Motilal Oswal

Investors with a penchant for high risk can consider the Motilal Oswal Financial Services (MOFS) stock. MOFS, with its diversified model straddling broking and wealth management, private equity and investment banking, appears well placed to benefit from the trend of improving market sentiment, promising pipeline of primary offers and increasing corporate deals. At current market price of Rs 166, the stock trades at about 15 times its likely FY10 per share earnings. Though the valuation is at a discount to the market, investors may be better off phasing out their exposure to the stock.
Expanding opportunity

Increasing retail participation and improving investor sentiment bode well for MOFS that derives a chunk of its earnings from equity broking.

Though the company has reported consecutive market share losses over many quarters — currently at 3.4 per cent down from previous quarter’s 3.7 per cent (4.5 per cent in the same quarter last year) — this hasn’t impacted its broking yield.

MOFS has improved its yield to 6.3 per cent from 5.8 per cent in the previous quarter (5 per cent in the corresponding quarter last year). This suggests that the company is veering away from chasing volumes to more profitable trades.

Despite the increasing share of derivative volumes in the stock exchanges (especially options trading), MOFS appears to have increased its focus on cash trades that enjoy higher brokerage commissions. Strengthening FII inflows may also help the company’s institutional broking business — its strong research team providing an extra fillip.

That said, improving overall yields from hereon might not be as easy, thus making it imperative for the company to focus more on the expansion of its client network. While the highly competitive nature of the business may keep client additions in check, MOFS’ expanding geographic presence and economies of scale do lend confidence.

Over the past year, it has expanded its reach to 576 cities from the earlier 487. What’s more, the expansion did not weigh on its margins, as it offset this through an optimisation of its branches. That this helped business is clear from the fact that MOFS grew its client base 14 per cent to 5.80 lakh over the past year. Addition of new clients would not only help improve volumes but also expand the scope for cross-selling.
Operating efficiencies

To align with the cyclical nature of the business, MOFS has managed to move to a flexible cost structure, through a model that hinges considerably on expansion through franchise networks. The company’s large size and strong market position also make it better placed to survive capricious fund flows in PMS business or even erratic volumes in its broking division.

This may explain how the company, despite the difficult market conditions throughout last year, managed to maintain its operating profit margins at about 40 per cent.

That the company has successfully steered itself through a number of market cycles also lends confidence on risk-management skills.
Improving revenue mix

Though broking income continues to be MOFS’ breadwinner — over 70 per cent of total revenues in FY09 — it has made significant strides in deriving revenues from its other businesses as well.

Increasing contributions from the investment banking, fund-based activities (margin funding and prop trading) and asset management fee (which includes fees from PMS and assets under advice in private equity) have helped arrest margin contraction as these businesses yield better margins.

For the coming years, the company is looking to further raise its non-broking business contribution to 40-45 per cent from the present 30 per cent. This may be achievable if the company’s AMC arm takes off.

For the quarter-ended September, the company clocked a sequential revenue growth of 15 per cent, driven primarily by improving brokerage yields, investment banking revenues and high ‘other income’ component (courtesy profit on sale of investments). Earnings too grew 31 per cent sequentially, helped by a three-percentage point expansion in operating margins to 44 per cent. Its fund-based income however fell 7 per cent sequentially (22 per cent down y-o-y), in spite of a stable loan book (now at Rs 170 crore).

This can be explained by the lower interest received on term deposits and the 3 percentage point dip in its margin funding yieldsSEBI’s move to allow exchanges to extend trading hours may however tell on the company’s margins (likely increase in costs). While the move could also help garner additional institutional interest and retail participation, the extent of benefit may be difficult to point out.

In August 2007, the company had tapped the primary market to raise over Rs 246 crore to build on its competitive position and support working capital requirements. It also planned to enhance financing facility for broking customers, infuse funds into subsidiaries and buy itself additional office space.

While it has since added generously to its client base (up by 77 per cent) and geographical reach, the company’s loan book has reduced by over 30 per cent - attributable mainly to market conditions and lack of retail participation in the current rally. Its PMS AUM on the contrary has grown, despite the equity downturn.

As for segment-wise performance, while the company’s retail broking, wealth management and institutional broking revenues have vacillated in tandem with the markets, those from its private equity and investment banking divisions have shown definite improvement.

While the PE division has turned around, the Investment Banking division has bettered earnings. The company has jointly with its subsidiary MOSL, acquired an office building at Prabhadevi in Mumbai for a consideration of Rs 165 crore last quarter.

via BL