Valuation and Investment Banking

Valuation Report on HDFC Asset Management Company

Institute: Xavier Institute of Management, Bhubaneswar

Submitted to: Prof. Rajiv Bhutani (Valuation & Investment Banking)
Submitted by: Group 5, Section 2, MBA-BM (Year 2)
Group Members:

Roll No. Name of Student IV= 1447 PER SHARE

UM19199 Ankeet Raj Mohapatra
UM19270 Anuj Sharma CMP = 2256 PER SHARE
UM19274 Anurag Singh DOWNSIDE RISK= 56%
UM19298 Priti Chauhan
UM19308 Sneha Verma
UM19312 Sonia Bansal
SELL
ECONOMIC OVERVIEW

We have done economic analysis pertaining to two main factors, that is GDP (per capita) and
gross domestic saving rate. Even though in comparison to other countries, India has the high
expected CAGR at 8.1% over the next 5 years. Still it has the lowest mutual fund investments
to GDP ratios in the world at 7 per cent, offering a vast untapped opportunity for MF houses,
which can leverage technology to enhance reach. MF investments accounted for only 3.4 per
cent of total financial investments by individual investors. This underlines the significant
untapped potential for growth in the Indian mutual fund industry. Globally, mutual fund
AUM (asset under management) has grown at a CAGR of 5.8 per cent over the past five
years.
For gross domestic saving, we have made comparisons across countries, and also looked at
trends of savings investments in different avenues. Over the years, gross financial savings of
Indian households have been ranging bound — around 9-10 per cent of GDP. But net
financial savings available for growth is falling. It fell from 7.2 per cent of GDP in 2011-12
to 6.5 per cent in 2017-18. Though the gross saving rate today it at satisfactory 31%, still
people are investing more in physical assets as compared to financial assets.

INDUSTRY OVERVIEW

In India, mutual fund is a sunrise industry with huge potential. Mutual fund industry AUM
has grown at a CAGR rate of 23 percent, from Rs 7 lakh crore in 2013 to Rs 21.4 lakh crore
(as of September 2019). AUM of equity funds has grown at a rate of 37.3 percent, which is
1.5 times the industry growth. Accelerated growth in equity is the result of retail investors
entering the market. As per Crisil, mutual fund industry revenues and profits are expected to
grow at a rate of 25 percent in next 5 years, fuelled by higher equity inflows.

On top of that, in Value Research's estimation, the industry as a whole has hit barely 10
percent of the total potential. Although the industry is getting a huge new number of investors
every year, an overwhelming number of Indian savers are yet to wake up to mutual funds.
This represents a large potential for growth. Mutual funds account for as low as 3 percent of
total financial savings of Indian households. However, pushed by falling interest rates on
traditional favourites like fixed deposits, and much lower friction that networked transactions
have brought to mutual fund investing, this will grow rapidly.

Investing on a monthly basis, - popularly known as SIP (systematic investment plan), is even
more popular now, than ever before and the contribution has seen a significant increase.
Overall, the net flow towards equity and money market has shown an increase, while the
investors seem to be diverging from the debt segment. And the share of passive funds as
percent-age of average asset under management has increased. Passive investments make
sense today as increasingly active ones are unable to beat it most times.

COMPETITOR ANALYSIS

There about 13 big players in the mutual funds domestic market. With the top competitors for
HDFC being ICICI Prudential Mutual fund, SBI mutual fund, Aditya Birla Sun Life Mutual
Fund and Nippon India Mutual Fund. HDFC had the second highest revenue in the market at
Rs 1915 crores. But has shown the highest profit over the years almost double of the other
competitors. It also has the highest profit per AUM at 0.27% close to ICICI Prudential and
Nippon at 0.21%.

Also, the net profit margin is significantly higher at 49%, than its other competitors. It also
has the highest market share of 14% followed by ICICI at 13%.

But in the global market it still has to hold a strong grip as compared to international players
it has only an AUM holding of 45. While others like Charles Schwab, BlackRock, and
Fidelity Investments have a comparatively high holding above 5000.lso the profits and
revenue are at a very low number. Though it has shown at a good ratio of Market
capitalisation by AUM in comparison to the other players. Also, it has the highest Net profit
Margin at 54.5%.

