Broking sector in a mess as losses spiral out of control

Religare Enterprise knows where exactly it hurts. It ran up a net loss of Rs 150 crore for the quarter ended 30 June 2011, compared to Rs 49 crore for the corresponding quarter a year ago. The company may be looking to raise Rs 500 crore through preferential allotment subject to approval of shareholders. But on a consolidated basis, its employee cost has actually spiked to Rs 306 crore from Rs 147 crore, which explains the loss.

 Broking sector in a mess as losses spiral out of control

Companies are in no mood to nurture high-value customers and their focus is on the speculative derivatives trading segment where broking fee is low. Arko Datta / Reuters

Religare is not alone in churning out dismal numbers. With foreign institutional investment slowing, interest rates and inflation creeping up and capital markets in no hurry to promise better returns, the stock broking industry is having a tough time.

The quarterly performances of Motilal Oswal, Edelweiss, Geojit BNP Paribas and other listed broking firms are a pointer to that. Motilal Oswal suffered a fall of 13 percent in the net profit while Edelweiss Capital saw a 23 percent slump. Geojit BNP Paribas Financial Services net profit skidded 30 percent for the June 2011 quarter.

Obviously, something is wrong -- somewhere. Companies are in no mood to nurture high-value customers and their focus is on the speculative derivatives trading segment where broking fee is low. With increasing options volume and less retail participation and falling cash volumes, brokerages are up against shrinking margins.

Edelweiss explains why it has been shifting to a banking model where they have got 60 percent of their revenue from interest income. So, their margins will be more in line with non-banking financial companies. It also admits that there has been a huge drop in investment banking. Though there are enough deals in the pipeline, closures can happen only if markets improve.

Post results, Motilal Oswal finds the change in cash and options mix surprising, which is hurting it the most. It expects the government to sort out the taxation issues and get the retail investors back into the market. Statutory transaction tax, mandatory with each transaction, is high at the moment. The issue is, therefore, two-pronged. On the one hand, volumes have fallen due to weak sentiment. On the other, volumes have not been offset by margins due to a surge in options volumes.

Moreover, the net flow of foreign institutional investment (FII) has been around Rs 5,000 crore from April to June this year, which looks meagre when compared to the Rs 49,500 crore in the two preceding quarters. Fund raising remains an issue as IPOs have lost a bit of their appeal. Nomura, in a client note, has warned that foreign institutional investors might react sharply to the inflation and rising interest rate numbers.

As cash flow dries up, private equity is the only option that is looking alluring. According to Reuters, industry specialist Bain and Co estimates a huge $20 billion waiting to be invested here. A couple of handsome deals could see some relief for the broking sector in terms of investment banking fees.

Meanwhile, foreign competition in the space has been eating into the market share for domestic players. Espirito Santo, Barclays, Royal Bank of Scotland, Daiwa, Jefferies and Newedge have been consistently investing in people and infrastructure, keeping a long-term view in mind. Managements of broking firms are hopeful. With long-term players trooping in, there is an expectation that India could be among the top five markets for investing by 2020.

Motilal Oswal, chairman and managing director, Motilal Oswal Financial Services, remains sceptical. "Smaller players will find it exceedingly difficult to carry on business as they cannot afford to keep investing in research or infrastructure when going gets bad," he said.

Investors will also look for clear-cut investment guidelines, where only bigger players can do well. So, this industry could well head for consolidation with bigger players pushing for more inorganic growth.

With the RBI making it clear that interest rates have not peaked yet, and industry getting increasingly jittery about investing in new projects, one cannot be sure whether retail players will be enthusiastic to flock to the market anytime soon. There is little hope that these companies could see better numbers anytime this year. But here is the consolation that all managements are giving themselves and others after the results: "The long-term India story remains intact." Yes, we trust you!

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Updated Date: Dec 20, 2014 04:06:35 IST