>RELIANCE CAPITAL (CITI)

Sell: 1Q10 Results – Asset Risks, Equity Leverage Shows Through

■ 1Q10 profits down 56% YoY, significantly below estimates — RCap's profits were dampened by lower investment gains in 1Q10 (-65% YoY) and were 46% lower than our estimates. The key business highlights of the quarter were: a) Sharp rise in asset deterioration in the consumer finance segment; b) Increasing growth in asset management; c) Significant market share erosion in the retail brokerage segment, and d) Continued focus on controlling expenses.

■ Asset deterioration, is it near the peak? — NPLs in RCap's consumer finance portfolio almost tripled QoQ to 5.6% (2% in 4Q) with ~25% losses in unsecured loans. We expect losses to stabilise as Rcap has stopped unsecured lending and management suggests pressures are peaking and has re-started disbursements in the secured loan segments (focus on mortgages and commercial vehicles).

■ Retail broking: Transition time — Revenues dropped 14% QoQ, volumes were up 7% (+65% QoQ industry growth). Management is focused on cost control (rationalised branches and employees), but it’s the topline that needs fixing – it is contemplating a change in revenue model to advalorem (from a fixed fee model currently). Expect subdued profitability in 2/3Q10 while it transitions.

■ Growth in asset management, unrealised investment gains — RCap's capital market leverage showed through – domestic AUMs increased 34% QoQ (+48% equity AUMs) and unrealized equity gains were Rs5bn (nil earlier). Continued strong capital markets and a keen eye on costs should support future profitability, but RCap remains exposed to any downsides, especially as its other businesses face relatively tougher times. We maintain a Sell rating on RCap.

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