Stock Review: Crisil

 

Crisil is one of India's leading credit rating agencies. It was the first company to commence credit rating operations in this country. Even though in recent years Crisil has diversified into other businesses as well such as advisory and research & information, rating remains its core business, contributing 53 per cent of its total revenue.

Crisil is also the leader in the high-end knowledge process outsourcing (KPO) industry. Irevna, its subsidiary, provides offshore investment research to investment banks and financial institutions. It contributes 46 per cent of Crisil's total revenue. Over the last five years, this business has clocked a topline growth in excess of 40 per cent. However, at 32 per cent, its operating margin is a little lower than that of the rating business (42 per cent).

Crisil is currently a subsidiary of Standard & Poors (S&P), the global rating powerhouse. S&P, together with its associates, holds 52.43 per cent stake in Crisil.

 

History

Crisil was set up in 1987 by Asian Development Bank and ICICI Ltd, the erstwhile corporate lending company. Later Asian Development Bank sold its stake to S&P to help Crisil develop its analytical skills for rating local debt issues. In exchange, Crisil helped S&P in rating overseas fund raisings by Indian companies. In 2005, S&P took control of the company by buying out the shareholdings of ICICI Ltd and other key stakeholders via an open offer.

 

Industry dynamics

The world over credit rating is an exclusive profession. Even globally only a handful of companies can claim to be members of this club. Regulators worldwide like the number of credit rating agencies to be limited so that they can keep a tight rein on them and pre-empt any foul play. In India, besides Crisil, we have only a handful of players like ICRA, CARE, Onicra, Brickworks and Fitch (a global player).

The demand for credit rating derives from the borrowing activities of the private sector. In a fast-growing economy like India, demand for credit is bound to be strong. In future capital expenditure of companies will only rise further. Large-scale infrastructure projects will further augment the demand for credit. Currently India has a credit growth rate of 20 per cent plus, and this is unlikely to decline anytime soon. According to analysts, capital formation of 30-35 per cent of GDP is required for a GDP growth rate of 8 per cent and above. Therefore, the credit rating business has strong prospects in the foreseeable future. Historically (since 2005) Crisil has been growing at a rate that is twice the rate of credit growth in India.

In 2007 the Reserve Bank of India (RBI) implemented the Basel II norms, which required banks to provide provisioning as per the credit rating assigned by an external credit assessment institution (ECAI) like Crisil. This is a win-win situation for all the players involved: banks have to provision less for highly-rated companies while a corporate with good rating is able to raise money from banks at a lower interest rate. Crisil is the leader in this segment with above 51 per cent market share. In India bank loan rating is a bigger business than bond rating.

 

Sources of moat

High entry barrier. As mentioned above, credit rating is an exclusive business. In India rating agencies need to obtain a licence from the Securities and Exchange Board of India (SEBI) to start operations. Since this licence is not granted easily, it acts as a high entry barrier for aspiring entrants. Moreover, with only a handful of companies operating in this space globally, there is very little competition for Crisil.

The rating agency business is also highly knowledge-intensive, which also serves as an effective entry barrier. Credit rating requires employees to have specific skills, which in turn requires constant training so that they keep abreast of the latest happenings in the market. For a competitor without any credit rating background to achieve both effectively and give Crisil a run for its money would be difficult.

Brand name. Getting rated for raising debt is, one, a regulatory imperative, and two, it also gives investors the confidence to invest in that instrument. Hence, getting rated by a reputed rating agency adds to the borrower's credibility. Crisil's longevity and its international lineage make it a powerful brand name in India. As a result, it has been able to create a perceived product differentiation in the minds of the investment community. It leverages its brand to command a premium for its services, which incidentally, is not too different from that delivered by any other rating agency.

Cash kitty. At the end of December 2010, the company had cash and mutual fund investments amounting to Rs 131 crore.

It had another Rs 107 crore tucked away in the form of long-term investments, primarily as equity investments in its own subsidiaries.

The company has successfully generated positive cash flows for the last 10 years. Its cash kitty gives Crisil added financial muscle with which it can battle any rival.

Furthermore, it gives Crisil the option to venture into new territories. The company has developed a reputation for acquiring small companies and then scaling up their operations by leveraging its (Crisil's) clientele, skills, and processes. Irevna, which it acquired in 2005, offers one example. From 29 per cent of total revenue, its contribution has now risen to 46 per cent. Recently Crisil acquired Chicago-based Pipal Research for approximately `58 crore . The latter provides research to the corporate sector.

 

What could cause moat to be breached

Breaching the moat of a company like Crisil is difficult, if not impossible. Its competitive advantage arises primarily from a regulatory barrier, and partly also from market dynamics. Being the first mover, Crisil has cemented its position in the market. Having the world's leading international rating agency as its parent also helps nullify competition in a business that banks heavily on reputation. In Crisil's case, its moat is more likely to be breached due to its own failings rather than due to a competitor's strategic brilliance. So far Crisil has judiciously used its surplus capital to further strengthen its position.

 

Financials

Over the last five years, Crisil's revenue has gone up from Rs 289 crore (CY2006) to Rs 628 crore (CY2010), a compounded annual growth rate (CAGR) of 39 per cent. Over the same period, its profit after tax has grown at a faster CAGR of 60 per cent to end CY2010 at Rs 216 crore. Its high rate of profit growth points to its ability to keep a tight leash on spending. Its average operating profit margin over the last five years stands at 37.32 per cent, though it took a hit in 2010, when its operating margin dropped by 300 basis points.

Crisil's return on equity is in the high 30s, while its high five-year average return on capital employed of 54.56 per cent shows that it has made prudent investment choices so far.

Another key characteristic of the company is that it has never borrowed money. Hence, it pays no interest cost. It is also a regular dividend-paying company, distributing at least one-fourth of its profits via dividends. For the past five years its dividend payout ratio has averaged 37 per cent.

 

Valuation

Currently the company is trading at a 12-month trailing price-earning ratio (P/E) of 27.31, which is close to its historic P/E ratio of 24.83.
The company's EPS has grown at a CAGR of 58.56 per cent over the last five years. This gives it a price-earnings to growth (PEG) ratio of 0.46, which, considering the company's potential and fundamentals, is an absolute steal. The icing on the cake is the dividend yield of 2.5 per cent. Moreover, the dividend payout ratio has been on the ascendant for the last three years.

However, the stock's high price and lack of liquidity would perhaps be deterrents for most investors. Currently a share of Crisil trades at the Rs 8,000 level, which makes it one of the most expensive scrips available in the market.