ICRA

Investors can consider accumulating the stock of Investor Information and Credit Rating Agency (ICRA). Having consistently delivered a high rate of earnings growth, ICRA is expected to manage growth at a fair clip over the next two-three years, given the sizeable opportunities in the credit rating business.

The sector’s oligopolistic nature, strong brand equity and higher demand for rating services likely from India Inc’s increased domestic capital raising plans, offer a sizeable opportunity for the company. The strong cash flows and low debt requirements of the business, impressive operating profit margins for the ratings business (51 per cent), also make the stock a stable addition to one’s portfolio, despite a small cap status.

At the CMP of Rs 485, ICRA is trading at a trailing one year PEM of 13.7 on a consolidated basis, at a discount to the lone listed competitor CRISIL. The discount may be justified by CRISIL’s more diversified business profile, even as ICRA is highly reliant on rating services.
Business

ICRA is engaged in the business of credit ratings, advisory, outsourcing, information and IT services. Over the last few years, the company has set in motion initiatives to diversify its revenues, although rating services still contribute the major chunk of revenues and earnings. For the nine months ended December 2008, rating services contributed 64 per cent of the total revenues and 92 per cent of the operating profit (EBIDT).

ICRA’s consolidated revenues grew at 34 per cent CAGR in the last three years (FY 2006- FY2008) while net profit grew by 41 per cent in the same period.

For the first nine months of 2008-09, the company’s profits grew by 35 per cent, due to a surge in rating income which grew by 39 per cent. Other businesses such as consultancy and outsourcing have grown at 42 per cent and 127 per cent, respectively, on a lower base.

The operating margin for the standalone business is 51 per cent; this drops to 35 per cent on a consolidated basis, as other business incurred higher operating costs.

With ratings being the key driver of margins, operating profit margins may see some moderation in the coming quarters. A decline in the average size of rating mandates (as the company rates smaller companies), even as the cost of monitoring rises (given the more susceptible credit environment), may keep realisations under check.

This may be partially offset by moderating employee costs as attrition-related pressures decline (employee costs account for 41 per cent of operating revenues).

In the non-rating businesses, ICRA’s Information service segment has seen fall in revenues and may continue to be vulnerable to the slowdown in coming quarters. Advisory services, given their lumpy nature, may not be a consistent contributor. ICRA’s IT subsidiary has acquired two companies (Axiom Technologies and Sapphire International Inc) in the last fiscal but the benefits from these acquisitions can only be reaped in the long term.
Growth Prospects

The near-term revenue driver for Indian rating agencies is the mandatory requirement of ratings for bank loan exposures. Industry estimates suggest that about 30 per cent of the current loan exposures of banks by value and about 55 per cent in number remain unrated as of now.

The RBI requires all commercial bank loans of above Rs 10 crore to be rated by end of 2008-09. Alternatively they will have to set aside more capital for such un-rated loans (through higher risk weights).

That may prompt banks to obtain ratings on the residual loans to free up capital for lending. ICRA has already signed MoUs with more than 23 banks, including SBI, Canara Bank, Central Bank of India and Andhra Bank for providing rating services and can be expected to reap revenues from their mandates.

Incremental loans advanced will also require ratings, spelling an ongoing opportunity for ICRA. Apart from the ‘line of credit rating’, banks may also require ICRA’s services when they raise capital to meet their capital adequacy norms. According to the RBI’s currency and finance report projection released in September 2008 , the banking sector would require additional capital of Rs 5,68,744 crore over the next five years to maintain capital adequacy of 12 per cent.

With India’s corporate debt market in a nascent stage, corporate credit ratings will be the key medium to long-term revenue driver for rating agencies such as ICRA.

With the focus of Indian companies turning back to domestic debt (post credit crisis), domestic debt funding will play a major role in India Inc’s capital raising plans over the next five years; spending related to the Five Year Plan may also expand debt raising. Estimates suggest that new issues in corporate debt have surged by 44 per cent in the first quarter of 2009.

The moribund state of the equity markets may also prompt more companies to turn to debt, especially given the downward bias in interest rates. In addition to corporate bonds, state and local level entities (municipal bonds and state level bonds) are also expected to tap the market for funding requirements. The securitisation market also offers huge potential but is still in an early stage of development.