UTI AMC: Significant Re-rating Candidate

Stock Idea: UTI AMC

Grade: TIER 2

(This business study of UTI AMC is taken from the Monthly Newsletter (Jan-21 Edition) of this Blog. The sample of Jan-21 edition was shared at this blog on 28th Jan, 2021.)

UTI AMC is a melodrama but the drama started with the debacle of US-64 fund of UTI in early 2000 forced Indian government to split UTI in 2003 into UTI Asset Management and Special Undertaking Unit Trust of India (SUUTI, having the junk/illiquid assets of UTI). First melody was tried with the likes of SBI, PNB, LIC and BOB acquiring 25% stake in the troubled (reputation) UTI AMC bringing in 500 cr.

Things were going fine but it still had the trauma of US-64 and then in 2009 these 4 decided to sell 26% stake to the US investment giant T Rowe Price who manages more than $1 trillion globally for $ 140 million (Rs. 650 cr). I think this was done to do some image makeover by bringing in global giant as largest investor as this would make people to have trust in UTI as global giant was picking a stake. This was a good move or we can say a perfect move. But these 4 could not leave the greed to manage one of the biggest AMC in India (holding some 10% (4^th biggest) share of Indian market at that time, now 6% share and 8^th biggest). They continued to interfere in the working of UTI along with government who wanted to dominate and control the board of UTI which was just the opposite of what had been promised to TR Price that UTI AMC would be a professional firm.

On the contrary except PNB, the rest three were having their own AMC businesses and they owned 18.5% stake each which clearly was a case of conflict of interests. After the initial stage, these 4 were not interested in running the UTI. In fact, LIC and SBI who were having relatively very small AMC business even tried to acquire the stake of others to control and merge UTI AMC with their own AMC business. It was without the head for two years and so could not introduce new schemes because SEBI rules do not allow a new fund offer without the approval from the head of a fund house. Even around 2018 TR Price took these four gentlemen to court. As the three gentlemen (except PNB) were running their own AMC businesses so they were not that much focused on growing UTI AMC as they were  having just 18.25% share in UTI so their only attempt was to merge it with their wholly owned AMC business.

The association of these three investors (LIC, SBI, BOB) having their own AMCs with UTI was a clear case of conflict of interests which was badly hurting the growth of UTI which was losing market share continuously (SBI now is the biggest AMC in India). So things were terrible for the growth perspective although the schemes of UTI AMC were doing well and they have done well in last 20 years. But then amid this tussle over controlling UTI; SEBI happened as a blessing. In 2018, SEBI in order to control the conflict of interests made a regulation that a sponsor of a mutual fund, its associates, group company and its AMC cannot hold 10 per cent or more stake in a rival AMC. They also can’t have a representation on the board of another mutual fund house. This regulation forced these three investors to sell their stake in the recent IPO and brought the same to 10%.

In the recent IPO, TR Price and PNB also sold 3% of their stake bring down their stake to 23% and 15%. So this is a significant event in the journey of UTI and in my view this is going to change the fate of this company.

In all research reports, I have seen issues related to high employee cost and high operating expenses eating out the profit margins so these reports conclude that UTI deserves lower valuation due to these issues impacting profitability and they declare it is working just like a PSU. But its historical ROE was around 16% and it is around this level in Dec-20 and Nippon is also having the similar ROE. HDFC is having high ROE of 31% but this is due to the fact that HDFC can distribute its funds from its vast banking channel at much lower costs and at a much bigger scale. Bank brand name also helps. Same has happened with SBI with highest market share although it is also a PSU. Also, low dividend payout and large cash in the books is one of the reasons for lower ROE for UTI and recently it has approved dividend policy for much higher dividends (50% of profits) so this will improve the ROE. Dividend payout ratio of UTI was around 20%-30% while the likes of Nippon and HDFC have much higher dividend payout ratios (80% and 50% respectively). Even due to growing net worth the ROE of HDFC has also fallen from 40% in 2018 to 36% in 2020.

