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Credit Analysis and Research

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Credit Rating
Sumit Duseja
[email protected]
Ph. No. 91 4289 5600 Ext.630
December 06, 2012 I PO - Note
Investment Rationale
Second largest player: CARE is the second largest player in
Indian credit rating industry in terms of rating revenues. It is
the 3rd rating agency established in India (1993) after CRISIL
(1987) & ICRA (1991). Company's top 3 shareholders are all
public sector banks which provide company strong network
across banking and other financial intermediaries. Owing to
its long years of experience, company has developed strong
brand recognition and credibility in the ratings market, gained
through years of experience in the ratings business.
Regulations ensure good long term opportunities: Mandatory
(Private Placement, Commercial Paper, IPO grading etc) and
incentivized rating (Basel II) of credit on the back of stringent risk
assessment measures adopted by regulatory institutions ensures
continuous long term growth of the credit rating industry.
Diversification into newer products category: CARE has entered
in fast growing new product categories such as the SME,
education institution grading, real estate ratings and valuation
of market linked debentures. CARE has the freedom to enter
into overseas markets as its major shareholders do not have
the same business out of India, unlike CRISIL and ICRA.
Revival in GDP growth rate would boost rating business:
Demand for rating services is driven by overall capital
mobilization in the economy which is linked with economic
growth that fuels demand for both capital and operational
related funding. Planning commission's target of 8.2% GDP
growth rate for the XIIth Five Year Plan (2012-2017) requires
estimated doubling of investment in infrastructure that would
boost the demand for capital and thus ratings.
Strong Financials: CARE registered robust revenue and PAT CAGR
of 38% and 44%in last four years. CARE is a debt free company
with cash and cash equivalent of INR 3,375mn, as of Sep 2012,
which translates into 118/share. Company generates high free
cash flow (FY12 FCF/PAT is 78%) and RoNW of 34%.
Valuation & Recommendation
We are optimistic on the huge long term opportunities for the credit
rating sector on the back of development in debt market which is at
nascent stage in India. CARE, being one of the largest players in the
industry is positioned strongly on back of years of rating experience
across various industries along with high brand recognition and
strong industry network. On the valuation front, at upper band,
stock is available at 21.5x annualized H1FY13 EPS. Historically,
industry PE has oscillated between 20x-30x. CARE, however, is more
comparable to ICRA in terms of size but outscores in terms of
operating margins and CAGR over the last 4 years which has been
38%vis--vis 20%for ICRA. Hence, it should command better
multiples enjoyed by ICRA. We recommend SUBSCRIBE to the issue
for listing gains as well as a good long term investment.
Credit Analysis and Research (CARE) is the second largest credit rating agency in India in terms of rating revenue. It offers
services across a diverse range of instruments and industries and operates broadly through two main verticals 1) Bank Loan
Rating and 2) Corporate Debt Rating. Its clients include BFSI, private sector companies, central PSUs, sub-sovereign entities,
SMEs & micro-finance institutions, among others.
Issue Snapshot
Issue Open: 7-December-12
Issue Close: 11-December-12
Price Band INR 700-INR 750
Issue Size INR5,528 mn - INR6,633mn
Market Cap INR 43,859mn - INR 52,630mn
@ INR 700 @ INR 750
Issue Size (No. of Shares) 7,199,700 7,199,700
QIB: 3,599,850 3,599,850
Non-Institutional: 1,079,955 1,079,955
Retail: 2,519,895 2,519,895
Face Value: INR 10/share
Book Value/Share: INR149 as of Sep-12
EPS FY12: INR 41
Capital Structure
Pre Issue Equity INR 286 mn
Post Issue Equity @ INR700 INR286 mn
Post Issue Equity @ INR750 INR286 mn
Bid Lot 20 equity shares & in multiples thereof
Minimun Bid Amount @ INR 700 INR 14,000
Minimun Amount @ INR 750 INR 15,000
IPO Grade Exempted from grading
Shareholding Pattern (%) Pre Issue Post issue Post issue
@ INR 700 @ INR 750
Promoter & Promoter Groups 0.0 0.0 0.0
Financial Institutions 100.0 74.8 74.8
Public 0.0 25.2 25.2
Total 100.0 100.0 100.0
Total Shares 28,552,812 28,552,812 28,552,812
Objects of the Issue
This is offer for sale by existing shareholders and there is no
fresh issue by the company.
