Rakesh Jhunjhunwala, the Badshah of Dalal Street, was as usual amongst the first to understand the potential of rating companies. He holds 40,00,000 shares of CRISIL (5.64%) worth an astounding Rs. 755 Crore at the CMP of Rs. 1888.
In an interview to NDTV a few years ago, the Badshah explained in clear terms why he is so fond of CRISIL and why a rating company makes for an ideal long-term investment. He gave several reasons:
(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.
Rakesh Jhunjhunwala put it in very simple terms so that even the dullest of his fans can understand. In an interview to ET, he called CRISIL a “Halwa” business, meaning that you have to do no marketing or effort to pull in customers. Keep the door open and customers walk in by themselves.
Since the day Rakesh Jhunjhunwala gave the interview (20.08.2010) CRISIL has given total return of 347%, which works out to a CAGR of 36%. Not bad at all for a risk-free business.
Daljeet Kohli, astute stock picker that he is, pays attention to such nuances. He waited for the opportune moment and put a buy on CARE in March 2014 when the stock price was Rs. 730. He promised a target price of Rs. 848. His reasoning was simple:
“Credit Analysis and Research Ltd. (CARE), incorporated in 1993, is the second largest full service rating company in India in terms of rating income (as of FY13). CARE offers a wide range of rating and grading services across a diverse range of instruments and has over 20 years of experience in the rating of debt instruments and related obligations covering wide range of sectors. Due to ongoing economic concerns, there has been slowdown in credit off-take in the form of bank loan and debt market activities which has impacted on the profitability growth of the company. Despite short term headwinds, we are positive on the long term opportunity for the credit rating sector on the back of development in debt market which is at nascent stage in India. We like CARE as a debt free, free cash flow generating sustainable play on the Indian debt rating business which has been growing steadily. We initiate coverage with BUY recommendation on the stock with a target price of Rs 848/- (P/E of 16x for FY16E).”
Then, in August 2014, when the stock price had surged to Rs. 1200, Daljeet issued an update urging investors to still buy the stock.
Today, just 7 months after Daljeet’s Initiating coverage report, CARE is at Rs. 1440, giving Daljeet and his followers a return of 88%, which works out to an annualized return of 150%.
It is still not too late for us to dive in because in his latest report, Daljeet has increased the target price to Rs. 1551 on the logic that:
“We are positive on the huge long term opportunities for the credit rating sector on the back of development in debt market over FY15-16E and CARE is our preferred pick among the listed credit rating agencies. CARE is best placed for cyclical recovery in corporate capex and bank credit growth. On the back of expected revival in debt market from FY16E we revised our price target and increased our multiple from 22x to 25x. At CMP of Rs 1,313/-, the stock is trading at P/E multiple of 26.0x and 22.0x for FY15E and FY16E respectively. We revised our rating upwards on the stock to ‘BUY’ with revised target price of Rs 1,551/ (25.0x P/E multiple for FY16E).”
So, there you have it. If you are looking for a solid, well run, risk-free, asset-light, high ROE, free cash flow & compounding business, CARE may be the stock you are looking for.