Crisil, a subsidiary of S&P (67 per cent stake) that was the first leading rating agency to diversify into research services, now derives close to 70 per cent of its operating profit from research.
The company picking up 8.9 per cent stake in CARE Ratings, a pure play on the ratings business, could be a strategic move to re-build its focus back on ratings. As the ratings business revives along with the underlying growth in the economy, Crisil should stand to gain from greater presence in this high-margin business.
CARE’s principal shareholders have long been keen on offloading their holdings. This can provide Crisil with scope to up its holdings in the company to a significant level, if it intends to. LIC currently holds 9.7 per cent stake in CARE.
After Crisil announced the 8.9 per cent stake buy in CARE at ₹1,659 per share, the stock of CARE Ratings has rallied by about 12 per cent from ₹1,422 levels. At the current stock price of ₹1,588, significant upsides may be limited, given the already steep valuations. For Crisil, given that the move could be positive over the long run, the price for acquiring the stake looks justified.
In India, the fortunes of ratings agencies depend on the underlying economy and capital market conditions. In recent times, lack of investment activity has impacted the revenues of rating agencies. If there is an improvement in capex cycle hereon, rating agencies stand to benefit. SEBI’s measures on consistency in recognition of default across rating agencies, and stability in ratings, put out last year, also augur well for the sector over the long term.
CARE delivered a modest 6 per cent growth in rating income in FY-17. This was lower than the 8 per cent growth reported by peers Crisil (2016 calendar year ending) and ICRA (FY-17).
How they stack upICRA, CARE and Crisil hold the lion’s share in the ratings market in India. Both Crisil and ICRA have foreign ownership, while CARE doesn’t.
Ratings contributes nearly 30 per cent of Crisil’s revenues, while research contributes about 66 per cent. Research also constitutes the chunk of operating profit for Crisil. Lacklustre rating revenue growth and somewhat slowing growth in research business in the past few quarters could add pressure to earnings in the near term. Nonetheless, leadership position, diversified business model and strong promoter background remain key positives. The stock trades at a rich 38 times FY18 Bloomberg consensus EPS. While it may continue to command premium valuation, significant upside is unlikely in the near term.
ICRA has four main business segments — ratings, consulting, outsourced services, and IT-related services. Ratings accounted for 64 per cent of the total revenue in FY-17.
Similar to rating revenues, ICRA’s consulting services too remained sluggish, as revenues grew 4 per cent in FY17. The ICRA stock trades at a steep 44 times its FY18 consensus EPS.
While near-term hitches persist, the company’s relatively stronger position in the ratings business, particularly in bond markets, will continue to sustain valuations.
Like its peers, CARE’s ratings revenue growth has been muted. However, the company, thanks to its pure ratings focus, commands the highest margins at about 65 per cent, compared to both Crisil and ICRA (at about 30 per cent).
Sustainability of superior margins will need some watching as it expands its revenues from the lower-ticket SME segment.
At the current price, the stock trades at 30 times its FY18 consensus EPS. Significant upsides may be limited hereon.