Opportunities in the broking space

This article was originally produced in November 2009.

The broking industry is considered to be at a nascent stage and evolving to grow bigger as they explore new areas for growth. Importantly, experts say that the Indian households’ savings will gradually move away from traditional instruments towards equity and other related instruments.

Room to grow
From the longer-term perspective, a growing economy and lower penetrations levels of financial services are positives. As the economy grows, households’ savings will also grow which will find its way into various savings instruments. “We generate about Rs 20 lakh crore of annual savings but only a fraction of this comes to the financial markets, which will grow as the economy grows,” says Motilal Oswal, chairman, Motilal Oswal Financial Services.

During 2008-09, only 4.7 per cent of total household savings of Rs 12,95,000 crore was deployed into equities. Experts believe that this ratio could gradually go up to 14-15 per cent by the year 2020. This along with the growth in GDP could lead to annual inflow of Rs 4.5-4.9 lakh crore into equities by 2019-20, significantly higher than Rs 61,400 crore in 2008-09. However, this will be a gradual process wherein investor participation will increase as a result of intermediaries expanding into new cities. We have already seen this happening, in the form of increase in the number of demat accounts with the CDSL and NSDL. “In India less than a per cent of population trades in the market, which is in sharp contrast to 25 per cent in the developed economy, which suggests that there is more room for the growth,” says CJ George, managing director, Geojit BNP Paribas Financial Services.

Investor rush
Considering that India is among the fastest growing economies, the country has been able to attract foreign institutional investors (FIIs) in the past. Its overall weightage in the MSCI global index has gone up from 0.4 per cent in 2006 to 0.9 per cent in 2009 – its weight in the MSCI Emerging Markets Index stands at about 6.4 per cent. As more investors look at India as an investment destination, the number of FIIs registered with the SEBI has gone up from just 685 in 2004-05 to 1,658 in 2008-09. And, while FII investments have risen over the years, their share in turnover now stands at almost 10-11 per cent of the total market turnover.

Domestic mutual funds, too, have played a large role. India’s mutual fund industry’s total asset under management (AUM) has gone up from Rs 79,500 crore in March 2003 to Rs 7,43,700 crore in September 2009 as more and more investors are looking for alternative instruments. According to estimates, mutual fund AUM is about 6 per cent of GDP, which is lower compared to about 80 per cent in the case of the US, over 85 per cent in the case of Australia and 40 per cent in the case of Brazil.

Inventing to grow
While the opportunities are immense, many large financial intermediaries have not restricted themselves to the equity broking business. They have begun to de-risk their businesses by diversifying into other emerging opportunities in the last couple of years. For instance, a few years ago, the commodity broking business contributed a small chunk to revenues, but it has now emerged as the growth engine for many companies. Likewise, companies have also ventured into wealth management, investment banking, mutual funds and insurance businesses. They are now looking at other areas like forex trading, which put together could further de-risk the business model in the medium to long-term.

Some concerns
Many companies have shown volatility in their earnings as the fortunes of these businesses are closely linked to the performance of the domestic and global markets. Although companies are diversifying into new potential areas, competition is only increasing and achieving noteworthy success in these new ventures may not be easy. Additionally, these initiatives will require substantial investments, thus only companies with sound business strategies will be able to garner the resources. Thus, experts also believe that over a period of time, smaller and weaker players will give way to efficient and large players.

Also, in many of the businesses regulations could be hurdles. We have already seen in the case of mutual funds, where third party commissions have been brought down. The same could be the case with the insurance business as IRDA is contemplating new guidelines on insurance commissions paid to agents which could impact the business. While companies will have to evolve themselves to the changing environment, the solution for distributors is to add value. Says CJ George, managing director, Geojit BNP Paribas Financial Services, “Considering the competition and falling commissions and brokerages from the third party products, the industry will need to shift focus from volume to value.”

Read on to know more on individual companies.

Motilal Oswal Financial Services
Among the key beneficiaries of the growth in capital markets and the long term opportunities in the sector would be Motilal Oswal Financial Services (MOFS). The company, which was largely into the institutional business, has also expanded into the retail segment. From 375 branches in 2004-05 its reach has increased to 1,257 across 576 cities. The company’s research capabilities, promoter’s experience, strong presence in the institutional business are among its key strengths.

The company has also successfully forayed into the commodity broking and other businesses like investment banking. In 2008-09, almost 30 per cent of its revenue came from the non-broking business. Further, MOFS has already entered into the mutual fund business, with its first scheme due for launch in the next few months. This is a logical move, as management says, that it already has a large PMS business of about Rs 750-800 crore.

On the retail side, MOFS has been expanding its branches and has been able to grow its client base from 2,38,000 in 2006-07 to 5,81,000 currently. Due to last year’s downturn, in 2008-09, the company reported a significant decline in revenues and net profits. However, it is expected to show a remarkable improvement going ahead – EPS of Rs 10.5 in 2009-10 and Rs 13 per share in 2010-11. At Rs 150, the stock trades at a PE of 14 times and 12 times its estimated FY10 and FY11 earnings, respectively; it is reasonably priced and could be considered with a long-term perspective.

India Infoline
Amongst the most diversified players in the industry, India Infoline has a strong footing the brokerage space operating about at 1,814 business locations covering 450 cities. The company started by undertaking research activities and later moved into equity broking with large success coming from internet-based trading. Today, online trading accounts for almost 80 per cent of the broking business. This gives it an edge over others and enables it to earn better returns as the resources (manpower and offices) deployed are relatively lower. Not surprisingly, its operating margins are in excess of 30 per cent and among the highest in the industry.

