Regulatory overhang continues to keep stocks under pressure
Q4 results have been a mixed bag on expected lines. By the end of Q4, the equity market had been in a consolidation phase for almost 18 months within the same range. Such long range bound consolidations tend to depress broking volumes in the cash segment, this segment is typically more active in the non F&O stocks. So long as the broader market continues to stay range bound, cash volumes only dry up till the next run starts. One should read the Motilal Oswal annual reports from the 2011-13 period to get a sense of how things play out in the Indian market. On the other hand F&O ADTO (average daily turnover) has gone up impressively, almost all leading players are now driving a higher proportion of their retail broking revenue from the F&O segment. With SEBI tweaking margin rules for brokers, the industry is set to only consolidate more with the Top 5 brokers. One needs scale to run operations well, especially with the newer regulations like upstreaming of client funds to the clearing corporation and ASBA facility going forward. Float income is set to reduce for brokers which can put many small brokers out to pasture, pure broking is a brutal business.
Within broking, the playbook that is working is on these lines –
- Customer acquisition is now digital, tech spends are going up even for traditional relationship management driven brokers. Cost to Income will see an initial spike and then trend lower
- Majority of the customer acquisition is now from Tier 2 towns and below – what Angel One was doing 2 years ago is now being done by everyone
- Custody AUM is still sitting with large bank backed brokers, new age brokers are nowhere close to matching the custody AUM of the legacy brokers for obvious reasons. Across the world, custody of assets lies with “safe” broking houses. Rich people prioritize balance sheet reliability while the retail segment prioritizes P&L savings
- The most interesting part is that reliance on broking income is only going down for players like ICICI Sec and Motilal Oswal. The diversification that their management speaks of is real, just that the market doesn’t want to give any appreciation till the market cycle turns. Every large broker will end up becoming a digital financial mart where customers can do broking, make MF investments, buy insurance, get access to capital for trading and obtain loans
- We are seeing the first signs of focused strategy by a few brokers rather than trying to do everything – IIFL Sec is pivoting towards the affluent segment and transferring its retail book to 5paisa. Their Q4 call is a must read for anyone tracking the broking segment, very candid comments by the management.
The AMC business segment continues to have the regulatory overhang of TER cut by SEBI, this is likely to impact the PBT by 10% once implemented. However AMC’s are likely to pass on a good chunk of this to distributors, trail commission will only come down as SEBI goes after lower TER. HDFC AMC clearly is best placed here given that performance is now top notch across equity schemes and their product portfolio has seen a marked improvement over FY23. As debt market rates peak out, debt schemes will become a bigger contributor over the next 3 years for the industry. However, AMC’s will see a spike in earnings only if the equity market breaks out of the range and goes on to make newer highs. Current valuation looks reasonable but it is that way due to the regulatory overhang.
Wealth management franchises continue to grow at a healthy pace but taxation changes to debt schemes and plugging of the tax loopholes that MLD’s and high value insurance policies enjoy is going to dent the upfront revenue for sure. These businesses will eventually have to move to a mostly trail income model, there might be a temporary dislocation for a year but things will stabilize at lower yield to AUA over time. This is the secular trend that every investor will need to be prepared for. IIFL Wealth is now talking of lower yield in the super HNI segment (50 Cr+) and now has a plan to focus on the 10 – 50 Cr segment where yield can be higher. Our take is that wealth management franchises will always be given a lower PE multiple compared to AMC businesses because of the linearity in the business model. AMC and broking businesses have a much higher degree of operating leverage built in compared to wealth management businesses.
The best AMC’s and wealth managers have only increased their PAT over the past 2 years, even if the market multiple has come down. In good equity market times, this multiple is likely to normalize and drift higher. We continue to prefer AMC’s over wealth managers if we had to choose one, however as a tactical bet we might prefer a broking business if we think we can play the cycle right. The delta that broking stocks provide can be massive in the positive part of the cycle, but one will need to be quick in and quick out.