Worst may be over for broking firms, says Espirito Santo

Moneycontrol Bureau

Battered shares of brokerage firms appear to have found a supporter in Espirito Santo, another broking company. In their report on the sector, Espirito analysts Santosh Singh and Nidhesh Jain have said that the worst may be over for the broking sector, and that current valuations of the stocks reflect too much bearishness.

"The Indian broking industry is trading at one of the lowest multiples globally, despite very little balance sheet risk. On balance we think volumes have bottomed, and CY12 (calendar 2012) could be the low point for investment banking fees," say the duo in their report.

Over the last couple of years, brokerage firms have been hit by a triple whammy of falling cash market volumes, weak investment banking fees due to fewer deals, and a steep decline in third party fee income from distribution of financial products. And all this in a rising interest rate scenario, which further reduces profit margins as the cost of funds rise.

Trading volumes in options have surged in the last few years, but that is not adding to the bottomlines of brokerage firms. Reason being that commission on options trade is a fraction of that earned from cash market trades. 

So what could change? The following, according to Singh and Jain:

* The share of cash volumes seems to have bottomed out (share has remained around 10% for last four quarters) and the intra-segment yields have stagnated. We do not expect further declines in cash volumes and yields.

* Cash trading velocity (the proportion of market cap to average daily traded cash volume) is lower in India compared with other economies, but we expect it to increase as Indian capital markets become more efficient.

* Also we are seeing action from various regulators to increase flows into life insurance and mutual funds, strengthening future funds under management.

* With regard to third party fee income, we have seen positive steps taken by regulators in both industries. SEBI increased the cap on expense ratios by 30bps for mutual funds and IRDA has begun to consult with the industry.

* Rates in wholesale markets have cooled off due to improved liquidity. We expect the central bank to cut the rates by 75 bps in H2FY13, which augurs well for margins in the lending businesses.

Espirito Santo has rated Edelweiss Financial Services and Motilal Oswal Securities as its top picks.