EYEING MARKET SHARE
	India Infoline	Religare Enterprises	Emkay Global	Geojit BNP Paribas	Motilal Oswal Fin	Edelweiss Capital
No. of branches & franchisee	1,500	1,600	377	501	1,257	53
No. cities	450	450	141	300	576	17
No. of customers	729,286	600,000	97,180	495,221	580,667	500
Revenue contribution of
Broking (%)	64	NA	93	79	75	33
Institutional broking (%) *	NA	2	45	15	NA	70
Internet trading (%) *	80	NA	2.3	18	15	**
Market share (%)	3.6	3.8	1.0	2.5	3.6	4.3
** Recently started; NA is not available; * as a percentage of Broking business; Source: company

Besides equity, the company has presence in the financing business and emerging segments like commodity broking, investment banking and wealth management. It recently got an in-principle approval for setting up a mutual fund. Although these businesses are not big, they are growing fast. During September 2009 quarter, while its life insurance distribution business grew at a healthy pace, the investment banking division was involved in several deals and is gathering momentum. The stock is currently trading at 17 times its 2009-10 estimated earnings, which reasonable in case for those who want to invest in the company for the long term.

Geojit BNP Paribas Financial Services
Geojit Financial Services changed its name after global banking major BNP Paribas took a majority stake in the year 2007. BNP’s entry has brought in the know how, experience and a global business for the company. However, Geojit still lacks in terms of diversification as compared to its larger peers given that majority of its revenues come from the south Indian regions. Also, a large part of the revenues come from the broking business. And now, the company has also exited the commodity business, which led to a fall in its revenues in 2008-09. The company however, has formed JVs and opened branches in the Middle East markets – primarily catering to the needs of non-resident Indians – which to some extent has diversified its client-base. Additionally, a large and growing client base of 4,95,221 has allowed the company to cross-sell third party products along with the broking business to grow. Nevertheless, its market share is at a respectable 2.53 per cent. At the current market price, the stock is trading 22.5times its trailing earnings, which looks relatively high even after considering its recent performance.

Edelweiss Capital
Edelweiss, whose number of customers at 500 is way below its competitors, has amongst the highest market of 4.3 per cent in the equity broking business. This is due to the company’s large presence in the institutional business, which accounts for almost 70 per cent of the total broking business. The positive side is that the company’s operating margins and the return ratios are among the best in the industry. In the last two years, the company has forayed into areas like retail broking, internet-based trading, wealth management, insurance broking, commodity broking and asset management. It generates about 33 per cent of its revenues from the broking business, while the rest comes from investment banking, asset management and financing activity. However, the company is yet to scale up its retail broking segment. Currently, it has 53 branches and franchisees spread in 17 cities, which is well below its larger peers. Based on the annualised results of the half year, the company should report an EPS of about Rs 8-40 per share for 2009-10, which suggests that at current market price the stock is trading at a PE of about 12 times and may be considered.

Religare Enterprises
Promoted by Malvinder Singh, erstwhile promoter of Ranbaxy Laboratories, Religare is amongst the fastest growing and most aggressive players in the industry. Within two years, its revenues have grown almost four-fold to Rs 1,148 crore in 2008-09 – to an extent helped by its acquisition of UK-based Hitchens Harrison in May 2008. The company started its retail and institutional broking business in 2001-02. Later, in 2005-06, it added PMS and financing businesses followed by private equity, life insurance, asset management, investment banking, wealth management and online broking in 2008-09. It also formed alliances with global names in the industry – with Netherlands-based, Aegon, for its insurance and asset management company businesses and with Macquarie for its wealth management business.

ON THE RECOVERY PATH
			For 12 months ended March 2009						For 3 mths ended Sept' 09				FY10E
in Rs crore	Net sales	% chg	Net profit	% chg	EPS (Rs)	% chg	Debt- equity (x)	RoNW (%)	Net sales	% chg	Net profit	% chg	EPS (Rs)	PE (x)	CMP (Rs)
Edelweiss Cap.	896	-17.2	186	-31.8	27.4	-29.2	0.48	8.64	260	4.6	65	49.2	38	11.9	451.6
Emk.Global Fin.	99	-28.6	-3	NA	0	NA	0.16	-3.46	24	3.4	2	796.2	3.9	15.6	61
Geojit BNP	188	-20.5	40	-31.8	1.7	-36.5	0.03	0.64	75	59.2	13	150.2	2.5	14.8	37.05
India Infoline	961	-5.8	145	-9.4	5.1	-81.7	0.2	8.65	313	13.5	58	44.3	7.5	17.2	128.8
Indiabulls Fin. Ser.	2003	18.8	99	-82.7	3.1	-85.2	2.56	2.67	297	-31.7	71	-46.8	10	14.4	143.65
Motil.Oswal.Fin.	468	-33.1	90	-47.5	6.4	-89.4	0.1	12.33	159	20	47	75.1	11	13.8	151.25
Religare Enterp.	1148	35.2	-65	NA	0	-100	1.37	-4.17	317	57.6	30	NA	11.1	34.7	385.7
Consolidated results, except for the Sept quarter results of Emkay; All net sales and profit figures have been rounded off CMP: Current market price as on 4th Nov E: Estimates % chg is year-on-year Source: CapitaLine Plus, Company

Diversification and moving along with global names could be a good strategy. However, these businesses are yet to be scaled up. This will also depend on capital infusion in the future and its ability to create a place in an already crowded market. Meanwhile, 80 per cent of its revenues come from broking and financing business. The impact of the downturn in markets was seen last year, wherein the company reported a loss of Rs 65.2 crore. This fiscal, the company has reported a net profit of over Rs 43 crore in first half. Overall, the company has a fairly large client base and market share as well as a diversified portfolio of products and services. However, at a PE of about 35 times (based on annualised first half earnings), the stock is expensive.