ICICI Securities Ltd

[Yogesh_s]

Story
ICICI Securities is the largest retail broker in India and operates popular ICICIDirect.com website. 63% of total revenue come from broking business, 90% of which comes from retail clients. As of March 2018, ICICIdirect had approximately 40 lakh operational accounts of whom 8 lakhs had traded on NSE in the preceding 12 months.

Sources of Income

Source: IPO Prospectus and FY 18 Earnings release.

Brokerage income consists of brokerage services offered to retail customers and institutional clients for trading equities, equity derivatives, currency derivatives, ETFs and overseas securities.

Income from services consists of commission from distribution of MF, life insurance and other financial products and fee income from advisory services.

Interest and other operating income consists of interest earned on bank fixed deposits held with exchanges as margin for brokerage business, interest earned on margin funding and interest earned on trade receivables.

Profit on sales of securities is the result of proprietary trading business.

Company’s classification of revenue is somewhat confusing as different terms are used in income statement, MD&A in RHP, segment results and results press release. Here is the summary if various business (totals may not add up due to differences in terminology).

Brokerage Business

Broking business is operated by 200 of own branches, about 2600 branches of ICICI Bank and 4600 sub-brokers and authorized persons. Over the years share of revenue from broking business has come down from 90% to 63% as other sources of revenue like mutual fund distribution, advisory, investment banking are growing.

Source: IPO Prospectus

Company has steadily gained market share in trading business.

Source: IPO Prospectus

Distribution Business

ICICI Securities is the second largest non-bank mutual fund distributor in India. It distributes third-party mutual funds, insurance products, fixed deposits, loans and pension products to retail customers for commission income. Except insurance products, company does not distinguish between the third-party partners whose products it distributes based on affiliation. Company earns recurring commissions for longer-term products.
Here are some key statistics of distribution business.

Source: IPO Prospectus and FY 18 Earnings release.

Investment Banking
investment banking business consists of equity capital markets services and financial advisory services that cater to corporate clients, the government and financial sponsors.

Source: IPO Prospectus and FY 18 Earnings release.

Treasury and Trading
Under treasury and trading business company manage treasury assets and engage in proprietary trading.

Source: IPO Prospectus and FY 18 Earnings release.

Charts



Source: IPO Prospectus and Capitaline.

During years of 2011 to 2014, equity markets were subdued and company’s revenue and PAT stagnated. Profits are on high gear since FY 2015 when current equity rally has began.

Balance sheet

Source: IPO Prospectus and FY 18 Earnings release.

Company has a strong balance sheet with no long term debt. The borrowings are largely for margin funding business. Company does not need any fixed assets and most of the current assets are held in the form cash or margin deposit with exchanges. Company earns interest income on these assets.

Peer Comparison
ICICI Securities is a pure-play broking and commission business and fund based revenue is minimal at present. Most of the peers earn a substantial portion of their revenue from funding activities and consequently have leveraged balance sheets, low ROE, lower operating leverage and high financial leverage.

Source: IPO Prospectus

Investment Rationale

Increasing Domestic Participation in Equity Markets
Indian markets until recently were dominated by FIIs. Over the last years, DIIs mainly mutual funds and retail investors have been a growing influence in the markets. This has resulted in diversity of opinions, lower volatility and increased depth of equity markets.

Strong macroeconomic factors such as growing gross domestic product, rising affluence, increasing formalization of economy, lower inflation and falling interest rates have contributed to the growing shift of household savings towards financial assets. Consequently, India is witnessing increasing retail and domestic institutional participation in Indian equity markets.

Growing share of financial assets
Household savings are increasingly shifting from physical assets to financial assets. The share of financial savings as a proportion of household savings has increased steadily from 31.1% in fiscal 2012 to 41.5% in fiscal 2016. The share of financial savings is likely to rise further, as stable inflationary trend is generally expected to diminish the behavior of physical savings such as investments in gold and real estate. In the past, positive real income growth and low inflation have had a positive effect on financial savings. According to CRISIL Research, the yields on 10-year Indian Government securities have reduced from 7.4% in April 2016 to 6.9% in October 2017 (Source: RBI). This falling interest rate cycle has helped channel higher investments towards equity instruments.

Leadership Position in brokerage business
ICICI Securities is the largest broker in India and is well placed to capitalize on the growing equity markets in India.

Margin Funding to grow
SEBI last year allowed brokers to offer margin funding. ICICI Securities has started offering margin funding and as of FY 18 has a funding portfolio of 556 Cr. Although small at the moment, this can grow over next few years.

Share of non-broking business growing
Share of non-broking business has grown from 10% in FY 13 to 35% in FY 18. This has resulted in lower cyclicality. This trend is likely continued further.