Lead Managers: Kotak Securities, ICICI Securities, DSP
Merrillynch, Edelweiss Financial Services, IDBI Capital Markets
and SBI Capital Markets
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Offer for sale snapshot
Offer for salesby Pre-offer Share Post-offerShare Change (%)
holding (%) holding (%)
IDBI Bank 2,454,400 25.79 17.19 8.6
Canara Bank 2,171,200 22.81 15.21 7.6
SBI 914,500 9.61 6.41 3.2
IL&FS 855,500 8.99 6 2.99
Federal Bank 584,100 6.2 4.15 2.05
IL&FS Trust & Milestone Trusteeship 60,000 4.04 3.83 0.21
INGVysya 60,000 2.2 1.99 0.21
Tata Investment 100,000 1.43 1.08 0.35
Total Shares for Sale 7,199,700 81.07 55.86 25.21
Source: RHP, SPA Research
Second largest player
CARE is the second largest player in Indian credit rating industry
in terms of rating revenues. It is the 3rd rating agency established
in India (1993) after CRISIL (1987) & ICRA (1991) and is first Indian
institutions backed credit rating company. Since incorporation in
1993, company has completed 19,058 rating assignments and
has rated INR 44,036bn of debt as of Sep 30, 2012.
Standalone Rating Revenue - FY12 (INR mn)
3,260
1,890
1,394
0
500
1,000
1,500
2,000
2,500
3,000
3,500
CRISIL* CARE ICRA
Source: Company, SPA Research; *CY11
Company's top 3 shareholders are all public sector banks which
provide company strong network across banking and other
financial intermediaries. Owing to its long years of experience,
company has developed strong brand recognition and credibility
in the ratings market, gained through years of experience in the
ratings business.
Regulations ensure good long term opportunities
Since the opening up of the economy in 1991, the RBI and other
regulatory authorities have enacted series of regulations and
policies for risk optimization. Various steps taken to develop debt
market activities in the economy led to the rise in credit rating
industry revenues. Below mentioned are some of the guidelines
which have encouraged industry players to demand for rating
services which augured well for the credit rating industry and
thus for CARE:
Rating mandatory for issuance of commercial papers
RBI made rating of public deposit schemes mandatory for
NBFCs
In 2003, SEBI along with stock exchanges made rating
mandatory for debt instruments placed under private
placement basis and having a maturity of year or more, which
are proposed to be listed
RBI in 2003 issued prudential guidelines on the management
of the non-SLR investment portfolio of all scheduled
commercial banks except regional banks and local area banks
to make fresh investment only in rated non-SLR securities
Non-government provident fund, superannuation funds,
gratuity funds can invest in bonds issued by public financial
institutions, public sector companies/banks and private sector
companies only when they are dual rated. Further such
provident funds, superannuation funds, gratuity funds can
invest in shares of only those companies which have
investment grade debt rating from atleast two credit rating
agencies
Investment by mutual funds and insurance companies in
unrated paper/non-investment grade paper is also restricted
The National Small Industries Corporation Ltd (NSIC) was
established by GOI to promote, aid and foster the growth of
SMEs in the country on a commercial basis. NSIC has
implemented the "Performance & Credit Rating Scheme" which
encourages SME's to get rated as good rating enhances the
acceptability of the rated unit in the market and also enables
it to access cheaper credit, faster
As per the SEBI regulations, no company shall make an initial
public offer, unless it has obtained grading for the initial public
offer from at least one credit rating agency registered with
SEBI
Implementation of Basel II standards by the RBI in 2008
resulted in large scale penetration of credit ratings across
sectors and geographies, which was previously limited to a
small group of clients. Although credit rating is not mandatory
under Basel II, banks are likely to save capital and
consequently charge lower interest rates to corporate if they
get their loans rated.
Diversification into newer products category
CARE has entered in fast growing new product categories such as
the SME, education institution grading, real estate ratings and
valuation of market linked debentures. SME rating although is a
lower margin business but offers huge volume growth
opportunities owing to more than 30mn SMEs in India.
CARE has the freedom to enter into overseas markets as its
promoters do not have the same business out of India, unlike
CRISIL and ICRA. Company has also expanded its ratings business
into the Republic of Maldives and planning to expand its ratings
Credit Rating
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business in other countries, including Nepal and Mauritius. CARE
is also planning to grow its research business by increasing the
number of subscribers to its research offerings and continuing to
expand its research coverage.
