Regulatory uncertainty weighs on valuations of AMCs

22 Mar 2023 , 10:50 AM

On the first issue, AMCs have maintained that any effective cuts in TER would be passed on to the entire value chain (distributors, RTAs, brokers, etc.), as was done in FY19 when TERs were cut by 25 basis points (analysts at IIFL Capital Services note that FY20 yield of the two covered AMCs were unaffected). On the other hand, on AUM growth, analysts at IIFL Capital Services expect that relentless selling in debt schemes should ease off and new flows in debt and equity should aid 10% AUM growth in FY24. Stock valuations, at 20-25% discount to their long-term average, offer favorable risk-reward from medium-to-long term perspective. However, news flow around possible regulatory changes can continue to weigh on near-term stock performance.

SEBI looks to further tighten MF TERs; AMCs confident to pass on the same

SEBI has initiated a study on the expenses charged by mutual funds (MFs); however, the regulator is yet to share details on the same (speculations are rife about some clarity in March end meet). Media articles suggest SEBI is mulling over: 1) Uniform TER at the fund level 2) Subsuming GST and trading costs within the scope of TERs. Assuming equity TERs are restricted to the fund’s largest scheme, HDFC AMC may see 20 basis points reduction on its equity assets; and ABSL AMC would see a 13 basis points reduction. GST on management fee ranges in 7-9 basis points across the four listed AMCs; while the impact of trading cost is difficult to determine. As such, the impact on AMC’s earnings would depend upon: 1) Changes introduced 2) Ability of AMCs to pass on the same within the value chain (distributors, RTAs, brokers, etc.) 3) AMC profitability. Analysts at IIFL Capital Services note that a 10 basis points change in TERs could lead to 23-34% change in AMC’s earnings estimates – least for HDFC AMC and highest for ABSL AMC. AMCs are confident that any effective cuts in TER will be passed on to the value chain.

Subdued AUM growth in FY23 YTD; new flows expected to drive growth in FY24

The MF industry average AUM grew by 7.3% YoY to Rs39.2 trillion in FY23 YTD (until February 2023) – lowest in last 10 years. As noted by analysts at IIFL Capital Services, sharp redemptions in debt schemes (Rs1.7 trillion) for the second consecutive year and slowdown in equity flows in FY23 to Rs1.2 trillion versus Rs2.6 trillion YoY (FY22 flows were supported by Rs786 billion flows through NFOs) weighed on AUM growth. Muted equity markets (Nifty index down 2% YoY in FY23 till date) also resulted in subdued AUM growth. For FY24, analysts at IIFL Capital Services expect flows to be healthy driven by both debt (assuming interest rate hike cycle nearing peak) and equity (sticky SIP flows). They estimate at least 10% YoY growth in FY24 versus past 10-year average of 18% p.a.

 

Near-term uncertainty weighs on stock valuations; long-term prospect intact

Slowing AUM growth and uncertainty around new TER regulations have weighed on sector valuations. Analysts at IIFL Capital Services note that in last six months – sector multiples are down 25% and now trade at 18x 1YF PE. They believe the current valuations offer favorable risk-reward from medium-to-long term perspective; also, once the TER issue is settled, earnings growth should largely reflect the AUM growth that is expected to be 14-15% p.a. IIFL Capital Services’ base case earnings growth of 10% for both AMCs and 15% CAMS builds in modest AUM growth (12% pa) and no impact of any TER changes. To account for regulatory changes, analysts at IIFL Capital Services have cut their target multiple by 20-25% and now value HDFC AMC at 27x 2YF EPS (long-term average is 35x) and ABSL AMC at 18x 2YF EPS (22.5x is long-term average). They continue to value CAMS at 35x 2YF EPS, as its dominant market share of the MF-RTA industry (70%) makes it a play on the industry and insulates from risk of underperformance of any one AMC.

Further, optionality of non-MF businesses, which the company expects would grow faster than MF business (not the base case of IIFL Capital Services), are also captured in valuations.