Highly profitable operations
Over last 3 years company has earned average ROE of 75%. Company distributes 50% of profits as dividends. Even at the bottom of the cycle, company has earned 25% ROE, more than what peers earn at top of the cycle.

Valuation
ICICI Bank came out with an offer for sale in March 2018 for Rs 520 a share valuing the company at 16,765 Cr or about 30 times TTM eps of 15. However, due to subdued market conditions at that time, IPO was undersubscribed and stock listed at 14% discount to offer price. Company is currently (April 21 2018) trading at 18% discount to offer price at Rs 425 or about 25 times FY 18 earnings. Given high ROE, leadership position, and growth prospects of the industry, this valuation appears to be fair. Cyclical nature of the business and current stage in the cycle will prevent any expansion of the PE ratio. Future returns are likely to come from earnings expansion.

At current price, dividend yield works out to be healthy 2%. Given the high profitability, company generates enough internal accruals to fund growth and pay decent amount of dividend.

Risks:

• Business is highly cyclical as revenue and volume of business both depend on level of equity indices while costs are fixed.
• Company has high operating leverage. A rise in revenue will directly flow to bottom line but a drop in revenue will also directly to flow to bottom line as costs are largely fixed. Over time, costs are likely to rise while revenue may drop occasionally depending on market conditions. In such a scenario, PAT can drop substantially.
• Company could be at a cyclical high right now and revenue and PAT could drop in next couple of years if markets drop.
• ICICI is one of the most expensive brokers in India for retail customers. Company will face stiff competition from discount brokers. Company has managed to retain its pricing structure even when discount brokers have grown in last 3-4 years.
• ICICI Securities competes with ICICI Bank for distribution of mutual funds and other services.
• Almost 75% of accounts on ICICIDirect are non-operational.
• Business is highly regulated.

Disclosure: No position but interested. Views are welcome.

[harshb232]

I would like to point here a personnel expirience. I am a recent college graduate. Intially most of my friends had demat accounts with ICICI or HDFC. But recently all of them have transited to discounf brokerages like Zerodha. Even my father have shifted to discount brokerages from ICICI Direct because commision charged by ICICI Direct is very high. I think that on the ground this trend of shifting from from full service brokers to discount brokerages is very real and this was the reason I didnt invest.

[prakashh1]

It has got one of best franchise, technologically for superior and dependable platform, credible research offerings and loyal customer base. It’s performance post listing was subdued and below expectations due to developments at parent level as well high IPO pricing. Considering the overall shift witnessed in savings pattern of individuals and gradual shift to equity markets, I expect great potential due to its great business model, credibility and safety of holdings, far superior product offerings. Though discount brokerages do pose some threat in the short term but that will vanish as such models are not sustainable as reflected in recent spate of defaults where investors suffered losses. Though their pricing is bit high but people are willing to pay the same for safety, convenience, superior products coupled with dependability of services. It’s a perfect candidate for long term sustainable growth. Disclosure: Invested in IPO, hence my views will be biased.

[shreys]

I’m currently a customer of ICICIdirect’s broking services. Most of my family members route their trades through ICICIdirect. My experience has been wonderful. Their portal is clutter free, easy to use and I’ve never experienced a technical glitch. It is without an iota of doubt an expensive broker but their prompt service and assurance of trade execution more than makes up for the exorbitant broking charges. I’ve read complaints from quite a few people whose trades were executed multiple times on the portals of discount brokers. Resolving such issues involves lengthy processes.

Also, when the portfolio churning is low, it may not be worth the while to switch to a new broker.
Avoidance of regret often prevents us from trying something new.

The biggest problem as highlighted by @Yogesh_s Ji is the cyclicality of this business. They make huge profits during bull markets but bear markets are lackluster for capital market companies. Volumes, in previous bear markets went down by as much as 50%.
Also, capital raising activities come to a standstill. Hence, investment banking business suffers.
The business is as cyclical as that of steel or other commodities.
In my humble opinion, a good time to invest in broking and investment banking companies could be in the middle of a bear market, when it’ll be available at cheap valuations. The bull market will end. Just a question of when- And whenever it happens it’ll spell doom for capital market companies.
It’s earnings potential could be nearing the top.

[hashims]

@Yogesh_s

ICICI is one of the most expensive brokers in India for retail customers. Company will face stiff competition from discount brokers. Company has managed to retain its pricing structure even when discount brokers have grown in last 3-4 years.

