ICRA’s Q1FY18 revenue dipped 20% due to sale of IT business; excluding which, revenue grew 5%. Ratings segment jumped a strong 9%, led by robust 17% surge in the profitable debt segment and negligible exposure to the SME segment. Adjusted operating margin catapulted 490bps due to sale of low-margin IT business and rising share of debt segment. Riding: (i) strong structural opportunities in domestic debt market where ICRA is in pole position; (ii) focus on core ratings business (driving 770bps Ebitda margin expansion over FY17-19e) and (iii) benefiting from strong parentage (Moody’s potentially further raising stake), we estimate 21% earnings CAGR over FY17-19. Hence, upgrade to Buy with DCF-based revised target price of Rs 4,527. However, with cash balance of Rs 4 bn, there is scope for diversifying acquisition, which may stall margin expansion.
Great showing in domestic ratings
Revenue grew 9% y-o-y in Q1FY18 led by spurt in corporate debt, while bank loan ratings remained muted. The outperformance was due to ICRA’s leading position in the profitable debt ratings segment and negligible exposure to the SME segment, where government subsidy was cut. Going forward, while management expects debt market to extend its strong growth trajectory, bank credit growth is anticipated to remain muted. Adjusted operating margin expanded 650bps y-o-y to 38%.
Outsourcing services slow down
The outsourced services segment slowed down to 3% during the quarter. Management attributed this to the segment maturing and rupee appreciation. Outlook for the segment is of high single digit growth; however, ICRA has been diversifying to customers other than Moody’s. Adjusted operating margin plummeted 930bps y-o-y due to higher expenses during the quarter.
Outlook and valuations
With robust structural avenues in debt market, we estimate 21% earnings CAGR over FY17-19. We value ICRA using DCF valuation due to its healthy growth prospects and strong brand franchisee, factoring 15% growth in the first 5 years, 14% in the next 5 and then declining growth over the following 5 years to terminal rate of 5% and discount rate of 9.1%. We upgrade to ‘Buy’ from ‘Hold’.