It has the largest risk diversifying advantage. As it is the fund house with the highest assets in
the industry. And has increased its asset size by another 3% by acquiring nearly 4%-5% of
the total assets of Morgan Stanley.
RATIO ANALYSIS (FY 2019-20)

Return Price to
PBDIT
COMPANY ROCE NPM on Assets Book Value
Margin (%)
(%) (X)
Hdfc AMC 40.70 63.01 29.29 11.15 78
Bajaj Finance 45.38 20.48 3.53 5.85 26
L&T Finance
56.11 2.35
4.28 2.95 66
Holdings
Muthoot Finance 30.69 34.63 5.98 3.47 78
Cholamandalem
Investment Finance 12.16 1.64
9.75 2.39 20
Company

The return on capital employed ratio shows how much profit each dollar of employed capital
generates. Always a higher ratio would be more favourable because it will mean that more
dollars of profits are generated by each dollar of the capital employed. Investors are
interested in the ratio to see how efficiently a company uses its capital employed as well as its
long-term financing strategies. In terms of ROCE the company is the second highest at 40.70
% and can be seen as an attractive avenue for investors in comparison to its competitors who
are having quite low ratios.

Net margin measures how successful a company has been at the business of marking a profit
on each dollar sales. The NPM for HDFC is far above the industry average of 25 %.Which
tells the investors how well the management and operations of a company are performing.
While Cholamandalem Investment Finance Company is seen to be having drastically low
ratio. The return on assets ratio measures how effectively a company can earn a return on its
investment in assets. Higher ratio is more favourable to investors because it shows that the
company is more effectively managing its assets to produce greater amounts of net income.
The company has been giving almost 5 times the ratios compared to its industry peers.

Price to book value ratio measures whether or not a company’s stock price is undervalued.
The higher the ratio, the higher the premium the market is willing to pay for
the company above its hard assets. Here the ratios are greater than 1 for all companies. Here
HDFC has the highest P/BV indicating that the shares have more liquidation value. A high
book-to-market ratio shows the market is valuing the company's equity cheaply compared to
its book value. And it has the highest valuation amongst it peer who mostly around 3.

HDFC and Muthoot finance have both shown a very high ratio which is favourable by the
investors and shows high risk and cost control by management. And have performed fairly
high above the industry standards.

SWOT ANALYSIS

Strengths:

 Stocks where Mutual Funds Increased Holdings in Past Month

 Rising Net Cash Flow and Cash from Operating activity
 Efficient in managing Assets to generate Profits - ROA improving since last 2 yeaR
 Growth in Net Profit with increasing Profit Margin (QoQ)
 Company with No Debt
 Strong cash generating ability from core business - Improving Cash Flow from
operation for last 2 years
 Annual Net Profits improving for last 2 years
 Book Value per share improving for last 2 years
 FII / FPI or Institutions increasing their shareholding
 MFs increased their shareholding last quarter

Weaknesses:

 Promoter holding decreased by more than -2% .

 Bearish Stocks - Stocks with Medium to Low Momentum Scores according to
multiple indices
 Inefficient use of capital to generate profits - RoCE declining in the last 2 years
 Declining Revenue every quarter for the past 2 quarters
 Promoter decreasing their shareholding
 Weak Momentum: Price below Short, Medium- and Long-Term Averages

Opportunities:

 Buy Zone: Stocks in the buy zone based on days traded at current PE and P/BV
  Brokers upgraded recommendation or target price in the past three months
 Biggest Price Gainers from Open

Threats:

 Companies with high market cap, lower public shareholding

 Stocks with Expensive Valuations
 Increasing Trend in Non-Core Income

VALUATION ANALYSIS

DDM MODEL

DDM model here was used valuing the stock. It was used to value stocks based on the net
present value of the future dividends. We have used a two-stage growth rate model. Since
there is no trend in the growth rate, internal growth rate is calculated using dividend pay-out
ratio and ROE. We found a growth rate of 16.81% based on that. And terminal rate of 4 %
has been taken here.

