JM Financial has downgraded HDFC Asset Management Company to sell and Reliance Nippon Life Asset Management to hold with target prices of Rs 3,175 and Rs 340 respectively, valuing them at 45x and 34x FY21E EPS, while earnings estimates remain unchanged.
"While we have been constructive on both AMCs since their respective IPOs, and even as the sector underwent regulatory pressures, we believe current valuations leave little margin of comfort," said the brokerage house.
AMCs have had a strong run-up in the recent past, with HDFC AMC and RNAM up 119 percent and 91 percent respectively, since April 30, 2019.
By contrast, FY21 EPS estimates have increased 25 percent and 4 percent for HDFC AMC and RNAM respectively, over the same period, said the brokerage.
As a result, HDFC AMC corrected nearly 3 percent intraday on November 26, in addition to 3 percent fall in the previous session. It was quoting at Rs 3,491.65, down Rs 96.05, or 2.68 percent on the BSE at 1256 hours IST.
RNAM share price also fell in morning but recovered immediately and traded at Rs 374.60, up Rs 2.75, or 0.74 percent at 1256 hours IST. It was down 1.5 percent in the previous session.
"The P/E multiple re-rating has been driven by a combination of factors, in our view: a) improvement in operating profitability, post the total expense ratio (TER) cut and banning of upfront commissions by SEBI and b) continued resilience in retail equity MF flows, despite the challenging equity market environment, which reinforces belief in the long-term ‘sticky’ earnings generation capability of these stocks," JM Financial said.
Separately, RNAM has witnessed a change in controlling shareholder (Nippon Life now owns 75 percent), which has addressed the promoter overhang, it added.
Operating profitability (PBT ex-other income as a percentage AUM) has improved to 26bps for RNAM (up 4bps YoY) and 41bps for HDFCAMC (up 7bps YoY) in the first half of FY20.
While operating profit expansion has largely been led by upfront fee-related cost savings, the operating revenue trajectory seems to be losing steam – core revenues declined 1.3 percent and 8 percent QoQ respectively for HDFC AMC and RNAM in Q2FY20, it said.
The brokerage believes these positives for the AMC sector have been largely factored into current valuations (currently 52x and 37x FY21 respectively for HDFCAMC and RNAM respectively, versus 30x and 20x as of April 30, 2019).
It said a reverse-DCF analysis on both stocks indicates that current valuations imply aggressive AUM CAGR estimates of 26 percent and 18 percent respectively over the next 10 years for HDFC AMC and RNAM, while also implying earnings CAGR of 27 percent and 20 percent.
In this light, it is pertinent to note that HDFCAMC/RNAM delivered a 19/11 percent CAGR respectively over FY09-19, it added.
As a result, JM Financial sees low margin of safety considering the fact that AUM & earnings for this business remain cyclical in nature.
While highlighting key risks to its recommendation on both stocks, the brokerage said strong surge in equity MF flows/ market appreciation could lead to elevated multiples/strong stock performance.
Separately, while passive MFs (ETFs / FoFs), are currently a low proportion of overall MF industry (6 percent), global trends point towards a rising proportion of low-yield passive AUM, which could compress yields/profitability going forward, it added.