In an earlier piece, I have distilled Rakesh Jhunjhunwala’s advice on why a credit rating stock is a safe and sound investment. It is worth recalling the salient points:
(i) Rating is an indispensible business. Every company has to have a rating before it is allowed to raise equity or debt;
(ii) It is an asset-light business. All you need are qualified personnel;
(iii) The entry bar is very high. Rating agencies need to have impeccable reputation before they are allowed to be set up;
(iv) The fortunes of the credit rating business are dependent on the level of debt issuances in the Country. In the USA, financial services is 16% of the GDP. In India, it is only 4%. This means that the scope for growth of financial services is immense;
(v) The business enjoys high ROE, it is debt-free and generates high level of free cash flows;
(vi) It is a duopoly business with CRISIL and CARE dominating the field (ICRA is a smaller player). Most companies obtain a rating for both (or all three) agencies and use the one that suits them best.
Now, Narendra Nathan of ET has issued a report recommending an investment in CARE.
He points out that the cyclical recovery in corporate capex and bank credit growth, and attractive valuation compared to its peers make Care the preferred choice with analysts.
He explains that Analysts are now getting bullish on the long-term (2-3 years) growth opportunities for the credit rating sector because it is best placed to benefit from the cyclical recovery in corporate capex and bank credit growth. The sector is already doing well because of the pickup in debt issuances in the recent past. He also points out that according to Prime Database, debt placements during the first half of 2014-15 went up by 22% compared to the corresponding period last year.
Narendra Nathan adds that another factor helping credit rating agencies is the improvement in the credit environment. He argues that the revival in market sentiments means that IPOs and debt issuances will rise manifold, increasing business opportunities for rating agencies like Care.
He further emphasizes that Care is the preferred choice because it is the cheapest stock based on valuations. It is quoting at 35 times trailing P/E ratio compared to 51 times for Crisil and 45 for Icra. Care also has a liberal dividend policy.