Views at a Glance / Income Report; AMP is cheap – should we buy for income? (AMP)

By Market Matters 02 May 18

Income Report; AMP is cheap – should we buy for income? (AMP)

Market Matters Income Report 2nd May 2018

The Australian market has been strong of late with the ASX 200 closing well above the psychological 6000 level yesterday, while at time of writing (10.35am), the index is up another +17points at 6032. We remain bullish stocks for now targeting the ~6250 areas for the ASX200, around 4% higher while we’ve also seen a decent recovery in the Hybrid market after a short term correction early last month.

The Royal Commission has clearly dominated the news wires with some damming headlines – the banks have been under intense pressure although we now think the market has become too bearish, while AMP has been the hardest hit – a topic we’ll spend time on today.  

In terms of the MM income Portfolio, the portfolio added +0.75% for the week with the portfolio up 5.96% since inception (5/7/17) versus it’s benchmark (RBA cash rate +4% - equates to 4.52%).  Our cash position remains low, which we are comfortable with given our short term market view and exposure to more defensive hybrid securities, however we remain keen to sell equities into strength.

AMP is cheap – should we buy for income?

We generally like to consider ourselves contrarian investors at Market Matters and one of the most obvious contrarian plays at the moment would be buying AMP, a stock that has been in the vortex of the Royal Commission and subsequently seen its share price trade from around $5.50, to below $4 in the last two months - a ~30% decline. It’s interesting to think that AMP has been the hardest hit to date from the RC – more so than the banks – yet the RC was set up as a result of poor bank behaviour, AMP was simply caught in the cross fire, although in fairness they provided a big target.

Firstly, a lot of the revelations from the RC are damming and clearly highlight some of the issues that underpin the provision of financial advice and the potential conflicts currently within the sector. We know this, and it’s one of the reasons why Market Matters has become a successful, straight talking general advice newsletter.

That said, we don’t think the AMP model is broken, severely damaged yes, but not broken. Today’s Income Report will delve a little deeper into the asset manager, apologies in advance for the length.

AMP Chart

The problem; Without going into all the detail, back in 2013 new legislation was put in place under the term FoFA – Future of Financial Advice – a good move which implemented a best interests duty – essentially that advisers needed to put client interests first (it’s a bit sad that it actually had to be legislated rather than just done as a matter of principal, but we live in a strange world). There was also the removal of conflicted remuneration, a ban on what they called volume based shelf fees (trails in short) and a few other bits and pieces. It basically meant that planners would become fee for service. A client wants advice, the adviser provides the advice and they are paid (by the client) for that advice rather than being paid from the product providers they were ‘recommending’ as part of the advice. AMP spent a lot of money implementing these changes with little success it seems.

Vertical integration & best interest test; If AMP are product manufacturers – fund managers, insurance providers and the like, plus their advisers provide advice into what products suit an individual client, is it in the best interests of that client to be directed into AMP product? An adviser may do this  because it’s easier than going externally, reporting is better, AMP have other soft incentives – it’s all very murky.  This was a clear focus of the RC and it brings into question the validity of vertical integration in financial services. This to me is the main takeout / challenge facing the company going forward.

The other matter of charging advice fees incorrectly (including to those who had passed away) got a lot of media attention however when you think that there were 15,000 customers incorrectly charged from a total of ~4m customers, this is clearly poor form but not a systemic problem.  

Trust & Financial Impact; The provision of financial services is built on trust, and often the status quo is maintained simply because of the perception of trust, and right now that trust has clearly been tested. As my late Grandfather often said, you only get one reputation son, don’t c*ck it up! AMP have (unfortunately) done just that. The issue though from an investment standpoint is  around quantifying the actual financial impact of such a meaningful hit to perception.  Realistically, the financial fall out will only be shown in time through AMP earnings / FUM flows etc - having a ’stab in the dark’ about what it could mean right now is very difficult. It’s probably the reason why analysts have been reluctant to publish reports in the last week or so, and the consensus price target still sits at  $4.60. 

Broker calls on AMP

The solution; Rebuilding Trust will be a herculean task for AMP, but if they are to rise from the ashes, that’s exactly what they need to do. When trust is fractured words mean little, actions are key. Interestingly, I doubt the regulator wants to unbundle the vertically integrated model that is currently under the microscope given it would likely mean a huge increase in smaller advice providers, a more fragmented industry which complicates regulatory oversight while smaller players don’t have the financial clout to make good wrongs or pay fines if they are imposed – so for those reasons I doubt the current AMP model is broken, it just needs refining.

Removing all possible conflicts and importantly having a defined structure that actually implements the original FoFA requirement around best interest is key. The other aspect is around how assets are held, which will impact AMP but also the industry more broadly.  WRAP platforms, and more specifically the difficulty in changing platforms and the tax consequences of changing platforms challenges the best interests duty. It seems to me the regulator may well address this making it easier for clients to change platforms, move assets  and seek more competitive offerings.

Failing this, the simplest way for the regulator to approach ‘vertical integration’ is to ban it. Advice is separate to product and to me that’s the only way they can ensure ‘best interest’, but I doubt that will happen.

Earnings & Valuation; Right now, AMP is cheap trading on 11.7 times and a forecast yield of 7.30% fully franked, however the earnings impact of the royal commission has yet to be felt. The impact on FY19 earnings from potential changes is likely to be small, hence the PE now looks attractive, however if changes happen and downgrades to earnings expectations eventuate, which they will, then the PE won’t look as compelling. As it stands, AMP advisers like using AMP products, however going forward, when an AMP adviser recommends an AMP product to a client, even if it may the best product for that client, scepticism will be very high. Ultimately, this will likely have a big impact on fund flows.

AMP Valuation Metrics

Conclusion (s)

AMP is cheap on current earnings plus the earnings however it’s the earnings for outer years that will be impacted
Quantifying the impact of reduced trust towards the AMP network is simply too hard
At the moment, AMP is cheap, but not cheap enough – we may change that view on a move below ~$3.70
We think Perpetual (PPT) is better placed to handle future challenges, it trades on a similar valuation and has not suffered such a big hit to their brand, although this is now a high risk play   

Have a great day!

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

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All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 02/05/2018. 11.08AM 

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