Reliance Capital: Demerger of commercial finance biz right step

Will turn firm into core investment-cum-holding entity, align overall operational structure

Shareholders of Reliance Capital approved plans to demerge commercial finance business into a separate wholly owned subsidiary, Reliance Commercial Finance, from April 1. The move is positive.

“All operating businesses of Reliance Capital, except the commercial finance business, are held in Reliance Capital’s wholly- or majority-owned subsidiaries. Hence, the proposal to demerge its commercial finance business will align its overall operating structure and will convert itself into a core investment company in terms of central bank’s rules,” wrote IiAS, a proxy advisory firm.  

Other market experts also consider the move as positive. Nidhesh Jain of Investec Capital says: “Earlier, this business was carried through Reliance Capital’s standalone balance sheet and there were not enough disclosures around profitability and return ratios. This will change after the demerger.”

The commercial finance business has been growing at a rapid pace over the past few quarters. In fact, this business’ profit before tax grew 36 per cent year-on-year to Rs 57 crore in the June 2016 quarter (Q1) with its assets under management growing at a healthy clip of 17 per cent to Rs 16,450 crore. Analysts at ICICI Direct expect this business to grow 15 per cent in FY17.

Reliance Capital’s other businesses including home finance and life insurance are also witnessing good traction. Although the asset management business (including mutual fund) remained flattish in the June quarter, it has been doing well. Overall, Reliance Capital’s consolidated earnings per share growth is pegged at 13 per cent for FY17, according to consensus Bloomberg estimates. The stock seems fairly valued for now as reflected in the average target price of Rs 543 of analysts polled by Bloomberg (current price is Rs 533). However, there are triggers. Improving growth of all its businesses and a bancassurance tie-up for its insurance business are key catalysts for the stock going forward.

“Consistently, Reliance Capital is divesting stakes and using funds to clean the balance sheet. Most pain has been taken while the current equity book is in profit. With core profits expansion at 18 per cent, we can see adjusted RoEs (return on equity) improving to double digits in a couple of years,” write analysts at ICICI Direct in a recent note on the company.

The firm plans to reduce its high proprietary book of Rs 8,000-10,000 crore over the medium term. Any delay in doing so will be a key downside risk.