Detailed Rationale

CRISIL Ratings has upgraded its ratings on the bank facilities of Pashupati Capital Services Private Limited (PCSPL; part of Pashupati group) to ‘CRISIL BBB+/Stable/CRISIL A2+’ from ‘CRISIL BBB/Stable/CRISIL A2’.

 

The rating action factors in the substantial improvement in PCSPL’s capital position owing to higher accruals during the last 2-3 years. The group has primarily been focusing on proprietary trading activities by capturing market-based pricing anomalies while hedging the position. During fiscal 2022 and fiscal 2023, the group significantly scaled up the proprietary trading activity by taking advantage of the opportunities available in the market. This led to a substantial improvement in internal accruals during this period. Group’s profitability augmented with RoE improving to 45.7% for fiscal 2023 as compared to 10% for the past few years till 2020 (excluding non-recurring profit on sale of investments).

 

With improvement in earnings profile, capital position has strengthened further: networth increased to around Rs 429 crore as on March 31, 2023, from Rs 333 crore as on March 31, 2022 (Rs 249 crore a year ago). In terms of gearing, at gross level (i.e. bank guarantee limit/networth) remained comfortable at around 2.2 times as on March 31, 2023 (2.1 times as on March 31, 2022). The group also continues to maintain healthy level of liquidity; their borrowing requirements are limited to bank guarantees (non-fund based) and these are backed with 50% of fixed deposits. Therefore, the gearing at net level is lesser at around 1 time. CRISIL Ratings overall, believes, given the steady accretions, the capital position of the group will continue to strengthen with gearing remaining at comfortable level over the medium term. The rating also takes into consideration management’s extensive experience in the equity arbitrage business.

 

These strengths are partially offset by the Pashupati group’s dependence on a single revenue stream, and vulnerability to regulatory changes with volatility inherent in the capital markets business. Revenue profile remains concentrated as more than 80% of income is generated through proprietary trading activities. Of late, competition on the segment that the company concentrates in has augmented substantially. This increase in competition results in lower margins and lesser opportunities. Therefore, the ability of the group to retain its position and capitalise on opportunities will remain.

Analytical Approach

The CRISIL Ratings has considered the combined business and financial profiles of PCSPL, Pashupati Derivatives and Commodities Pvt Ltd (PDCPL) and TradeAir (IFSC) Pvt Ltd (erstwhile PCS IFSC Pvt Ltd) to arrive at the ratings. This approach has been taken on account of the high degree of management, business and financial integration of the companies.

 

Please refer Annexure - List of Entities Consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths: 

Adequate capitalization; strengthened by stable internal accrual:

Capitalisation remains adequate with a comfortable absolute networth of Rs 428.7 crore as on March 31, 2023 (Rs 333.3 crore as on March 31, 2022). Growth in networth has primarily been through internal accrual as no incremental capital infusion has been made during the last 14 years. Carrying out proprietary trading via in-house algorithm and software has led to sustaining the conservative stance on directional trading; which reduces exposure to unexpected losses. Gearing (on-balance-sheet) has also remained healthy at below 0.5 time in the last six years. To carry out their proprietary transactions, the group primarily furnishes bank guarantees to stock exchanges for meeting margin requirements. On gross basis, the bank guarantee limit (not part of balance-sheet) was around 2.2 times the networth as on March 31, 2023. The bank guarantee/networth is expected to be within manageable limit over the medium term but will remain a monitorable.

 

Continuous improvement in profitability supported by higher revenues from arbitrage operations and tighter control on operating costs:

Profitability has improved due to higher revenue from proprietary activities particularly during the last 2-3 years. The income from arbitrage activities within topline continued to be the major source of income with it accounting for close to 80% of the total income during fiscal 2023. The group has been carrying out transactions through the SLB platform of the National Stock Exchange (NSE). Moreover, the group also benefits from earning stable interest income on fixed deposits—at Rs 478 crore as on March 31, 2023. Further, the group continues to benefit from having one of the lowest cost to net total income ratio—at 51.4% during fiscal 2023 as against 44.4% during fiscal 2022. At gross level, the cost to income ratio remained comfortable at 17.4% during fiscal 2023 and 16.8% during fiscal 2022. These factors aided substantial improvement in profitability. The overall profit after tax (PAT) improved to Rs 95.9 crore during fiscal 2023 from Rs 78.6 crore during fiscal 2022. It also factors in the improving capitalisation with higher accrual contributing to growing networth in the past 2-3 years. Nevertheless, given the majority of the income is linked with capital markets, the ability of the company to maintain its profitability and RoE at current levels will be key monitorables.

 

Extensive experience of the management in capital market and arbitrage business

The group’s operations are managed by Mr Pashupati Nath Chaudhary and his brother Mr Uma Shankar Chaudhary with the second generation of promoter, namely Mr Vidit Chaudhary, also getting in to the business.  All of them are personally involved in managing the operations.  They have extensive experience in arbitrage operations, and especially almost more than a decade’s experience in executing sophisticated proprietary strategies to take advantage of pricing inefficiencies while hedging its position. The philosophy of the management is to have minimal open exposure.  Consequently, the group has not reported losses during the past 15 years.

 

With view to further diversify and leverage on experience in proprietary segment, the promoters have established ‘TradeAir (IFSC)’, a wholly-owned subsidiary of the group in the GIFT city. Through this company, the group has entered in fund management business (through its CAT-III AIF fund) and proposes to offer proprietary strategies to foreign, NRI and Indian investors. CRISIL Ratings, nevertheless, will continue to monitor the performance of this company and its overall contribution to the group’s credit profile.