Thanks @Yogesh_s Yogesh_s, for the nice write up as usual.
As you have pointed out already above as one of the negative point. I feel that’s really one of the key point to see going forward apart from cyclicality of the business.
I’m a user of ICICIDirect for almost 5 years but always bothered by their huge charges. For sure there is a premium they can demand for the excellent features they provide in their reporting and data presentation for the transactions. Top notch! However the gap is very much wider than they can prevail in future especially where there are lot more of options available in the market in recent 2-3 years. Finally two years ago, i have opened an another Demat account (discount brokerage) where i do major chunk of my transactions leaving very minute portion at Icicidirect. If they can match or even little bit higher with their nearest competitor HDFC(in my opinion) then they can sustain their leadership.

[drgrudge]

Thanks @Yogesh_s, good topic and stock presentation. I had a look at the DRHP and after FY18 earnings and still not convinced.

Positives: (to add more what @Yogesh_s wrote)
Isn’t ICICI Trading costlier?

People thinking Zerodha is “free” and ICICI/HDFC charging upto 0.55% and thus not sustainable, there is more to what meets the eye.

1. They charge all inclusive, even the NSDL/CDSL DP charges when you sell from your holdings.
2. More features like: margin facility, GTC/VTC orders, best price of NSE/BSE orders, etc.
3. No technical glitches, faster, better reporting and better interface

More Trustworthy
I would trust ICICI demat than Zerodha, Angel or Edelweiss. I recommend ICICI Sec or SBI for demat/trading account to whomever ask me. Zerodha’s brokerage is “free” but there is a price we pay with the poor support (actually calling it poor is being mild), server jams when volatility is high, etc. When our portfolio value is large we should have demat (atleast the core holdings) with large banks only irrespective of the cost.

Negatives

1. Better opportunities may be available
   There are many ways to play this “financialization of savings”. I own HDFC Life and ICICI Pru Life (and planning to keep only one going forward). HDFC Mutual Fund will come up soon and within a year even NSE. I might invest in HDFC AMC, ICICI/HDFC Life and NSE to play this theme.

@Yogesh_s

At current price, dividend yield works out to be healthy 2%.

BSE is available with a better dividend yield.

2. Lately, I’m skeptical about ICICI management (read this and this and not to do anything to Chanda Kochhar). Maybe there is a reason why ICICI group stocks trades at a lower valuations.

Disc: Do not own ICICI Securities.

[mylu]

I agree on the ICICI securities high charges and people moving to ZERODHA account. Surely the ICICI charges are way too high and unless they relook at it this type of shift will continue.

One of my friend got fed up with this high charges and tried closing it but in vain . They were always telling him to keep it as basic and no/minimum charges.

He went ahead and opened a ZERODHA account in hardly 30 minutes and started using it almost from almost next day onwards.

Also one more point to highlight is its easy opening 3 in 1 account with ICICI but closing it is a mammoth task. I myself had this done before and it take minimum 4-6 weeks and you need to followup many times. The process starts with closing demat account which they never allow and ask you to move to some basic account with no charges. You need to first convince them . It takes 1-2 weeks. Once this is done, you need to request for closing the trading account which again will takes its own sweet time. Further SB account closure will happen.

[sumi00]

IMO, this stock will be a perfect shorting candidate whenever the cycle turns. Let’s see what do they have which can’t be replicated.

Research - I would rate both Edelweiss and Motilal a better research house than ICICI and yet charging lower brokerage.

LTCG - Many folks that I know are long term guys but LTCG will force them to trade a bit higher. Many take comfort in keeping core holding in ICICI/HDFC but higher trading costs will force them to look elsewhere.

Discount Brokerage - There will be a space for Zerodha but I have a feeling that low transaction costs coupled with quality research wins hands down for many long term folks. I know a guy who shifted to small finance bank for savings and Motilal for broking. For me Kotak/Edel/Motilal remain winners in the long term.

Capive Clients - There is a competitive advantage here but as new age subscribers which are more tech savvy with Payment banks linkage etc, bigger market pie will be outside.

Tech - It is a commodity and anyone can buy off the shelf stuff therefore not really an advantage for any broker these days.

the IPO came at a perfect time to milk the valuation and yet they failed in getting enough subscribtions.

Disc - hold Edel

[shreys]

There definitely is a migration from full service brokers to discount brokers, especially those who trade often. The savings can be significant and can aid return generation.

But, in my humble opinion, not a lot of discount brokers may survive the onslaught of a bear market. Reason being the reduced volume that accompanies lacklustre markets.

Some large discount brokers will survive and become even stronger. The horrid experience of seeing a broker go bankrupt will ensure loyalty of quite a few customers to full service broking firms.

Sure, volumes of even full service broking companies will go down significantly. They may even incur losses. But, their large size and support from massive parent banks will ensure they survive.

Over the long term, a small group of discount brokers will become large and there’ll be increased acceptance among traders and investors. So what may eventually happen is that those with very large portfolios and low churn may prefer full service brokers while for those who trade often discount brokers are the obvious choice. In any case the rise of discount brokers is inevitable.

