HDFC Asset Management Company (AMC) (NSE: HDFCAMC, BSE: 541729) continues to be the face of the Indian mutual fund industry. The AMC operates as a joint venture between Housing Development Finance Corporation (HDFC) and Standard Life Investments (SLI). As on 31st March 2020, HDFC holds 52.72% and SLI holds 26.89% of the AMC.
Positives
Strength of HDFC brand – The HDFC brand carries great strength. The HDFC group has a strong presence across financial products and services, especially in the retail sector. HDFC group has emerged as a recognized financial conglomerate in India with a presence in housing finance, banking, asset management, life and non-life insurance, education finance, and real estate funds. Some listed companies of the HDFC group are HDFC Ltd, HDFC Bank, and HDFC Standard Life Insurance Company.
Dominant Position – HDFC AMC has been the largest asset management company in India in terms of equity-oriented asset under management (AUM) since the last quarter of financial year 2011 and is consistently ranked among the top two asset management companies in India in terms of total average AUM since August 2008 (as per CRISIL). Its market share was 14.3% in total AUM and 14.7% in equity-oriented AUM as of March 31, 2020.
The company has been able to consistently maintain the share of equity oriented mutual funds in Total AUM share well above the industry share. As on March 31, 2020 equity mutual funds constituted 38.3% of the total AUM share as against the industry share of 37.1%. As equity-oriented schemes generally have a higher fee structure compared to non - equity oriented schemes, the company’s profitability is higher.
HDFC AMC also accounts for ~27% of the total number of unique investors in the Industry.
Market leader in the retail investor segment; strong SIP flows – HDFC AMC is the largest player in the individual investor segment, with 15% of the industry market share in individual MF AUM. AUM sourced from individuals tends to be more ‘sticky’. Individual Monthly Average Asset Under Management (MAAUM) stood at 57.2% with respect to the industry average of 52.2% on March 31, 2020.
Top 30 (T30) cities contributed to 86.4% of the MAAUM, while Beyond 30 cities (B30) contributed 13.6%. HDFC AMC is the 2nd largest player in the B30 market segment with 11.9% market share.
A key metric to assess the ‘stickiness’ of the AUM is the inflow from systematic investment plans (SIPs). Moreover, 81% of the SIP book has a tenure of over 5 years, and 69% over 10 years. SIP flows, which come from retail investors and HNIs, tend to be largely directed towards equity MFs.
Strong distribution network – HDFC AMC’s distribution franchise spans across with 221 branches, which are supported by a strong and diversified network of over 70,000 empaneled distribution partners across India, consisting of banks, national distributors and independent financial advisors (IFAs). HDFC Bank contributes ~5.6% of total AUM and 9.9% of equity AUM. As on March 31, 2020 47.8% of the Total AUM was related to direct distribution channels and 40.3% of the equity oriented AUM was related to IFAs.
Class-leading profitability – The below charts shows that HDFC AMC has been the most profitable large AMC in terms of Annual Average Asset Under Management (AAAUM).
|
FY15 |
FY16 |
FY17 |
FY18 |
FY19 |
|
|
Operating Income |
1,022.44 |
1,442.54 |
1,480.04 |
1,756.77 |
1,915.18 |
|
ROCE (%) |
61.61 |
62.37 |
62.14 |
57.56 |
51.64 |
|
ROE (%) |
41.12 |
42.08 |
42.75 |
38.79 |
35.08 |
|
Operating Margin (%) |
61.88 |
49.86 |
54.85 |
60.77 |
72.45 |
|
Net Margin (%) |
39.04 |
31.98 |
34.65 |
38.04 |
44.38 |
|
Cash EPS (Rs) |
168.63 |
194.3 |
223.39 |
34.23 |
44.38 |
Risks
Cyclical nature of markets and investment management performance – Almost the whole of operating income of the AMC comes from investment management fees. This is a function of assets under management (AUM) and total expense ratio (TER). Whereas TER is capped, AUM is directly proportional to the scheme performance. In the event of market or scheme underperformance, investors may redeem their holdings, which would cause the AUM to shrink, thereby lowering the fee income.
Drop-in financial savings rate – Erosion in the financial savings rate, triggered by outperformance of physical assets (gold / real estate) or underperformance of financial assets, or a general decrease in savings in the economy, pose a risk to our thesis.
High dependence on equity markets – HDFC AMC is heavily geared towards equity markets, which by nature tend to be volatile. Equity funds also have the highest income generating potential. While this likely benefits the AMC in an upcycle, during a down cycle, the profitability may be significantly affected.
Competition from other asset classes especially exchange-traded-funds (ETFs) – Many alternative asset classes exist which via for investors’ attention pose a potential threat to the AMC’s core business. These include ETFs (passive funds, revenues are much lower), alternative investment funds, portfolio management services, gold, real estate, insurance and retirement products.
Competition – The AMC business is intensely competitive. Increased competition may result in a decrease in its AUM market share or force it to reduce investment management fees, which could adversely affect the results of operations.
Outlook
HDFC AMC has reported a weak quarter of revenue and profitability on account of a sharp fall in equity prices in 4QFY20 and a generally risk-averse environment due to COVID-19/lockdown. As per management commentary, company did 0.65 million transactions in Feb 2020 and 1.03 million transactions in March 2020. ~75% of the revenue came from equity funds. Besides taking self-initiated cost reduction measures, a shift towards digital transactions would also aid in cost control. Digital platform business across distributor websites, aggregator platforms and HDFC MF’s own platform are expected to increase. Unrecognized NCD loss from Essel group worth INR 95 crore impacted other income and earnings.
While applicable TER will increase marginally as AUM falls, distributor commissions will remain constant. Company doesn’t renegotiate distributor commission based on AUM movement. The drop in equity market share was partly due to higher fall in small/mid cap funds which form a larger proportion of the company’s AUM compared to its peers. Redemptions were little.
A steep correction in equity markets has impacted both AUM and earnings momentum. Near term outlook remains uncertain but structural changes, including increase in financial savings, remain positive. The company is expected to maintain its leadership through healthy AUM growth. Focus on strong operating efficiency & higher proportion of equity AUM is seen aiding profitability.
India continues to be a relatively untapped mutual fund market. Mutual fund industry AUM rose at a CAGR of 17.4%, from INR 1.1 trillion as on FY00 to INR 23.8 trillion as on FY19. The mutual fund industry had 41 AMCs (excluding Infrastructure Debt Funds) as of March 2019, up from 32 in March 2000, after a brief drop to 28 in 2004. Mutual fund AUM as a percentage of GDP rose from 4.3% in FY02 to 12.5% in FY19. However, the industry still has tremendous potential for growth, considering a large untapped market with favorable demographics of a young population. Mutual fund penetration ratio (AUM to GDP) is significantly lower in India, compared to the world average of 62% and emerging economies like Brazil and South Africa at 59% & 49%, respectively.
The company falls in the category of a ‘great business’ with high operating margins (50% plus), near zero capital requirements (very small fixed assets base, zero leverage), high return ratios (about 60% return on capital employed), healthy stream of free cash flows and a high dividend pay-out ratio. The company’s operating revenue and net income has grown at a CAGR of 16.99% and 22.33% respectively in the last five years.
HDFC AMC is currently available at a CMP of INR 2,527.80 (as on April 17, 2020) at a PE of 42.50, which is below its 1-year median PE of 50.76. The current valuation provides a great opportunity for a long-term investor to be a part of company which is not only a market leader but also part of an industry that has been enjoying strong tailwinds due to the changing investment behavior of the Indian population.
Team 3C Capitals
Sources
