CDSL Initiating Coverage Research Report By Motilal Oswal

Value play on the Indian capital market

Central Depository Services (CDSL) is one of two depositories in India and the only one to be listed. The BSE initially promoted CDSL, but subsequently diluted its stake to leading banks, which became CDSL’s ‘Sponsors’.

CDSL +4% today
Central Depository Services (India) Limited

Govt directs all unlisted companies to dematerialise shares by Septemberhttps://t.co/tx8nDv2XpF

— Nigel D'Souza (@Nigel__DSouza) June 15, 2018

Part of duopolistic industry with high entry barriers:

NSDL (promoted by the NSE) and CDSL (promoted by the BSE) are the only two depositories operating in the country. Given their strong parental lineage, these depositories will enjoy a clear advantage over any new entrant, in our view.

CDSL’s strategy of consolidating its position among retail investors has helped it expand its share in incremental beneficial owner (BO) accounts (63% in FY18) and depository participants (594 v/s 276 for NSDL).

We believe this strategy enables CDSL to spread its risk and not depend on a few large institutions.

Diversified revenue mix; growth avenues beyond capital markets:

Around 70% of CDSL’s revenue comes from market-linked activities (such as transaction, IPO charges and annual issuer charges) and the rest from online data charges/KYC and other such value-added services.

Moreover, opportunities such as digitization of academic records, depository services to unlisted companies, insurance and commodity repositories provide further room for diversification beyond the capital market.

Central Depository Services (CDSL) has reported another impressive financial performance https://t.co/yoS6lQr2Wc

— Financial Express (@FinancialXpress) January 25, 2018

Asset light business model, operating leverage drive robust cash flows:

A robust EBITDA margin of ~60% (major costs being employee and technology), coupled with a negative working capital cycle and minimal capex requirements, makes the business cash-rich. Given the inherent strengths, CDSL is likely to maintain healthy free cash flows, dividend payout (~40%) and return ratios of ~17%.

We expect revenue/PAT CAGR (FY18-20) of 8.1%/8.2% to INR2.2bn/1.2bn led by steady growth across segments.

Valuation:

We believe CDSL is an attractive play on the capital markets growth story and the financial inclusion theme. The duopolistic nature of the business, plenty of opportunities to scale up, low capex requirement and cash-rich balance sheet, makes CDSL a long-term steady compounder.

The stock has corrected ~40% from its peak, in tandem with the fall in the equity markets, especially midcaps. However, current valuations of 19.4x FY20E EPS appear attractive, given the inherent strengths of the business and the relative discount to NSDL’s valuation (post the recent stake sale announcement, Exhibit 25).

Further, the company has net liquid investments of INR5.6bn, which is ~24% of current market cap.

We value CDSL at 25x FY20E EPS to arrive at a target price of INR290, implying 29% upside. We initiate coverage with a Buy rating.