We are upgrading the stock from EW to OW and raising our price target by 40% to Rs 3,130 (from Rs 2,235). Our new target implies 22% upside from current levels. Stock has underperformed year to date and has significantly underperformed both Sensex and Bankex. The stock is down 20% YTD after strong performance in 2019 vs. +8% for Sensex and -8% for Bankex. Since Nov 19, the stock has significantly de-rated, with 1-year forward price-to-earnings multiple declining from a peak of 57x to ~36x now. Since May 31, 2020, while Sensex is up 38% and Bankex is up 52%, HDFC AMC stock is up only 2%.
Reasons for the under-performance. Weak industry fundamentals, the asset management industry has seen continued outflows in equity ex ETF (more profitable business), despite systematic investment plan (SIP) inflows remaining fairly resilient.For the mutual fund industry, equity ex ETF funds have seen outflows for the past five consecutive months, and FYTD outflows have been ~Rs 187bn. SIP inflows of ~Rs 556bn have been offset by non-SIP outflows of ~Rs 743bn. Loss of market share: Further, HDFC AMC has progressively lost market share in equity ex ETF. For Oct 20, its market share in equity ex-ETF funds was 13.5% (on a monthly average AUM basis) vs 15.3% as of Oct 19. In the past, on its Q3FY20 post earnings conference call, management has attributed the loss of market share to underperformance of the mid-cap and small-cap categories, which were then ~19% of AUM for HDFC MFvs. ~11% for the industry.
Why OW now? Stronger markets ahead, along with broad market recovery. The Morgan Stanley India Equity Strategy team expects a broad-based earnings recovery and double-digit returns in 2021, with small- and mid-cap stocks outperforming. The team expects BSE Sensex to be at 50,000 by December 2021, which implies ~12% upside from current levels. This should benefit the asset management industry, and HDFC AMC should likely be a disproportionate gainer. We believe that,as the macro environment continues to improve, non-SIP domestic flows should come back strongly in FY22, and there could be a case of rise in contribution from SIP flows, too.
This, along with mark-to-market gains, should drive AUM growth for the industry. HDFC MF should be a disproportionate gainer, if our assumption of a broad market recovery ensues.
We value HDFC AMC stock using our base case target P/E multiple. In the past, we have discussed that our DCF computations support a base case P/E multiple of 30-35x. We were valuing the stock at the lower end of this valuation range (30x) this year because of uncertainty around the economy because of Covid-19 and resultant broad market weakness. As mentioned our DCF computations support a base case P/E multiple of 30-35x, we now value the stock at 36x our March 2023 EPS estimate (we have rolled forward our valuation by 12 months from March 2022, which is based on one-year-forward earnings and P/E multiple, i.e. FY23, average P/E multiple since listing of 36x). This is driven by structural benefit to the mutual fund industry and to players with larger market share on the back of change in investor sentiment and stronger equity markets could directly help earnings via higher AUM (mark to market gains + higher equity inflows).
We forecast EPS growth of 20% in FY22 and 18% in FY23. Thus, we arrive at our price target of Rs 3,130, implying 22% upside from the current market price. Our bull case scenario value of Rs 5,215 implies 103% upside. It assumes an EPS CAGR of 24% (F20-23e) and a target P/E multiple of 45x (peak valuation multiple has been 57x). A key risk to our rating is weaker-than-expected markets, especially broad market weakness and continued market share loss at HDFC AMC.