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More likely on a cyclical top

Central Depository Services (CDSL) remains a stable play on capital markets and is a prime beneficiary of higher retail participation. This led to 53% growth in FY21 revenues split 101%/10% between market linked/non-market linked components. While CDSL’s leadership in demat account additions and cost control remained strong achievements in FY20/FY21, the cyclical nature of retail business is an inherent limitation to secular earnings growth. Going ahead, growth will become challenging on the high base of FY21 (Q1FY22 sequential revenues grew only 14%). Post ~300% increase in stock price over the past year, we recommend REDUCE with a target price of Rs1,160.

* What are the constructs of rich multiples for CDSL post FY21?

The following facts about CDSL were always known: 1) it enjoys a duopoly in India’s depository ecosystem along with NSDL (market share as at Jun’21 for CDSL / NSDL was 64%/36% in terms of demat accounts); 2) it is almost a monopoly in incremental demat account additions (88% market share in FY22-TD); 3) it has optionality in terms of digital avenues for growth; and 4) it has a steady non-market linked annuity component. Yet, EBITDA grew at only 12.5% CAGR between FY16-FY20. This was because market linked / non-market linked revenues expanded at only 20%/14% CAGRs in that time period.

Market linked revenues include transaction charges, IPO / corporate action charges, online data charges, etc., while non-market linked revenues include annual issuer charges, E-CAS, E-voting, etc. FY21 was a watermark year for CDSL as market linked revenues jumped 101% while its non-market linked counterpart grew only 10% during the year.

Hence, the investment thesis, which is added to the already existing list, is the high amplitude of a retail upcycle as seen in FY21. This will keep getting directionally stronger with continuous demat additions. Hence, CDSL becomes a safe play on retail flows along with the merits of steady non-market linked annuity revenue streams and valid optionalities. We accordingly ascribe 40x multiple to core earnings of CDSL’s for valuations.

* Recommend REDUCE: We expect a revenue CAGR of 25% between FY21-FY23E driven by strong growth in market linked revenues (29% CAGR during the period). We expect non-market linked revenues to clock an 18% CAGR across the same timeline. Within market linked revenues, we expect transaction revenues to witness a strong CAGR of 33%. We also estimate IPO / Corporate action and Online data charges to grow at 27% / 25% CAGR on the back of continued retail participation in capital markets in the medium term.

Within non-market linked revenues, we expect annual issuer charges to rise at 13% CAGR between FY21-FY23E. We also forecast operating leverage benefits to accrue resulting in margin expansion from 61.6% in FY21 to 67% in FY22, and 69% in FY23. We value CDSL at 40x core EPS of Rs25.7 and free cash of Rs136/share to arrive at a target price of Rs1,160.

* Estimating revenues from demat additions – an empirical approach. Demat accounts can be linked to market linked revenue streams. However, demat account additions will be somewhat proportional to capital market activity also. So, empirically, we calculate the revenues possible for CDSL with 60mn demat accounts (vs 40mn currently). Total revenues per average demat account increased from Rs118 in FY20 to Rs128 in FY21. While FY21 was a cyclical top in terms of retail market activity, at the FY21 rate of revenue per demat account, CDSL’s potential revenues can be Rs7.7bn with 60mn demat accounts vs our estimate of Rs5.3bn in FY23E.

* Risks: Continued retail momentum and increase in pricing are key upside risks.

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