>Reliance Capital (BNP PARIBAS)

Obstacle course for growth and margin

Initiate with REDUCE – valuation ahead of fundamentals We initiate coverage on Reliance Capital (RCFT) with a REDUCE rating and a TP of INR400. While the long-term outlook for RCFT is attractive, we expect significant growth and margin pressure in the near to medium
term. We expect all of its core businesses (insurance, asset management, general insurance, broking and consumer finance) to slow down. We believe the recent rally in the stock price is out of line with fundamentals and investors can find more attractive alternatives, given the overhang in the market.

Multiple pressures on growth and margins
RCFT’s core business growth is tied to the outlook for equity and capital markets in India – in the form of unit-linked life insurance products, returns on its proprietary investment book, income from asset management and broking. We expect relatively muted equity markets in FY10 to impact RCFT’s revenue growth. We expect RCFT (which has more than 95% of its life products in ULIPs) to clock life premium growth of 11% for FY10 compared to 40% y-y growth in FY09. We estimate RCFT’s consolidated net revenue will decline by 4% y-y for FY10. We expect a sustainable NBAP margin for life insurance of 15% compared to management guidance of 18-19%. Based on our channel checks and analysis, we believe RCFT’s insurance business growth was based on aggressive pricing, which is more evident in the general insurance business. In addition to margin pressures, RCFT’s core businesses are still in a capital consumption mode and will impact ROE over FY10-11. RCFT is a high beta play and in addition to improvement in core businesses, we’ll turn more positive on signs of a sustained market rally.

Valuation
We value RCFT at INR400 using a sum-of-the-parts approach. On a per share basis, we value life insurance at INR145 (8x FY10E NBAP), asset management at INR130 (3.5% to FY10E AUM), the standalone book along with consumer finance business at INR100 (0.8x FY10E ABV) and Reliance Money at INR25 (8.0x FY10E EPS). Our TP implies 15.5x and 1.3x price to FY10E consolidated EPS and ABV respectively.

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