-week low of ₹2,725, hit on December 23, 2022.
ICRA, on the other hand, has advanced 31 percent in the last 1 year and almost 17 percent in 2023 YTD. It has been volatile this year, giving positive returns in 5 and negative in 5 months of the 10 completed so far this year. It rose the most in June, up over 7 percent, and shed the most in September, down over 6 percent.
Currently trading at ₹5,351.85, the stock is now over 14 percent away from its record high of ₹6,249.00, hit in August 2023. Meanwhile, it has risen over 37 percent from its 52-week low of ₹3,900.00, hit on November 12, 2022.
The brokerage has initiated coverage with a SELL call and a target price of ₹3,300, implying a downside of 21 percent.
"CRISIL is the largest rating agency in terms of revenue, with a proven track record of rating quality. Its revenue diversification efforts in the past decade have helped deliver 10-11 percent revenue CAGR, helping wade through the ratings business downturn. This, in turn, led to a much lower exposure to credit ratings (15 percent of revenue). While we build a positive view for the rating business given the tailwinds, there is less confidence in building similar organic revenue growth for the non-ratings business due to its high linkage to global investment banks and capital markets. Overall, we forecast 14 percent earnings and 16 percent EBIT CAGRs for FY2023-26E, with EBIT margin expanding by 300 bps in this period to 26 percent," it explained.
The brokerage initiated coverage on ICRA with a REDUCE rating and a target price of ₹5,100, indicating a potential downside of 8 percent.
"Compared with CRISIL, ICRA is a relatively direct play on credit ratings (55 percent of revenues. However, the company is coming out of a fairly volatile earnings performance during FY2015-21 (-5 percent EBIT CAGR), hurt by muted credit growth and a decline in securitization volumes during Covid. FY2022-23 has seen a strong recovery (near doubling of EBIT in FY2023 from FY2021 low). We believe growth rates will likely moderate at close to 13-14 percent, led by similar revenue growth. Operating leverage benefits for ICRA, unlike CRISIL, could be back-ended due to the need for catch-up on investments," it said.
Key risks: For CRISIL, growth revival in businesses linked to IB/global markets (50 percent of revenues) is a risk; for ICRA, faster-than-expected margin expansion in ratings.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of MintGenie. We advise investors to check with certified experts before taking any investment decisions.
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