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"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". When Warren Buffet said this iconic line, he could have very well been talking about CDSL. Being promoted by BSE, and regulated by SEBI, CDSL operates as a depository to keep securities or shares. Being promoted by a stock exchange in a favorable regulatory framework acts as a massive barrier to entry, and as such, it enjoys a duopolistic market structure alongside NSDL.
Starting operations in 1999, CDSL has gained significant ground over NDSL in terms of demat accounts, even though NDSL started operating 3 years prior. CDSL enjoys 65% of all demat accounts and 580 depository participants catered through 20,000+ service centers. The low operating cost, lower net worth criteria for depository participant, and technology investments are some of the reasons that have possibly attributed to CDSL gaining market share.
Key revenue sources for CDSL include annual issuer charges and transaction charges. Annual Issuer charges contributed to around 20% of the revenue in the second quarter of the current fiscal year, with CDSL charging 11 rupees per folio. 71% of the revenue was collected from transaction charges which are directly related to the delivery-based transactions in the cash market.
Key Moats are:
Asset light business with significant operating leverage
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
The company is in a perfect place with retail activity expected to further go up with the LIC IPO, and the market shifting to discount brokerages. As a cynic, we must ask ourselves, if this will this last forever? The business is vulnerable to the market cycles which will make growth happen in a step function. Slow growth in the bear phase followed by sudden jump in a bull run.
So, what is our view on company valuation?
Company share price has appreciated 3 times in last one year primarily on the back of multiple expansion. CDSL trades at a price to earnings ratio of around 60 times. The long term annual growth of the company is expected to be around 15 -20%. As the Company could have high volatility in earnings with majority of revenue being transaction charges, high PEG ratio will not be sustainable. So, the company seems overvalued at the current levels. However, overall the business seems good and investor should evaluate investing at lower levels.
As for the risks to this analysis, Market sentiment and liquidity is expected to remain buoyant in short term which can take share price higher.
So, would you invest in CDSL?
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