InvestorQ : In the last few months, HDFC AMC and Reliance Nippon AMC have shown a sharp price appreciation. Which stock to prefer?
Anjana Aiyar made post

In the last few months, HDFC AMC and Reliance Nippon AMC have shown a sharp price appreciation. Which stock to prefer?

Arya Nanda answered.
2 years ago

Both the stocks you have mentioned are asset management companies. While HDFC is the largest asset management company in India in terms of AUM, Reliance used to be No.1 but has now fallen below Number 5 in the ranking. It recently had a management shift after Nippon acquired the entire stake of Reliance Capital and gave a full exit to Reliance Cap from the asset management business. Here are some important things you must know before you buy into AMC stocks.

· The revenue of these AMCs comes from the size of the AUM and India has seen a 3-fold growth in AUM from Rs.8 trillion in 2014 to $25 trillion in 2019. To that extent the business size of the large players will keep increasing in the future too as savings get increasingly financialized.

· HDFC AMC has announced stellar numbers in the March 2019 and the Jun e2019 quarters and that has given greater confidence to investors. That is also something that will weigh on the price.

· How are AMCs valued? Unlike companies that are valued based on the future earnings discounted, the AMCs are valued based on percentage of AUM. That is unique to AMCs across the world. That is because; AMCs are in the business of managing money and the stock tries to create wealth out of the earnings from managing this money. AMCs are rarely valued on the basis of P/E ratios; hence these ratios are hardly relevant.

· Normally, you consider market value as a percentage of AUM. This is called the value that a buyer would pay to take over the AMC. 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.360,000 crore and market cap of Rs.55,000 crore, the stock is already quoting at more than 15% of its AUM. That is higher than what any AMC with a strong equity franchise can hope to command. Even assuming that the AUM will be growing, this is a steep overvaluation.

· You also have the problem of margins narrowing for these AMC companies. The biggest source of revenues for the asset management companies comes from the fees charged by the AMC in the form of total expense ratio (TER). There are two problems. Firstly, SEBI has 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 customer angle. Last five years have been years of high returns. Hence investors did not grudge the cost of equity funds. If markets move higher, you could see outflows and also a shift to index funds. That will certainly impact AMC revenues.

· In the recent past, there has been an overhang of the FMPs and that problem is far from being fully resolved. HDFC AMC has also given a commitment to its unit-holders to protect their portfolio value up to a point. That is a cost that the AMC will bear up to Rs.500 crore and that will also impact the profitability of HDFC AMC.

Now how do you make a call between HDFC AMC and Reliance AMC? HDFC AMC is clearly the larger of the two by a margin in terms of AUM. Also, it is still owned domestically, unlike RNAM that is now substantially owned by Nippon. To begin with, you should be cautious on the overall AMC space as such. The reasons have already been given. The only good thing for you is that RNAM is more reasonably valued and has seen a management change. From that perspective you can prefer RNAM over HDFC AMC.