When HDFC AMC announced stellar numbers in the March 2019 quarter, the markets were abuzz with buying ideas. How good an idea is it to buy AMC stocks in the equity market? Of course, there are only two listed AMC stocks of Reliance and HDFC AMC and hence the choice is fairly limited. However, before taking such decision, here are 3 important points to consider.
Value as yield on AUM
An asset manager is obviously not to be valued like other typical valuation basket cases. It is in the business of managing money and the stock tries to create wealth out of the earnings from managing this money. Globally, AMCs are rarely valued on the basis of P/E but they are valued on the basis of value as a percentage of AUM. This is called the value that a buyer would pay to take over the AMC. Normally, for reputed funds with a higher exposure to equity AUM, the regular rate is 7-8% of the AUM. Considering that HDFC has AUM of Rs.345,000 crore and market cap of Rs.36,000 crore, the stock is already quoting at more than 10% of its AUM. That is higher than what most AMCs with a strong equity franchise have commanded in the past. In pure valuation terms, the valuation may still depend on how quickly the AUM grows and one must remember that it depends on competition and on the continued appetite for mutual fund investing. That makes growth a major challenge!
Margins are narrowing
What is the biggest source of revenues for the asset management companies? Obviously, it comes from the fees charged by the AMC in the form of total expense ratio (TER). This is charged proportionately on a daily basis to the NAVs. There are two challenges for the AMCs here. Firstly, the SEBI has already taken steps to reduce the costs for mutual fund investors and that is going to have an impact on the AMC profits. Secondly, there is a customer angle. Last five years have been years of high returns. Hence investors did not grudge the cost of equity funds. But as markets reach higher levels, you could see outflows and also a shift to index funds. That could also impact AMC revenues.
FMP uncertainty for AMCs
The big question mark could be what happens to FMPs which have been used to fund promoters via pledged shares. It is estimated that promoter funding by MFs is to the tune of Rs.3.2 trillion with nearly Rs.1.2 trillion coming up for redemption in the next few months. One must be prepared for a lot of ungainly revelations when these come up for redemption. How that will impact the valuation of these AMCs will be known only when push comes to shove? The moral of the story is not to get carried away by the hype surrounding the AMC stocks. The real picture on AMC stocks may be a lot more complicated! ©