Retail brokerages in India are passing through a tough phase, with stock prices of listed brokers falling by an average of 23% this year, underperforming the broader market, which has fallen 10.8% in the same period.
Yet, many of the larger brokers are trying to scale up diversification plans to shore up growth prospects.
The market slump this year has been accompanied by a fall in volumes in the cash segment, and a lack of retail investor appetite has hit most brokers hard. Average cash volumes so far in May have in fact reached a 32-month low of 766 million shares.
“Retail as a proportion of overall trades has come down and the lack of initial public offerings (IPOs) meant that new investors were not coming,” said Pankaj Agarwal, an analyst at Ambit Capital Pvt. Ltd, who pointed out that October and November, when a large number of IPOs happened, were also the best months in terms of revenue for retail brokers. “When IPO activity picks up and retail investors subscribe, they then generally start trading.”
Growing volumes in the derivatives market, which offers lower commissions, and decline in cash volumes has been evident for a year now. It came as no surprise to see most brokers report lower revenue numbers for fiscal 2011 compared with fiscal 2010.
If the current situation of stagnant or declining turnover persists for longer, it might force some smaller brokers to shut shop or become sub-brokers or join franchisees of bigger players, said Agarwal.
Still, faced with declining revenue and profit as well as falling valuations, several brokerages are diversifying and rationalizing costs with some success.
Three of the largest listed brokerages—India Infoline Ltd, Edelweiss Capital Ltd and Motilal Oswal Financial Services Ltd—have taken the lead in scaling up their operations in non-core activities such as investment banking, private equity, asset management and lending.
Edelweiss and India Infoline have already seen their non-broking revenue outgrow their broking revenue in fiscal 2011.
For instance, the lending business of Edelweiss, which contributed one-third of revenue last year, now contributes to half of overall revenue. Similarly, the non-broking revenue of India Infoline nearly doubled last fiscal even as broking income fell, and now contributes to a majority of overall revenue, largely led by a growth in its financing business.
But while the diversification plans of these brokerages bode well for the long term, they are unlikely to appear attractive to shareholders in the short term.
“Some of the businesses like i-banking and mutual funds are capital market related. The only deleveraged business is the financing activity, in which Edelweiss and India Infoline are trying to scale up, but that activity is capital intensive and tends to depress the return on equity at least in the short term,” said Agarwal.
Even in asset management, in which Edelweiss and Motilal Oswal have a presence and India Infoline has recently got a licence, they have tended to focus mostly on non-conventional products such as quantitative portfolios or exchange-traded funds (ETFs), which are not actively managed.
As this is a new business and distribution costs are high for conventional mutual fund products, the focus of the asset management firm has been on ETFs so far, said Motilal Oswal, chairman of Motilal Oswal Financial Services.
Most brokers have also slowed branch expansion plans and are focusing on high networth individuals to bring down costs.
The industry is going through a natural phase of evolution, said V. Venkataramanan, executive director at consultancy firm KPMG. “Earlier, you could justify valuations by the number of branches you had across the country,” he said. “But now the focus is on how productive your branches are and how much cash you can generate out of the business.”
pramit.b@livemint.com
Ravindra Sonavane contributed to this story.