 

Weaknesses:

Marked dependence on single revenue stream

Since proprietary trading accounts for entire revenue (80% of the total income as on March 31, 2023), the group remains exposed to income volatility as any adverse change in business will severely affect earnings. Nevertheless, fairly conservative decisions have led to stable profitability. However, proprietary trading activities have seen significantly intensified competition in the past few years. This increased market participation leads to reduction in margins and lesser opportunities. Therefore, the ability of the group to retain its position and capitalize on opportunities will remain monitorable.

 

Susceptibility to regulatory changes and volatility inherent in capital market-related businesses

Over the last couple of years, the broking industry has witnessed continuous regulatory revisions. With the objective of further enhancing the transparency levels and limiting the misuse of funds, the Securities and Exchange Board of India (SEBI) introduced a few regulations in the last one year. The newer margin collection practices will change the vintage business model of various small to mid-sized broking companies that relied on relationships by offering differential leverage and margin payment avenues to clients. This is likely to lead to decline in the overall competitiveness in favour of larger digital and bank-based brokers. The regulations of upfront margin collections for intraday trading have reduced the leverage considerably in the industry. This reduction in leverage essentially means that the level of positions (in terms of volume) taken by retail investors will also get impacted. Furthermore, as per new regulations, the shares owned by investors can be lien marked with the respective broker instead of having to follow the current practice of transferring it to the broker’s pool account.

 

CRISIL Ratings understands that most top and few mid-sized brokers have already streamlined their systems in accordance with the revised regulations. However, this may impact small and mid-sized brokers given their not-so-advanced IT infrastructure and risk management systems. Nevertheless, most of these regulations pertains to the client business (pure broking business). As far as Pashupati group is concerned, the business is primarily confined to proprietary/arbitrage business and they don’t cater to client broking business. Hence, these revised regulations did not have any visible impact on the group thus far. CRISIL Ratings, nevertheless, will continue to monitor it on an ongoing basis. CRISIL Ratings, further, believes these regulations will benefit the industry with increased transparency and de-risk the broking platform for retail customers.

 

Operations are concentrated primarily in the equity market through arbitrage trading. On account of the cyclical nature of the business, arbitrage volume and earnings are heavily dependent on the level of trading activity. Volatility in equity markets is driven by economic, political, and social factors that guide investor sentiments. Turnover and volumes in the equity broking business move in tandem with market sentiment. Global factors also influence the fortunes of the domestic market. Also, though SLB is a relatively new platform, entry of more players might result either in fewer opportunities or lower margins, or both. In such a scenario, the group might find it tough to maintain topline However, in the past 5-6 years, CRISIL Ratings has not identified any major impact on the group. Furthermore, increasing automation by large players in performing arbitrage activities may also result in lower margins and lesser opportunities over the medium term.

Liquidity: Adequate

The group largely depends non-fund-based facilities. The fund-based facilities are used only for meeting short-term needs. The group, like other entities in the capital market segment, and in the arbitrage business in particular, enjoys the flexibility to square off positions at short notice and improve liquidity, if urgently required. Given the group primarily engages in proprietary trading business, the liquidity requirements are mainly for any unexpected sharp volatilities in the markets. For such situations, the group maintains loan against property facility that can be utilized. The cash and bank balance as on May 31, 2023 was Rs 196 crore (excluding the deposits of Rs 478 crore kept with bank against bank guarantee). The company also holds investments in the listed equity shares which can be liquidated if needed.

Outlook: Stable

CRISIL Ratings believes the Pashupati group will maintain its earnings profile primarily due to higher income from arbitrage operations and tighter control on operating expense. The steady accretions are also expected to support the capital position of the group, over the medium term.

Rating Sensitivity factors

Upward factors:

• Further improvement in capital position with networth increasing to over Rs 600 crore
• Improvement in earnings profile with return on networth (excluding POSI income) maintained at over 40%
• Ability to diversify revenue stream thereby reducing dependence on proprietary trading activities

Downward factors:

• Weakening in earnings profile with decrease in topline and return on networth reducing to below 20%
• Deterioration in capital position with networth reducing to below Rs 200 crore

About the Group

The Pashupati group was set up in 1999 by Mr Pashupati Nath Chaudhary and Mr Umashankar Chaudhary. The group carries out securities arbitrage trading through PCSPL (set up in 1999) and commodities arbitrage trading through PDCPL (2004). Additionally, it undertakes arbitrage trading for its clients (around 130), most of whom are high-networth individuals. It has four offices in Mumbai, which house 60 dealers. During fiscal 2023, profit after tax was Rs 95.9 crore on total income of Rs 256.9 crore, against Rs 78.6 crore and Rs 175.8 crore, respectively, in the previous fiscal. The group has also made investment in GIFT City platform through branch office in domestic zone. The group has deployed a team of over twelve employees ranging from dealers, IT support and managers.  This platform has been generating substantial proprietary trading turnover. The group also implemented a back-up of head office operations in the GIFT City office.

 

Additionally, the group has established a wholly-owned subsidiary, TradeAir (IFSC) Pvt. Ltd., in GIFT City.  Further, through TradeAir (IFSC), the group is launching a CAT-III AIF (Fund) offering the group’s proprietary strategies to foreign and NRI investors.

Any other information: Not applicable