Too much dependence of revenue on capital markets is a double edged sword- During bull markets performance is exemplary and during bear markets it’s horrifying.

Some businesses are cyclical. There’s little that can done to curtail cyclicality. We just have to accept it and incorporate it in our evaluation of the company.

Companies can make money in 2 ways:

1. The product/service will be successful if it saves time for the customer.
2. The product/service will be successful if it helps the customer make more money.

Discount brokers excel at point 2. They help customers make more money by reducing brokerage. Its bound to succeed. The only question remains - Which discount broker will survive the catastrophic bear market and emerge stronger?

[ashoksharma]

Nice writeup @Yogesh_s .

But I completely disagree with your opinion. The trend is of lowering costs of trading. There is continouous downward trend towards low costs of brokerages and margin. Sometimes, I do think that it will completely become free beyond taxes.

Those who have stuck with ICICI Securities will be always with them because people are comfortable with it. But the main game is to attract new clients and especially new gen. New gen are going towards discount brokerages due to their flexibility and low cost.

[prashantrane2000]

World is moving towards intermediary free environment, People are bound to become more financial savvy hence we can see Zerodha is thriving. That said I will wait for an opportunity to enter brokerage business when it’s a real bargain.

[Agarwala]

@prakashh1

@prakashh1

Though discount brokerages do pose some threat in the short term but that will vanish as such models are not sustainable as reflected in recent spate of defaults where investors suffered losses.

Some discount brokers might have vanished. That is right. But it seems an overstatement to say that all discount brokers will vanish. Will you please elaborate about the recent spike of defaults? I am interested as I am also having an account with zerodha. Although I also have an account with ICICI Direct.

[vijay1994]

Thanks @Yogesh_s for the write up.

I would like to share my experience with ICICI Direct as well.

I had opened a ICICI Direct Demat account along with a SB salary account. Back then, I only had investments in MFs through SIPs. The brokerage they charged me was 0.6% for a transaction which essentially makes it 1.2% for complete buy/sell transaction. This is in addition to the approx. MF expense ratio of 1.5% - 2.5%. When contacted them, I was informed that the charges are inline with other brokerages/distributors.
I then shifted to FundsIndia, and now using Coin from Zerodha since the additional 1% could make a serious dent when compounded.

I had sent multiple requests for closure of this ICICI Demat account and they are yet to act on it. I have given up this process and paying only the annual maintenance charges now.

The only thing they are good at is cross-sell their products. I remember many of my friends too had made the same mistake of choosing ICICI Direct when they opened a salary account with ICICI Bank. As long as gullible investors are there, they will survive.

[jajushobhit]

I agree…the greatest challenge will be to attract new customers. I have an account with them for the past 6 years. I also opened an account with a low-cost broker around 12-18 months back. I no longer execute any F&O trades in Direct as the difference between brokerage in huge and not much of a differentiation in experience.

I still execute my long-term trades through direct as moving my trades out will be costlier, but I don’t think they can survive on long-term trades as the quantum of such trades in the overall market is minuscule. If I were to start investing today, I will not open an account in Direct because I have no reason to pay ~1% brokerage for adding no real value. In a trading position, often that is the size of the opportunity available.

Though I like what these low-cost brokers are doing, they seriously need to improve their platform, services and support. ICICI Direct in my opinion still provides the best interface and services to trade, there is no reason why these low-cost brokers can’t match or improve their platforms and services, but they have not been able to until now.

Regards
SJ

[harshb232]

A few days back, I got this mail from Zerodha stating that they are now the 3rd Biggest broker in India. Mail also contained a chart representing the Active clients. And growth has been phenomenal for the Discount Brokerages. I am attching the chart provided in the mail.

[yudiagg]

Why should they do it free? What is their business model ? How do they earn money to cover their huge expenses?

[tbhavesh]

I think the key difference between Zerodha and brokers like ICICI and HDFC is type of customers that they have.

While ICICI and HDFC has clients that are broadly investors with limited number of trades per quater who rely on their recommendations to invest. Zerodha mainly addresses the needs of day time traders and they play the volume game. They do charge minimal brokerage for Intraday and FNO trades.

[sumi00]

Well, they made 140cr profit. They charge Rs 50/month for mutual fund platform, 300/annum for equity and 200 for FnO. These platform charges. They have minimised costs a lot by keeping most of the processes online.

[yudiagg]

Thanks for clarification that they are not free for all.

[shreys]

In my humble opinion, over the long term, the company will have to reduce its reliance on broking services. Probably diversify into auxiliary services. It’ll be incredibly difficult to survive competition with discount brokers. Even in the US, discount brokers dominate the stage.
Is it possible that Direct too will tweak their business model and become discount brokers? It seems implausible today. But, who knows the future?