Data for the year 2020

DPS (Rs.) 28.00
EPS (Rs.) 59.37
Dividend Payout Ratio 47.16%
Earnings 1,259.33
Net Worth 4,029.26
ROE 31.25%
Expected growth rate in EPS 16.51%

Applying Two Stage DDM

Expected Payout
Year g EPS Ratio DPS Cost of Equity Present Value

2021 16.51% 69.17 47.16% 32.62 14.15% 28.58

2022 16.51% 80.60 47.16% 38.01 14.15% 29.17

2023 16.51% 93.91 47.16% 44.29 14.15% 29.77

2024 16.51% 109.42 47.16% 51.60 14.15% 30.39

2025 16.51% 127.49 47.16% 60.13 14.15% 31.02

2026 4.00% 132.59 47.16% 62.53 14.15% 317.79

Value per Share 466.73

FCFE AND FCFF MODEL

FCFE or Free Cash Flow to Equity and FCFF are the Discounted Cash Flow valuation
approaches used here to calculate the Fair Price of the Stock. While FCFE measures how
much “cash” a firm can return to its shareholders and is calculated after taking care of the
taxes, capital expenditure, and debt cash flows. FCFF measures the cash flow available to
both the equity and debt owners.

FCFE model has also been done on two stage growth rate model basis. Here we have
calculated the growth rate for the next five years on basis of Non cash ROE and reinvestment
rate which is 31.80%.Here the per share value has come to be Rs 398.13.

Data for the year 2020

Particulars (Rs.)
Net Income 1,259.33
After Tax Cash Income 0.54
Non-Cash Income 1,258.79

Book Value of Equity (2019) 3,070.72

Book Value of Cash Assets (2019) 31.99
Non-Cash Book Value of Equity (2019) 3,038.73

Non-Cash ROE 41.42%

Capital Expenditures 30.69

Depreciation, Amortization &
(50.37)
Impairment
Change in Non- Cash Working Capital 978.49
Net Debt Cash Flow 7.55

Equity Reinvestment Rate 76.77%

Expected growth rate in Net Income 31.80%
 Applying Two Stage FCFE
Expected Net Equity Reinvestment Cost of Present
Year g Income Rate FCFE Equity Value
76.77% 337.64
2021 31.80% 1,659.10 385.43 14.15%
76.77% 389.85
2022 31.80% 2,186.72 508.00 14.15%
76.77% 450.13
2023 31.80% 2,882.13 669.55 14.15%
76.77% 519.73
2024 31.80% 3,798.69 882.48 14.15%
76.77% 600.08
2025 31.80% 5,006.73 1,163.12 14.15%
76.77% 6,147.68
2026 4.00% 5,207.00 1,209.64 14.15%
Value of Operating Assets 8,445.12
Add : Cash & Cash Equivalents and Bank Balance (2020) 27.10
Value of Equity 8,472.22
Number of Shares 21.28
Value per Share 398.13

FCFF model on the other hand has taken growth rate to be 30.30 % on the basis of Non-cash
ROC and reinvestment rate. The per value of the stock is taken to be Rs 375.74.

Data for the year 2020

Particulars (Rs.)
EBIT 1,662.03
Cash Income 0.72
EBIT - Cash Income 1,661.31
Tax Rate 25.00%
EBIT (1-t) 1,245.98
Book Value of Capital (Equity + Debt )
3,195.95
(2019)
Book Value of Cash Assets (2019) 31.99
Non-Cash Book Value of Equity (2019) 3,163.96

Non-Cash ROC 39.38%

Capital Expenditures 30.69

Depreciation (50.37)
Change in Non- Cash Working Capital 978.49

Reinvestment Rate 76.95%

Expected growth rate in Operating
30.30%
Income
 Applying Two Stage FCFF
Expected Present
Year g EBIT (1-t) Reinvestment Rate FCFF Cost of Capital Value
2021 30.30% 1,623.57 76.95% 374.20 13.92% 328.49
2022 30.30% 2,115.57 76.95% 487.59 13.92% 375.74
2023 30.30% 2,756.68 76.95% 635.36 13.92% 429.80
2024 30.30% 3,592.07 76.95% 827.90 13.92% 491.63
2025 30.30% 4,680.61 76.95% 1,078.78 13.92% 562.36
2026 4.00% 4,867.84 76.95% 1,121.93 13.92% 5,898.37
Value of Operating Assets 8,086.40
Add : Cash & Cash Equivalents and Bank Balance (2020) 27.10
Less : Debt (2020) (117.68)
Value of Equity 7,995.82
Number of Shares 21.28
Value per Share 375.74

All the above calculations have been done without taking any of our own assumptions.
According to the below assumptions that we have taken we found the FCFE model value per
stock to be Rs 1447.