Company has also entered into a non-binding memorandum of
understanding with four credit rating agencies, each located in
Brazil, Portugal, Malaysia and South Africa, to establish an
international credit rating agency, which would provide
international scale ratings to assist local issuers in mobilizing
resources from international financial markets.
Revival in GDP growth rate would boost rating business
Demand for rating services is driven by overall capital
mobilization in the economy which is linked with economic growth
that fuels demand for both capital and operational related funding.

35.2%
30.1%
26.7%
23.1% 22.8%
24.4%
23.6%
7.5%
9.5% 9.6%
21.3%
6.5%
8.5%
7.4%
6.8%
9.3%
0
5,000
10,000
15,000
20,000
25,000
FY 2005 FY2006 FY 2007 FY2008 FY 2009 FY2010 FY 2011 FY2012E
0%
5%
10%
15%
20%
25%
30%
35%
40%
Gross Bank Credit to Industry (INR bn) - LHS Credit Growth (%) GDP Growth (%)
Source: RBI, SPA Research
Planning commission recently set the target of 8.2%GDP growth
rate for the XIIth Five Year Plan (2012-2017) which requires
estimated doubling of investment in infrastructure. Although, the
country is currently witnessing slowdown owing to sluggish global
environment and delayed policy actions, the growth is expected
to pick-up with increased focus of Govt. to fasten the reform
measures as evident by recent policy announcements. Also, direct
cash subsidy, if executed well, could be a big step in the way of
boosting consumption scenario followed by revival in investment
cycle.
Strong Financials
CARE registered robust revenue and PAT CAGR of 38%and 44%in
last four years on the back of implementation of Basel II by RBI in
2008 and higher demand by corporate to raise capital through
debt market in order to diversify their funding requirements. The
volume of debt rated by the company increased from INR 4,326bn
in FY08 to INR 9,269bn in FY12, at a CAGR of 21.0%.
Operational Metrics:
Particulars FY09 FY10 FY11 FY12
Volume of Debt Rated
- Bank Loan Rating 3,889 3,547 5,199 6,788
- Corporate Debt Rating 2,021 2,980 2,870 2,480
Total Volume of Debt Rated (INR bn) 5,911 6,527 8,069 9,269
Total New Issues Rated 1,579 1,808 2,187 5,980
Avg. Issue Size (INR bn) 3.74 3.61 3.69 1.55
Avg. Fees (%) 0.016% 0.021% 0.021% 0.020%
Total Employee 158 222 310 500
Avg Revenue/Employee (INR mn) 5.96 6.14 5.37 3.78
Source: RHP, SPA Research
CARE is a debt free company with cash and cash equivalent of INR
3,375mn, as of Sep 2012, which translates into 118/share. Company
generates high free cash flow (FY12 FCF/PAT is 78%) and RoNW of
34%.
Industry Overview
Indian credit rating industry is dominated by 3 major players
which are CRISIL, CARE and ICRA owing to their early mover
advantage, strong back-up and long presence in the industry. These
three are only allowed by RBI for bank loan rating which accounts
for higher share of total rated volumes. Credit rating business
largely depends upon credibility and strong networking which
prevents new player from establishing its presence in the industry.
In the initial stages, the rating agencies faced several challenges
as the corporate debt market in India was at an embryonic stage.
However, after subsequent regulatory guidelines and requirements
that encouraged and made rating mandatory, credit rating has
made rapid strides in terms of the number and value of instruments
which have been rated.
The demand for rating also depends upon the development of
debt market in the economy. India's corporate bond market
(comprising public debt offers, debt private placements and
commercial paper) is relatively small in comparison with the
other markets. The ratio of corporate debt to GDP in India is ~14%
which is quite low as compared to other nations.
Also, share of corporate bonds in total debt is also lower at ~4%
compared to 17% in China and 11%in USA. This therefore presents
large scope for the development of corporate debt market which
consequently benefits credit rating industry. Government also
lately realized that the corporate bond markets need to be
strengthened to encourage participation of long term investors,
reduce cost of public issuance and increase liquidity through
improving the market infrastructure. GOI is expected announce
some reforms soon, including easing of norms for investment by
pension and provident funds in these corporate bonds, to give
this segment some sort of depth.
Credit Rating
4
Peer Comparison
Historically, industry PE has oscillated between 20x-30x. CARE, however, is more comparable to ICRA in terms of size but outscores in
terms of operating margins and CAGR over the last 4 years which has been 38% vis--vis 20%for ICRA. Hence, it should command better
multiples enjoyed by ICRA.
