HDFC AMC’s move to acquire Essel bonds weighs on the stock

Radhika Merwin | Updated on June 19, 2019 Published on June 18, 2019

While this increases uncertainty for investors, sound financials and leadership position of the company offer comfort

In a bid to offer respite to FMP (fixed maturity plan) investors left in a lurch owing to the schemes’ exposure to the Essel Group (grappling with debt woes), HDFC AMC decided to offer liquidity by taking on the NCDs issued by Essel Group on its own books. The liquidity arrangement may involve an outlay not exceeding ₹500 crore, according to the exchange filing by the company.

This could imply two things for HDFC AMC: If the Essel Group manages to pay back its dues on the NCDs, then the impact on the AMC will be minimal (depending on the price at which it acquires these bonds). However, if Essel Group reneges on part or whole of its dues, then the AMC would take a big knock, impacting its earnings.

Either ways, the company’s move — while offering comfort to investors in HDFC mutual funds — may not go down well with investors in the stock of HDFC AMC. With credit risks on the rise, the possibility of similar bailouts in the future can keep investors on tenterhooks.

That said, HDFC AMC has been among the top two players in terms of AUM in the last few years. In FY19, despite various regulatory changes impacting revenue and profitability, the company managed to grow its total AUM by 18 per cent and net profit by 31 per cent.

FMP episode

At the current price, HDFC AMC is trading at a premium valuation of about 11 per cent of AUM (as of March 2019); Reliance Nippon Life Asset Management is trading at about 5.8 per cent of AUM.

AMCs gave Essel Group time till September 2019 to make payments. Hence, FMP investors holding these bonds did not receive the full redemption amount on maturity.

For HDFC, one of its FMPs got rolled over (HDFC FMP-XXXV-1168D-Feb 2016), while the other was redeemed (partly). HDFC AMC has more FMPs maturing before September, and now, instead of waiting for payments from Essel, it has decided to provide liquidity to honour the redemption commitment

What it means for investors

Whether HDFC AMC manages to get payments from Essel or not will be important and will determine the impact on the AMC’s earnings. For investors in the AMC stock, this move by the company throws open uncertainties in future.

However, the company’s leadership position and sound financials offer comfort. Over the past year, several regulatory changes have had an impact on mutual funds’ earnings. A SEBI circular dated October 22, 2018, imposed a ban on payment of upfront commission and made it mandatory that all scheme related expenses be paid from the scheme only.

For HDFC AMC, there was a strong uptick in operating profit as fees and commissions fell by 27 per cent year-on-year in FY19, due to phasing out of upfront commission. Other expenses also fell by a tidy 23 per cent. Hence, net profit grew by 31 per cent.

SEBI’s regulatory changes on the total expense ratio (TER) is also set to impact AMCs from April 2019. SEBI, in its notification last year, revised TER limits sharply lower — in particular for large equity schemes.

The management of HDFC AMC expects the TER cuts to impact equity schemes by 24-25 bps. But given that they have been able to pass much of this to distributors, the net impact for them will be limited to about 3.4-4 bps of equity AUM.

Published on June 18, 2019
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