ICICI Securities cuts CDSL rating to ’reduce’ over high valuations, sees 14% downside

Domestic brokerage firm ICICI Securities has downgraded its rating on Central Depository Services Limited (CDSL) from ‘hold’ to ‘reduce’, citing concerns over peak cycle multiples and potentially lower-than-expected earnings growth on a high base, making the risk-reward ratio unfavourable.

Despite this downgrade, the brokerage has revised its target price for CDSL upward to ₹1,320 per share, up from the previous target of ₹1,118. However, this revised target still reflects a 14.23 percent downside from the current market price of ₹1,539 per share.

The report highlights detailed historical instances where CDSL has experienced flat or lower revenue growth, along with declining margins, leading to stock price corrections. Between FY20 and FY22, CDSL's stock price surged 6x, outperforming asset management companies, registrars, transfer agents, brokers, and wealth managers.

The company also delivered an 88 percent return in FY24 and approximately 70 percent in FY25 to date, as quarterly EBITDA increased to around ₹1.5 billion in Q4 FY24 and Q1 FY25 from an average of ₹800 million in FY23.

However, the brokerage notes that periods of consolidation and upcycle multiples, such as those observed now, often do not sustain over time.

Elevated multiples

According to the brokerage, the stock is trading at 59 times its 1-year forward core EPS and 53 times its 1-year forward EPS on FY26 estimates, nearly double the historical averages. It points to periods of flat or declining revenue growth, as seen in FY18–20 and FY23, and declining EBITDA margins due to higher costs and lower revenue growth in FY19 and FY20.

Additionally, the brokerage has noted that the price cuts, as seen in Q1FY25, indicate a possible passing of the benefits of operating leverage to consumers, which will likely limit margin expansion.

The brokerage also points out that if markets expect a significant increase in cash volumes due to restrictions on options, the impact will likely be more pronounced in the intraday segment rather than delivery, where CDSL primarily benefits. The brokerage underscored that the trend shows that delivery as a percentage of total cash trades has declined from 26 percent in FY18 to 21 percent in FY24.

ICICI Securities has projected a compound annual growth rate (CAGR) of 26 percent for revenue, 29 percent for EBITDA, and 28 percent for PAT from FY24 to FY26. Based on these estimates, CDSL’s core EPS is forecast to be ₹22.9 for FY25 and ₹27.9 for FY26.

Additionally, the valuation includes free cash investments of ₹63 per share. The upward revision in the target price reflects anticipated strong growth in capital markets, the permanent impact of increased demat accounts, potential higher cash volumes following restrictions on options, reduced regulatory risk in capital market plays, expected operating leverage, and growth opportunities in the insurance depository business.

Since August 23, the company’s shares have been trading ex-bonus at a 1:1 ratio. Over the past 17 months, the stock has surged by 232%, driven by strong participation from Indian retail investors and a steady increase in demat accounts.

For the quarter ended June 2024, CDSL reported an 82% increase in net profit, reaching ₹134.20 crore, up from ₹73.57 crore in the same period last year. Revenue for Q1 rose 72% to ₹257.38 crore, compared to ₹149.68 crore in the previous year’s corresponding quarter. As of June 2024, CDSL held a 77% market share in the number of demat accounts.

Established in 1999, Central Depository Services was set up to address the challenges of paper-based trade settlements and to facilitate more efficient securities trading in India.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before taking any investment decisions.