Company
CMP M-Cap Cons. Sales Cons. Sales Cons. EBIDTA Margin RoNW FY13E EPS P/ E
(INR) (INR Mn.) FY12 (INR Mn) 4 years CAGR FY12 (%) FY12 (%) (INR) (x)
CARE @ 700 700 19,987 1,905 38% 71% 34% 34.9# 20.1
CARE @ 750 750 21,415 1,905 38% 71% 34% 34.9# 21.5
CRISIL* 1,029 73,230 8,070 19% 33% 50% 32.7# 31.5
ICRA 1,400 14,000 2,075 20% 33% 19% 55.6# 25.2
Source: Company, Bloomberg, SPA Research *CY11EPS #Annualized
Investment Concerns
Any sharp fall in GDP growth and consistent high interest rate
may limit demand for credit thereby impacting rating revenues
Currently, accessing the overseas debt market by Indian
borrowers and issuers is regulated, which includes end-use
restrictions of such borrowings. Any change in such regulatory
regime, which liberalizes accessing overseas markets for
raising debt funds, may adversely impact issuance of debt
instruments in the domestic market
Long term risk related to adoption of IRB (internal rating based)
approach by the banks to rate the corporate loans. As per the
timeframe specified for implementation of the IRB Approach
as set forth in the Circular, RBI may, subject to an 18 months
detailed analysis of the applicant bank, commence grant of
approvals by March 31, 2014
Credit Rating
H1FY13 - Consolidated
Particulars (INR mn) H1FY13
Revenue from Operations 912
Employee Benefit Expenses 243
Other Expenses 79
EBIDTA 590
EBIDTA Margin (%) 65%
Depreciation 19
Other Income 128
EBT 699
Tax Expense 202
Tax Rate (%) 29%
PAT before minority interest 497
Minority Interest (1)
PAT 498
PAT Margin (%) 54%
EPS 17
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Financials Standalone
Income statement
Year ended 31st March FY09 FY10 FY11 FY12
Income from Operations 942 1,362 1,665 1,890
Growth (%) 81.21% 44.63% 22.24% 13.51%
Employee Benefit Expenses 153 216 308 411
Other Expenses 59 68 99 127
EBIDTA 730 1,078 1,258 1,353
EBIDTA Margin (%) 77.52% 79.18% 75.56% 71.57%
Depreciation 10 14 22 19
Profit before Interest & Tax 720 1,064 1,236 1,334
Financial Charges 0 0 0 -
Other Income 58 158 58 282
Profit Before Tax 778 1,223 1,294 1,616
Tax Expenses 254 366 414 459
Profit after tax 524 857 879 1,157
PAT Margin (%) 55.64% 62.91% 52.82% 61.22%
Balance Sheet
Year ended 31st March FY09 FY10 FY11 FY12
Share Capital 78 95 95 286
Reserves & Surplus 1,257 2,040 2,847 3,482
Net Worth 1,335 2,135 2,943 3,768
Loans - - - -
Non-Current Liabilities 32 33 47 58
Current Liabilities & Provisions 211 275 368 455
Total Liabilities 1,578 2,443 3,357 4,281
Fixed Assets 179 278 421 483
Investments 1,172 1,860 2,586 2,749
Other Non-Current Assets 100 133 126 125
Current Assets 127 172 224 923
Total Assets 1,578 2,443 3,357 4,281
Cash Flow
Year ended 31st March FY09 FY10 FY11 FY12
Cash Flow from Operating Activities - A 505 748 855 979
Cash Flow from Investing Activities- B (471) (675) (808) 25
Cash Flow fromFinancing Activities- C (22) (38) (56) (404)
Net Cash Flow (A+B+C) 12 36 (9) 601
OpeningCash 47 59 94 85
Closing cash 59 94 85 686
Key Ratios
Year ended 31st March FY09 FY10 FY11 FY12
Debt to Equity (x) - - - -
Cash EPS(Rs.) 19 31 32 41
RoCE (%) 44.78% 43.00% 33.10% 28.46%
RoNW (%) 48.36% 49.40% 34.64% 34.49%
BV/Share (Rs.) 47 75 103 132
EPS (Rs.) 18.35 30.01 30.80 40.52
P/E at lower band (x) - - - 17.27
P/E at upper band (x) - - - 18.51
Source: RHP, SPA Research
Credit Rating
6
Credit Rating
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