Which AMC stock should you bet on?

The pandemic has impacted all industries; the mutual fund industry, too, saw no escape.

While on one hand investors liquidated their investments owing to the pandemic, on the other hand, the market carnage in March 2020 further brought down the assets under management (AUM) for the three listed asset management companies (AMCs).

In the September quarter, while the market rebound helped ease the pain sequentially, AMCs still reported lower revenue from management fees on a y-o-y basis.

AMCs derive close to 90 per cent of their total revenues from investment management fee, and another 1-2 per cent from portfolio management fee and fees charged for other advisory services. While this sums up the operating revenue, AMCs also earn other income dividends and mark-to-market gains (or losses) on their own investment book.

The Indian mutual funds industry saw an 8.35 per cent (y-o-y) increase in overall AUM in September 2020.

While both Nippon India AMC and UTI AMC reported a 1 per cent increase each in their mutual fund AUM, HDFC AMC witnessed a 3 per cent y-o-y drop in its overall MF AUM.

However, since equity AUMs fetch higher yields than other categories, with a drop in equity-oriented AUM, all three companies reported lower revenues. Owing to a 14.3 per cent drop in equity AUM, HDFC AMC reported an operating revenue of ₹456 crore in the September quarter — down 8.4 per cent (y-o-y). Nippon, too, saw a 13.8 per cent decline in management fee revenues for the quarter — at ₹259 crore — following a 10.4 per cent drop in equity AUM.

UTI AMC that got listed on the bourses last month posted a 3.61 per cent y-o-y growth in its revenue from operations. However, the growth predominantly came from revaluation of investments held; revenue from management fee declined by about 3 per cent to ₹181 crore in the recent September quarter.

In the case of UTI AMC, while equity AUM inched up by 2 per cent, funds in the liquid category saw net outflows to the tune of ₹1,300 crore in the September quarter.

Consequently, the overall AUM for the company increased only by 1 per cent (y-o-y).

Good operating margin

Despite the plunge in MF AUMs witnessed in the initial months of the pandemic, the high operating leverage of the AMC business continued to pique investor interest.

Lower dependence on distributions for its AUM (47.4 per cent of the AUM flows through direct channels) helped HDFC AMC’s operating margins reach about 80 per cent in FY20. Even in the September 2020 quarter, despite a drop in AUM, the company reported an operating profit margin of 77 per cent (versus 76 per cent in corresponding quarter last year).

The management, in its earnings call, indicated scope for further improvement in margins, with an expected re-bound in MF AUM and further pruning of fixed costs (such as re-negotiation of rentals).

Post its re-branding in 2019, Nippon also worked on its cost rationalisation measures to scale up profits.

In the September quarter gone by, Nippon posted a healthy growth in profits (up 6 per cent y-o-y) owing to a 20 per cent (y-o-y) decline in costs (employee costs and other expenses). With the company’s operating margins still hovering around 49 per cent, there could be scope for further improvement.

Another interesting trend observed in the quarter was the increase in digitisation measures adopted by the AMCs to counter the impact of the lockdown. HDFC MF reported that electronic transactions have constituted about 87 per cent of all transaction in FY21 so far (HDFC MF website and mobile application constituted 18 per cent of total transactions). Digital contribution to total mutual fund purchase transactions was at 48 per cent for Nippon.

UTI AMC, too, reported that online gross sales comprised 95.1 per cent of total sales for the company.

For UTI AMC, a significant rise in employee costs and finance costs (up 30 per cent and 19 per cent, respectively) led to a drop in (standalone) profit margin to 37.4 per cent in September 2020 quarter, compared with 52.2 per cent in September 2019.

Valuations and outlook

Given the low penetration of mutual funds in the country, prospects for the AMC business is sanguine.

That apart, much of the industry’s current AUM comes from the top 30 cities (over 79 per cent).

In the long run, AMCs with greater brand recall (top five players in the industry had a market share of 57 per cent in March 2020) and well-diversified distribution channels would continue to acquire more market share.

These factors, coupled with existing high profitability, could augur well for HDFC AMC. Currently, operating expenses constitute about 12 basis points of the company’s AUM (as of the first half of FY21), resulting in an RoE of over 30 per cent.

At its current price, HDFC AMC trades at 13.7 per cent of its AUM, compared with its IPO valuation of 7.9 per cent of the then AUM (March 2018). Despite the re-rating in the stock, HDFC AMC is a better bet among the listed AMCs.

The metrics of Nippon are a step below HDFC AMC’s (return ratios at 16 per cent, low operating margins, etc). At the current price, Nippon trades at 6.1 per cent of its AUM (compared with about 7 per cent at the time of its IPO).

The stock was de-rated in 2018 to just about 4-5 per cent of its AUM.

Later in 2019, after the acquisition of additional stake by Nippon Life, the stock was re-rated back to 7 per cent levels (post the open offer).

If the operational metrics better in the coming quarters, Nippon could see further re-rating.