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Sector valuations palatable; favourable risk reward for long term investors

While AMC stocks have underperformed NIFTY off late, we expect the sector to witness a turnaround going ahead and see our coverage getting back on a healthy earnings growth trajectory aided by a) strong AUM growth driven by superior scheme performance, b) continued market share gain by top players and c) impact of back book re-pricing on top-line yields moderating thus aiding operating profitability improvement. Distribution remains an important driver for AUM growth with c.77% of the Equity MF MAAUM as of Oct’22 coming from distributors. Further, bank-led AMCs enjoy an inherent advantage as they benefit from well-established branch infrastructure of the parent. While 97% and 69% of total distributed AUM in FY22 by SBI and ICICI Bank is towards SBI MF and ICICI Pru MF, this number was much lower at 28% for HDFC Bank and HDFC AMC. However, with the impending merger of HDFC Bank with HDFC Ltd., the Bank is expected to more aggressively market HDFC AMC’s schemes as it becomes a direct subsidiary of the Bank. A back of the envelope calculation suggests that HDFC AMC’s overall AUM/Equity AUM can increase by c.2%/4% with a mere 10ppts increase in HDFC AMC’s share in overall AUM distributed by HDFC Bank which in turn should drive robust incremental equity flows for HDFC AMC translating into a higher equity market share.

HDFC AMC is our top-pick in the space and the stock can see a meaningful rerating in the near to medium term driven by robust AUM and reverting back to earnings growth trajectory. We also maintain our positive stand on UTI AMC given the steep discount to peers and the potential valuation re-rating if the news regarding potential acquisition materialises. NAM is trading at 18x NTM P/E (34% discount to LTA) and could bridge its valuation gap with larger peers if equity market share improves (stable since Mar’22). We have refreshed our earnings growth estimates primarily driven by recent rally in the equity markets. Maintain BUY on all 3 names.

Dependence on distribution remains: Equity mutual funds still remain a push product with c.77% of the Equity MAAUM for Oct’22 coming from distributors. While, the proportion of direct AUM has inched up over the years (from 14% in Mar’16 to 23% in Oct’22) with the increasing popularity of direct schemes and advent of fintechs, the overall proportion still remains low at 23% as of Oct’22. Though we expect the share of direct to continue on an upward path, one cannot discount the importance of distribution network in overall scheme of things. For HDFC AMC, 22% of the equity AUM comes from direct channels, while MFDs, national distributors and banks contribute 41%, 24% and 13% resp. For UTI AMC, 33% of the equity AUM comes from direct channels, while MFDs and banks & distributors contribute 55% and 12% resp.

Bank-led AMCs enjoy inherent advantage: Bank-led AMCs have 2 inherent advantages in our view: a) brands which investors trust with their money, which these AMCs can capitalise on and b) well-established branch infrastructure – which gives them an advantage in terms of distribution. Of the top 5 AMC by equity MF AUM, 4 are bank led showcasing the dominance of bank led AMCs. Our data suggests that of the total AUM distributed by SBI in FY22, c.97% was for SBI MF, while for ICICI Bank and Axis Bank 69% and 59% of their total AUM distributed was towards ICICI Pru MF and Axis MF. This number was much lower at c.28% in HDFC AMC’s case. Further, c.20% of the FY22 overall AUM for SBI MF was distributed by SBI while 13% of Axis MF’s AUM for FY22 was distributed by Axis Bank. This number for HDFC AMC and ICICI Pru MF is lower at 5% and 7% resp.

HDFC AMC expected to gain with HDFC Bank merger: With the impending merger of HDFC Bank with HDFC Limited, HDFC AMC will become a subsidiary of HDFC Bank. With this change we expect the Bank to more aggressively market HDFC AMC’s schemes. A back of the envelope calculation suggests that HDFC AMC’s overall AUM/Equity AUM can increase by c.2%/4% with a mere 10ppts increase in HDFC AMC’s share in overall AUM distributed by HDFC Bank. Additionally, HDFC AMC’s scheme performances have improved considerably over the past few quarters the equity AUM has started to see positive net inflows from 1QFY23 onwards. Consequently, we expect HDFC AMC should enjoy a higher share of incremental equity flow market share translating into higher equity market share going ahead.

AMC universe valuations look better post underperformance: AMCs under our coverage HDFCAMC/NAM/UTIAM have underperformed NIFTY by 38%/44%/40% since midSep’21 and are now trading at 28x/17x/12x F24E EPS. We expect the sector to witness a turnaround going ahead and see our coverage getting back on a healthy earnings growth trajectory aided by a) strong AUM growth driven by superior scheme performance, b) continued market share gain by top players and c) impact of back book re-pricing on topline yields moderating thus aiding operating profitability improvement. HDFC AMC is our top-pick in the space and the stock can see a meaningful rerating in the near to medium term driven by increase in AUM (aided by HDFC Bank merger) and reverting back to earnings growth trajectory. UTIAM still trades at 58%/29% discount to HDFCAMC/NAM and we maintain our positive stance on the stock. We see a significant re-rating potential in UTI AMC if the news regarding potential acquisition of UTI AMC materialises which along with expectations of strong AUM growth and improvement in operating profitability should drive stock performance going ahead. NAM is trading at 18x NTM P/E (34% discount to LTA) and could bridge its valuation gap with larger peers if equity market share improves (stable since Mar’22). Current levels provide an attractive opportunity for long term investors to enter the AMC space. Sharp deterioration incrementally in fund performances and/or prolonged period of outflows is a key risk to our estimates.

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