AMP becoming opportunity for only second time since 1998

Thursday, August 9th, 2018

AMP is interesting because it is so hated and under-owned that any news better than the market expects would spark a rebound. Three per cent of the equity is short-sold, which would add to any squeeze. The stock trades on just 10 times 2019 consensus earnings per share, which seems incredible compared with the All Ordinaries Index on 15 times and many stocks of all sizes trading on multiples in the high teens or over 20 times in an elevated overall market.

AMP’s record share price was $15.86 way back in August 1998, a month after the stock listed. The very long history of disappointments since the mid-2000s is attributable to risk underpricing and excess claims in the life insurance business, fee compression in the Australian advice business, adverse government policy changes, a chronic inability to convert the heritage brand into customer and sales growth, and most recently the scandals revealed at the Royal Commission. The market fears major brand damage from the scandals and a mass exodus of customers, planners and funds under management/advice.

Your author has followed and covered AMP for its entire listed life but has not recommended it since the turnaround of 2002-03. Backing turnarounds of large ASX companies has an excellent record as an investing strategy – is AMP the next such opportunity? This hinges on whether the new CEO, yet to be announced, can divest or adequately provide for the life book while steadily growing advice, funds management and bank earnings. That is how AMP has to drive value.

We would not expect to hear AMP’s turnaround strategy for some months after the new CEO starts. In the meantime we are left with the recent earnings downgrade and business “re-set” announced by acting CEO Mike Wilkins. In the interim result to be reported on 8 August AMP will provide $290 million for advice remediation and declare an interim dividend at the low end of the 70-90 per cent payout ratio target range. AMP also cut fees for 700,000 MySuper customers, will invest an extra $35 million per annum in risk management and compliance, and will restore priority to last year’s portfolio review, which aims to release capital from the life and mature books currently being managed for value, not growth. The package added to existing downgrades to consensus 2019 EPS to see this measure now nearly eight per cent lower over the last three months.

Bulls think this is the worst AMP will throw at shareholders. We think the fee cuts are the only recurring negative but we lean towards further large costs taken below the line (once-off, non-recurring items) and possibly one last rebase of earnings above the line in the new CEO’s first result. Before the new CEO starts, the central question is the extent of sustainable profitability and value in the existing business, which hinges on the extent of brand damage, how many customers and planners leave, the conservatism of existing assumptions in the life book and whether business retention strategies are working. We need to see the interim accounts (to be reported tomorrow, 8 August) and management’s business review before forming a firm view. Conservative valuations of AMP today should reflect the existing business, not growth potential.

AMP also needs to reassure the market on capital, as the 30 June $1.8 billion capital surplus above regulatory requirements sounds good but sits uneasily with the decision not to neutralise the 1H18 dividend reinvestment plan, which implies a board appetite for more capital. Capital benefits from selling the life and mature books could be offset by the costs of separating and divesting them.

AMP’s last great crisis in 2002-03 triggered a full rethink of the business. Another opportunity presents itself today in the form of board and management renewal during and after the Royal Commission. AMP’s post-2003 model needs an overhaul to comply with today’s community expectations, regulatory landscape and financial services market. The years of disappointment create a unique moment for bold leadership to re-evaluate how the existing brand, assets, balance sheet and business capabilities can be reconfigured to drive growth and ensure the heritage brand finally achieves its potential for the first time since listing. The current focus is to calm investors’ nerves, demonstrate resilience in the core businesses and respond to the Royal Commission’s findings. AMP is doing this under the stewardship of Mike Wilkins. We think the opportunity to rebuild AMP post-Royal Commission will attract a field of quality CEO candidates and we expect the market will welcome chair David Murray’s choice of CEO. This is an upcoming positive catalyst for the stock.

Our sense is an opportunity in the stock is forming because the implied three times earnings multiple on the wealth business is too low and the market is probably expecting more downgrades and value loss than AMP will deliver. Another example of the deep value in the investment is the near-convergence of the earnings multiple (10 times) and dividend yield (eight per cent). The downgrade and reset announcement guided to growth in the wealth, funds and banking businesses which seems in line with what the market expected, which was no further downgrades to the core businesses. The disappointment was in life. The core ongoing business units are probably more resilient than the dire sentiment on the stock and its earnings multiple imply. The central investment question is the bear case valuation and whether the stock has already fallen there. If so, the worst is already priced in.

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