Industry Assumptions

(1) Net inflow/ Last year Aum – Equities is assumed to be increase by 5% in FY 2020-
21 as it is assumed that investment in equity is likely to decrease due to COVID effect
and shrink in economic growth because in uncertain times people like to invest more
in safer securities.
Going ahead we’ve assumed that Net inflow/Last year AUM will be 15% till FY25 as
it is 12.4% in FY 2019 and according to our industry analysis it seems that in normal
times investor’s interest in equity investments is increasing.

(2) Net inflow/ Last year Aum – Others is assumed to be 15% for FY 21 as it consists of
debt and ETFs which are assumed to be more safer assets as compared to equities, so
as investment in equity will decrease for this FY 21 investors’ inclination towards
safer assets mean that investment in these assets will decrease. Going ahead the
investment in these assets assumed to decrease by 1% every year as Net inflow/ Last
year AUM metric as investment in equity increase.
 (3) Return on equity- Return on equity is assumed to be 7% till FY 2025 as NIFTY 500
return for the last 10 years is 88. So, on an average basis it has been taken as 7%.
(4) Return on others- Return on others has been taken on historical basis.

HDFC AMC Assumptions

(1) HDFC AMC Market share- Market share of HDFC is assumed to be constant at 15%
till FY 25.
(2) Revenue as % of Average AUM- It is assumed to be decrease at 2% year on year till
FY25 because increase in size of Avg. AUM is possible with reduction in asset
management fees as competition is increasing.
(3) Other Income as % of average AUM- Three year moving average is taken to forecast
till FY25
(4) Fees and Commission as % of Average AUM – It has decreased significantly in the
year 2020 as SEBI has banned upfront commission to mutual fund distributors, so
company is not receiving upfront commissions as a result of which its revenue from fees
commission and fees is about 0.01% in 2020 as compared to 0.08% in 2019 and likely
to remain so in future as well.
(5) Employee benefit expenses as % of AUM –It is assumed to decrease by 0.04% on year
on year basis as AMC industry is employee intensive work done by per employee is
flexible i.e. if one asset manager is managing AUM worth of Rs. 30 crores he can also
manage AUM worth of 40 crores with ease so employee expenses will not increase in
the same proportion as revenue or as average AUM.
(6) Other expenses as % of Average AUM- Other expense as % of avg. AUM is assumed
to decrease by 0.005% on year on year basis as the size increases scale of operations
will play its role

Important Consideration
Before going ahead there is an important change in accounting of Leases in India from 1st
April 2019, IND AS 17 was applicable before this date which says to differentiate between
accounting treatment of operating leases , however at present time IND AS 116 is used for
leases which says that all lease should be treated as operating leases for accounting
purposes, this rule is applicable from the date mentioned above. Now, for the companies
who were treating lease as financial leases there is major change in their fixed assets and
non-current liabilities after transition from IND AS 17 to IND AS116.
(7) Depreciation as % of gross fixed assets - Depreciation is assumed to be 25% of gross
fixed assets on historical basis.
(8) Tax expense – It assumed to be 25% as marginal tax rate.
(9) Gross fixed assets as % of addition in average AUM- It has increased dramatically
from 14.8 to 58.7 due to change in accounting rules of leases as mentioned before but
going ahead we’ve assumed average of last three years for FY 21 and for the rest of the
years a reduction 2% on YoY Basis has been assumed because as the size increases it is
assumed the fixed assets requirements of the firm will decrease as AMC industry is not
capital intensive.
(10) Maintenance Capex- It is assumed to be depreciation of last year.
(11) Trade receivables – It is taken as % of total revenue and assumed to remain constant
as % of total revenue for forecasting purposes.
(12) Other Receivables - It is taken as % of total revenue and assumed to remain constant
as % of total revenue for forecasting purposes.
(13) Other Financial Assets - It is taken as % of total revenue and assumed to remain
constant as % of total revenue for forecasting purposes.
(14) Trade Payables- It is taken as % of total revenue and assumed to remain constant as
% of total revenue for forecasting purposes.
(15) Other Financial Liabilities- It is taken as % of total revenue and assumed to remain
constant as % of total revenue for forecasting purposes.
(16) Interest Cost: Interest cost was not in the balance sheet before FY 2020 because
interest cost is basically interest on lease and before FY20 it was shown as interest
expense.
Interest expense is assumed as a % of other financial liabilities as it is interest on lease
and around 70% of other financial liabilities consist of lease liabilities.
(17) No debt schedule has been made because debt is too small as a number in total
liabilities and forecasting doesn’t makes sense for such small number, so we’ve
considered change in current debt as part of change in working capital and long-term
debt is assumed to be constant.
(18) Considering the above point in view calculation of FCFF doesn’t make any sense as
interest is quite small as a number not even 1% of profits and also there is no change in
debt so FCFF and FCFE will not give any significant difference in valuation.
 (19) Reinvestment rate: ROE* Retention ratio as company’s depreciation is more than its
capex so using other methods doesn’t makes sense considering current growth rate in
FCFE.

