Broking firms to face rough weather: Report

Domestic brokerage firms are likely to see challenging days ahead with bearish market sentiments and tightening macroeconomic situation keeping investors away, a latest report says.

“Declining market turnover due to dwindling retail and institutional investor participation, significant correction in stock prices, dismal investment banking outlook and a worsening macroeconomic scenario do not bode well for brokerage firms,” according to a report by German banking major Deutsche Bank.

Further, the fragmented nature of the brokerage industry, coupled with increasing competition from large players in the retail and institutional broking side, is likely to exert pressure on the ability of broking houses to maintain market share, margins and consequently return ratios, it added. The bank maintains negative outlook for two of the leading brokerages in the country - India Infoline and Edelweiss Capital.

“A substantial portion of revenues for both the brokerages comes from capital market-related activities. We believe declining volumes, coupled with high operating leverage embedded in their business, is likely to exert severe pressure on earnings in the near term,” the report stated.

It added that despite growth in newer financial products there seems little increase in profitability of brokerages in the long run. “Growth does not necessarily mean profitability. We believe technological advances, the lack of significant balance sheet strength and the absence of pricing power in a commodities’ industry will continue to be the key worries and determinants of profitability in the long term,” it revealed.

Besides, the low market concentration and hence the propensity to intensely compete could exert significant pressure on returns and players with larger distribution networks stand to gain.

It also mentioned that players such as Reliance Money are taking the lead in network expansion, while capital availability, risk of technological advances and lack of product diversity remain key shortcomings, mainly on the institutional side. The report expects brokerages to report 5-10 per cent earnings at compounded annual growth rate for the next three years.

Broking companies have operating leverage, in times of declining market volumes it becomes very difficult to protect operating margins as we believe nearly 50 per cent of costs are fixed, it added.