The Hindu Business Line : ICRA: Book profits

Investors in the initial public offering from ICRA have reaped substantial rewards from their investments, though only two months have elapsed since the offer. After listing at a significant premium to the offer price, the stock has delivered almost a three-fold appreciation from its IPO price of Rs 330.

At the current price levels of Rs 940, investors can look to book profits on at least a part of their holdings, as current stock valuations appear to capture a good portion of the earnings growth potential over the next couple of years.

At about 47 times its trailing 12-month earnings, the stock also trades at a valuation premium to ICRA's peer in the ratings space — Crisil (which trades at 33 times trailing earnings).

This is despite Crisil having a larger and broader revenue and earnings base. All comparisons have been made on consolidated operations.

Margins improve

As the IPO was structured mainly as an offer for sale by the co-promoters of ICRA, the lion's share of the offer proceeds will not be deployed in the business. Investors in ICRA will, therefore, have to look mainly to organic growth in the company's existing businesses to deliver an improvement in earnings from current levels.

On this score, the first set of earnings numbers declared by ICRA, as a listed entity, has bettered expectations at the time of the IPO.

On a consolidated basis, ICRA has managed net profits of Rs 19.9 crore on a total income of Rs 70.57 crore for FY-07. This translates into per share earnings of Rs 19.9 on the expanded equity base of Rs 10 crore.

The company's EBIDTA margins have also staged an improvement in relation to the previous year, with margins for the financial year ended March 2007 hovering at about 42 per cent against 38 per cent last year.

The key positive feature of the numbers is that while the rating services business has seen an improvement in profit margins, the company has also witnessed improving profitability across other business segments such as advisory services and outsourcing services.

With a ramp-up in revenues from non-rating businesses, the company's business mix has undergone a subtle shift, with the reliance on the ratings business waning.

The contribution of rating services to revenues has declined to 55 per cent in FY-07 from 57 per cent in FY-06.

Non-rating businesses

A continuation of this trend may have positive growth implications for ICRA over the long term. The company's advisory, outsourcing and information services businesses are currently in a nascent stage and offer significant potential for scaling up from current levels.

Continued traction in these businesses could help ICRA bridge the gap in earnings and revenues with its leading competitor Crisil, which last year derived over two-thirds of its revenues from non-rating businesses.

Crisil's research and information services business has, in fact, been its key growth driver over the past couple of years and has helped boost its earnings growth. Higher growth as a result of the changing business mix could, however, result in a lower margin profile for the company over the long term, as the rating services business offers the highest margins among the various businesses managed. Trends on this score over the long term would bear watching.

Outlook for ratings business

Continued growth in ICRA's rating services business would hinge on the health of the domestic capex cycle and the willingness of corporate borrowers to access domestic debt markets. On the former, there are relatively few concerns given the ambitious capex plans lined up by leading Indian corporates and the fact that ratings on corporate fund-raising programmes are mandated by regulatory fiat.

New triggers such as rating requirements for bank loan exposures as they transition to Basel-II norms and a revival in the securitised debt market could also enhance the growth prospects for the rating services business.

However, continued recourse by Indian companies to overseas debt funding does pose a threat to ICRA's ratings business, as it derives its ratings mandates mainly from domestic borrowers.

Valuations

Apart from its own business prospects, ICRA's stock valuations are also likely to be gauged in light of those enjoyed by its closest competitor in the listed space — Crisil. On this score, ICRA's current valuations, after the stellar run enjoyed by the stock over the past two months, appear rich.

From a business standpoint, Crisil has a larger and wider earnings base, a higher and more established growth trajectory and has a controlling stake held by global rating agency S&P (Moody's has only a 28.5 per cent stake in ICRA).

Potential also exists for value unlocking on Crisil's investment book from holdings in institutions such as NCDEX.

In the light of the above factors, the current stock valuations for ICRA could be exposed to downside risk, which makes this a suitable time for IPO investors to book some profits in the stock. Given the high growth potential and the superior margin profile of ICRA's businesses, it remains a good stock to retain in one's long-term portfolio.

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