RELATIVE VALUATION
In relative valuation, the objective is to value an asset based on how similar assets are
currently priced by the market. We have taken comparable firms for HDFC mutual funds
belonging to the same industry and having growth potential, cash flows and risk similar to it.
Price-Earnings ratio, Price-Book ratio and Price-Sales ratio have been calculated taking in
consideration the current prices of the firms and values from latest annual reports.
Regression model is applied to estimate the effect of independent variables on the dependent
variable.

Price No. of
BV per per Shares
share share o/s OPM NPM P/E P/S P/BV
Company
in
FY20 crores FY20 FY20 FY20 FY20 FY20
INR INR INR
HDFC AMC 189.28 2111 21 0.78 0.67 35.30 23.53 11.15
Bajaj Finance 536.48 3139 60 0.26 0.18 37.60 6.95 5.85
Muthoot Finance 313.88 1088 40 0.78 0.336 12.69 4.27 3.47
Bajaj Finserv 1967 5803 16 0.16 0.07 24.70 1.64 2.95
L&T Finance
73.22 58.3 201 0.66 0.09 9.00 0.84 0.80
Holdings Ltd
Cholamandalam
Investment & Fin. 100.04 238.7 82 0.20 0.13 16.72 2.23 2.39
Co.

Price to Book Value Ratio

P/BV Book
Net Payout Predicted
Company FY20 Value of ROE
income Ratio P/BV
equity

HDFC AMC 11.15 1273 4028.86 31.60% 0.47 10.96

Bajaj Finance 5.85 5031 32327.06 15.56% 0.11 4.20

Muthoot Finance 3.47 3436 12583.76 27.31% 0.20 3.41
Bajaj Finserv 2.95 3739 31303.87 11.94% 0.02 2.47
L&T Finance Holdings
0.80 3739 14691.72 25.45% 0.11 0.94
Ltd
Cholamandalam
2.39 1300 8199.34 15.85% 0.13 4.62
Investment & Fin. Co.

Regression Equation = 5.44 + (-31.17)*ROE + 32.61*Payout Ratio

R-squared is 88.18% which means 88.18% of the dependent variable data can be explained
by the linear equation.

Since predicted P/BV is lower than actual P/BV, hence stock of HDFC AMC is overvalued.

Price to Sales Ratio

P/S NPM
1 year Predicted
Company FY20 FY20
Beta(Weekly) P/S Ratio

HDFC AMC 23.53 0.67 1.07

21.471878
Bajaj Finance 6.95 0.18 1.58 4.7426902
Muthoot Finance 4.27 0.34 1.22 9.537024
Bajaj Finserv 1.64 0.07 1.28 -0.352463
L&T Finance Holdings Ltd 0.84 0.09 1.32 0.7258259
Cholamandalam Investment &
2.23 0.13
Fin. Co. 1.79 3.302648

Regression Equation = -5.78 + 37.18*NPM + 2.31*Beta

R-squared is 88.61% which means 88.61% of the dependent variable data can be explained
by the linear equation.

Since predicted P/S is lower than actual P/S, hence stock of HDFC AMC is overvalued.