Company Name – Central Depository Services (India) Limited (CDSL)
Current Share Price – INR 1,224 (August 16, 2022)
Market Cap – INR 12,789 cr
1. What is interesting about the stock?
"I like to invest in companies that are so simple to run, that even an idiot can run it, because sooner or later one will"
- Warren Buffett
Warrenji may have been thinking about CDSL.
CDSL (promoted by BSE) and NSDL (promoted by NSE) are the two entities that operate as depositories in India. Regulated by SEBI and registered under the Depositories Act, 1996, the sheer nature of CDSL’s existence, i.e. promoted by stock exchanges, its business model and regulatory framework has acted as a strong entry barrier. These entities thus enjoy a duopolistic nature of existence.
While being a late entrant, CDSL (commenced operations in 1999) in the recent past has gained considerate market share over NSDL (started operations in 1996) in terms of demat accounts. CDSL has ~70 million demat accounts and compares with ~30 million demat accounts for NSDL. In terms of market share, CDSL thus, enjoys c. 70% of overall demat account accounts as of June 2022. On an incremental basis since March 2020, CDSL’s market share stood at 85% riding the increase in market share of discount brokerages. CDSL had 580 depository participants (DP) catered through 21,000+ service centres and compares with 277 DPs in case of NSDL.
The low operating cost, lower networth criteria for depository participant (DP), and technology investments are some of the reasons that have possibly attributed to CDSL gaining market share. Hence, most of the new discount brokerages have gone with CDSL. Another shot in the arm for CDSL was the management challenges (after exit of Chitra Ramakrishna) at NSE which led to lower focus on NSDL.
CDSL’s transaction charges, which are more linked to number of debit transactions, are more attractive than those of NSDL. While NSDL charges a flat rate of INR 4.50 per debit transaction irrespective of the DP’s total monthly transaction bill amount, CDSL has a slab-based tariff structure which leads to lower value.
Key revenue sources for CDSL are:
Annual issuer charges (31% of revenue in Q1FY23) - CDSL charges annual issuer fees to corporates for their securities admitted at a rate of INR 11 per folio, subject to minimum slab-based fees depending on the nominal value of securities. As a security depository, CDSL functions as the central accounting and record-keeping office of the securities of the companies admitted into its system and held with the demat account holders.
Transaction charges (28% of revenue in Q1FY23) - Transaction charge for the depositories are directly related to the delivery-based transactions in the cash market and is a factor of number of shares traded, active beneficiary accounts, and overall investor sentiments.
Online data services: CDSL through its subsidiary, CDSL Ventures Limited (CVL) is into the business of KYC services for the capital market intermediaries including mutual funds. CVL is the first ever registered KRA entity with SEBI and had around 60% market share
IPO/Corporate Charges (10% of revenue in Q1FY23): CDSL charges INR 2 per folio for verification of subscriptions and INR 10 per folio for allotment to the issuing company in the year of issuance.
Key Moats are:
Duopoly – regulatory framework provides entry barrier
Network effect – Higher number of demat accounts or DPs make the business more competitive as the fixed cost is distributed on a higher number in an asset light business
Of India’s 1.36 billion people, only about 3.7% invest in equities, compared with about 12.7% in China, according to stock depository data on the number of investment accounts (and assuming one account per person which we know is not accurate). In the US, by contrast, a poll found about 55% of the population owns stocks either individually or through a mutual fund.
Company is in a perfect place – retail activity is expected to further go up with the LIC IPO and the push to try & open demat accounts for all policyholders, bull market (increase in volume) and market shifting to discount brokerages. CDSL Management (as Shahrukh Khan in Om Shanti Om) can say this dialogue on their current business position –
“Itni Shiddat se maine tumhe paane ki koshish ki hai, ke har zarre ne mujhe tumse Milane ki saazish ki hai. Kehte hain ki…agar kisi cheez ko dil se chaaho to puri kayanat usey tumse milane ki koshish mein lag jaati hai.”
As a cynic I will ask – Will this last forever? The business is vulnerable to the market cycles which will make growth happen in a step function – slow growth in a bear/neutral phase for the market followed by sudden jump in the bull run.
2. Key Historical Financials
CDSL became the first depository to register ~7 cr demat accounts in June 2022 (Q1FY23)
Number of demat account almost doubled in FY22
Company has solid growth (Revenue, EBITDA and net profit level) in FY22 on the back of increased retail activity. However, the revenue growth was flat for Q1FY23 on a QoQ basis
Net profit has fallen for last three quarters - peaking in Q2FY22
3. What is my view on company valuation?
Company share price has appreciated 6.5x in last three years primarily on the back of multiple expansion. CDSL trades at P/E (TTM) multiple of 42x vs long term (5 yr) average of ~30x. I expect long term annual growth of the Company to be around 15-20%. As the Company could have high volatility in earnings with majority of revenue being transaction charges (which depend on market sentiment and liquidity), high PEG ratio will not be sustainable. Using PEG ratio of 1.25x, the P/E multiple comes to around 25x so the company seems to be overvalued at current levels.
On an overall basis, business is good but expected to have high earnings volatility and significantly overvalued at the current levels.
4. What are the risks to the investment analysis?
Risks to the analysis are:
Market sentiment and liquidity is expected to remain buoyant in short term – can take the share price higher
Significant portion of revenue comes from transaction charges and company benefits from operating levels but it could reverse if there is any bear market (margin can contract in addition to the fall in revenue)
About the Author
I have over 15 years of experience in venture capital, private equity and investment banking in India and Middle East across a wide variety of sectors. I was last working with Majid Al Futtaim Holding (MAF), a leading conglomerate in Middle East, to look after investments, M&A and venture capital. I have prior experience in India with Tata Capital (Private Equity), Merrill Lynch (Investment Banking or IB) and Ambit Corporate Finance (IB). I bring the long-term ownership mindset to the analysis.
I graduated from the MBA program of the Indian Institute of Management Lucknow (2005) after completing the Bachelor of Technology program at the Indian Institute of Technology, Kharagpur (2002).
I am an Insignificant Investor in the public market and co-founder of SocInvest.
I have no stock, option or similar derivative position in any of the companies mentioned since last 30 days, and shall not initiate any such positions within the next 5 days. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from SocInvest). I have no business relationship with any company whose stock is mentioned in this article.
I am not a SEBI registered advisor. This article is purely for educational purpose and not to be construed as an investment advice. Please consult your financial advisor before acting on it.
I have used publicly available information while writing this article.