Income Report / Income Report; Without stating the obvious, AMP faces some major challenges

By Market Matters 04 July 18

Income Report; Without stating the obvious, AMP faces some major challenges

Market Matters Income Report 4th July 2018

We’re starting to see some slight weakness creep into the market today after a strong session yesterday – banks down a touch after a good move on Tuesday, while Telstra is going back to back – trading up 1% at time of the writing. Around the region, Asia is mixed but mostly higher (bar China) while US Futures are fairly flat. In terms of the ASX200 , we’re trading at 6190, down 21points on the session which keeps us neutral just here from an index perspective. A move below 6140 would turn us more bearish.

Sector moves this morning

The MM Income Portfolio was up 0.61% over the past week while the ASX200 added 0.2%. Since inception (5/7/17 – one year tomorrow), the portfolio is tracking above its benchmark, up 6.671% versus benchmark (RBA + 4%) of 5.47%. No changes were made to the income portfolio this week, with much of the performance over the past week has been driven by a strong rebound in PPT which rallied over 7% during the week. To see the current Income Portfolio click here

The growing challenges at  AMP

Yesterday, Macquarie was the latest major financial firm to ban grandfathered commissions for its advisers, a move already undertaken by BT/Westpac and one that is being promoted by the regulator, and rightly so. Other banks may follow suit and this is putting significant pressure on the likes of AMP (and IOOF for that matter) to bring their models into line.

The term ‘Grandfathered Commission’ in the financial service space gained prominence about 5 years ago when the industry moved from conflicted ‘trail type’ remuneration to fee for service, however there was a carve out for any existing products that were still accruing a trail.  Westpac has shown leadership in this area and was the first to announce the end of grandfathered commissions for its salaried sales force (which represents approximately half its 939 planners). The objective was not just to get ahead of potential regulatory change but also to put pressure on competitors. When we say competitors, AMP is squarely in the spot light here, as are IOOF (IFL).

AMP –cheap, but not cheap enough; I spoke with Alan Kohler recently for his talking finance podcast and one of the topics was AMP being a cheap income stock. At the time I suggested it was cheap, but not cheap enough, while the dividend is clearly at risk.  It currently trades on 10.82x consensus earnings for next year with an expected grossed up yield of 11.24% - seems too good to be true and it probably is.

According to Bloomberg, the consensus price target on AMP is $4.08 v its current price of $3.57, leaving about 14% return potential. Analysts are fairly divided on the stock which is not surprising, with the most bearish at Shaw and Partners suggesting its worth $3.00, while the most optimistic call sits at Evans and Partners at $5.03 The bigger firms mostly congregate around the mid $4’s.

Analyst calls on AMP

The divergent views around AMP is largely built on whether or not we see the regulator act to ban grandfathered commissions. If we do, then $3.00 may be a conservative downside target.

AMP Chart

3 main things that concern us about AMP

1.       The removal of grandfathered commissions

2.       The buyer of last resort (BOLR) facility that AMP makes available to their network which included 1454 planners at end of 2017 – this is a great facility (for the adviser!), but a big potential liability for AMP

3.       The usual restructuring changes and then the overhand of fines and class actions that seem very likely.

Grandfathering; Westpac got the jump on their competition announcing plans to end the practice for their  salaried sales staff. Macquarie have joined suit and this is clearly a way of putting pressure on their competitors while also appearing to be good corporate citizens – a win win! AMP and IFL have a lot more to lose than WBC or MQG by doing this. In the case of AMP, Shaw and Partners AMP Analyst Brett Le Mesurier - who is the most bearish in the market -  on the stock,  reckons it will cost AMP  around $250M pre-tax, which is significant.

The Buyer of Last Resort Facility; What a great facility, for the adviser! In broad terms, the facility allows AMP planners to receive a payment of 4 times the revenue of their practice if they can’t sell it elsewhere. According to Brett’s numbers,  if the average payment per planner is $1M then the potential liability for AMP is $1.5B ).  A potentially huge liability  and given AMP has no material excess capital then if they were called on this, they would likely need to lower dividends and/or raise capital.

Restructuring charges, class actions and fines: AMP is in the market for a new CEO. Call us cynical however history has shown that new CEO’s like to re-base earnings pretty quickly, draw a line in the sand for their tenure and build up from there. There is obvious risk of AMP doing this when they find themselves a new leader. Furthermore, last week, ASIC launched civil penalty action against AMP Financial Planning which could result in further fines

Clearly, these issues are real, and they could be potentially large. Throw in the fact that AMP will struggle to attract new planners – or even retain existing ones, while they will also find it  hard to grow funds under management.

The short sellers are yet to really pounce on AMP in any meaningful way, with shorts growing, but not by a lot -  however a sniff of a likely capital raising would likely change that trend pretty quickly. The risks to us seem skewed to the downside.

 

Conclusion (s) 

While AMP is clearly cheap, the risks around the stock are high.

Lower dividends and / or a capital raise is clearly on the cards, while a new CEO will likely re-base earnings expectations 

There are simply better places to invest.

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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