Further, banks distributing schemes of AMCs related to their group are a clear conflict of interest as banks are forcing their group mutual funds on the customer rather than really giving honest advice and in this process they are earning huge commissions from the group AMCs. But I think SEBI is going to tighten the things more here in the near future. Direct schemes (Online sale without any intermediary) are gaining momentum as current investors are well informed and they don’t need to go to some selfish intermediaries for deciding their choice of fund as they can do the research on their own in this digital age. So things are going to change in the fund distribution very fast. Already direct channel has grown to 50% share from some 30% 2-3 years back. In today’s world, investors can find the information related to consistent fund performers like UTI against others and they can take independent decisions so due to this there is a possibility of smaller funds growing faster than the other big brands. Like, UTI is one of the best performer in the retirement solutions (pension funds) and its funds under this are growing faster. Its retirement benefit pension fund is the largest in its category.

I was looking for the performance evaluation of UTI AMC schemes and luckily I found the recent report from CITI which has very detailed data and I found the same in their report saving much of my time. UTI schemes have done much better. In last one year, UTI Equity schemes have outperformed the benchmark index in 63% of their schemes. The same figure is 10% and 30% for HDFC and Nippon. Axis is the leader with 78%. The equity schemes of HDFC are performing badly and it is losing market share (at 13.6% from 15.8% last year Dec-19). Its stock price is also doing badly with negative returns in last one year. Actually people do not realize that AMC is a knowledge based business and skills of managers matter the most rather than their costs. UTI has higher employee costs as it got large number of employees from the erstwhile UTI in 2003 split and management is working on it to reduce it. In next 5 years the retiring employees will reduce some 80-90 cr payout.

But if it has legacy issues then it has some high growth catalysts also. First, most of these problems were related to past and already happened in time and space and current board run management is working to resolve these issues. Second, UTI AMC has strong distribution strength in Tier 3 cities (B30) having the largest share. Future growth in the AMC/Mutual fund industry will be driven by these small cities. These cities have higher focus on equity schemes where charges are higher than debt funds so UTI can earn higher than other due to its strong presence in these cities. But for me the most important event is the coming possible restructuring in the ownership of UTI. I don’t think the likes of LIC/SBI/BOB have any scope left to acquire it or mismanage it. In fact, they have sold their stakes in UTI Trustee Company to TR Price in line with their stake sale in AMC business. A Mutual fund trust holds assets of the fund on behalf of investors and monitor performance and compliance with regulations.

So trustees have significant control over the working of an AMC due to regulatory powers. After the stake sale by these three; now TR Price holds 51% stake in Trustee Company which enables it to indirectly control the operations at AMC also. TR Price is a global giant and is waiting patiently for the things to turn good in India as India is the next high growth market. It has waited 11 years for the things to take shape in india which shows its commitments to India. So my feeling is that very soon something is going to happen in UTI AMC shareholding. It may be that these four may sell their stake (or part) making TR price the majority holder running the show. TR Price can channelize huge funds from its US business to India for investment through UTI.

UTI AMC has big business in PMS where it manages the funds of Employees Provident Fund Organization (EPFO), Postal Life Insurance (PLI), National Skill Development Fund (NSDF) etc. UTI manages the largest share of the funds of EPFO. SBI is the second AMC who manages the funds of EPFO. Earlier it was only SBI who was managing the funds of EPFO but it was performing very badly (not being able to beat the bank FD rates). I think the likes of EPFO may opt for an independent AMC like UTI rather than corporate owned AMC like HDFC AMC where there is a clear case of conflict of interest as they may be biased in their EPFO fund investment strategies.

Summary of Analysis levels Involved in the study of UTI AMC:

1. Level 1 (Lower relative valuation) – Low valuation (18 PE and 2.4 times book value) keeping in view the established brand, expertise, market share. Underlying performance metrics are not that weak as compared to other two listed players. It is more the result of market perception.

2. Level 2 ( Industry level growth and restructuring)- Mutual fund industry will grow fast in India as people are getting aware of the financial assets and planning for the same quite early.

3. Level 3 (Forecasting of management decisions which may result in massive future growth and value unlocking) – However, the most value will come from the actions of the management in shedding the Government control, PSU work culture and becoming more professional, TR Price acquiring majority shareholdings or some other private player coming by acquiring the share of other PSU investors. 

This one is a Tier 2 grade stock as of now but once it implements dividend policy distributing liberal dividends, management becoming more independent and professional in approach and any stake sale by 4 PSU shareholders this will be transformed into Tier 1 quite fast and aggressively. 

(This study is a business analysis of UTI AMC. Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your own Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post. This business study of UTI AMC is taken from the Monthly Newsletter (Jan-21 Edition) of this Blog. For subscribing to the monthly Newsletter reach at oscillationss@yahoo.in).