Are bargains surfacing in the Diversified Financials?

A number of the diversified financial stocks have experienced a tough year with the Hayne Royal Commission weighing on many in the sector e.g. AMP is down over 30% over the last year. Also, the bears are certainly echoing that a large pullback is ominously close at hand – we have been among them at times!

For this report, the negative market sentiment looking forward may eventually become an opportunity because investors appear to be dodging the sector as fund managers usually struggle in bear markets. However their valuations are already fairly cheap and if we do see a sharp 5-6% correction from here then they will look compelling in a number of cases i.e. somebody still has to look after the growing pool of superannuation!

MM often looks at unloved sectors because the elastic band virtually always becomes too stretched.

1. Challenger $10.37

CGF has been one of the most popular stocks on the ASX over recent years due to the success of its annuity products but the polish has clearly come off the stock since late 2017 illustrated by its 28% correction.

Rising bond yields are not great news for CGF while their decision to lower the risk profile of their asset pool (that underpins annuities) is also a negative for earnings. On the flipside, the  company has a number of tailwinds including an ageing population and currently appearing to be on the correct side of the government, plus they have growth paths through Japan.

CGF is trading on a P/E of 15.7x Est 2019 earnings while yielding 3.4% fully franked.

We like CGF but like all stocks only at the correct price. MM are potential buyers of CGF under $9.75, another 6% lower.

Challenger Ltd (CGF) Chart

2. IOOF Holdings Ltd (IFL) $8.03

IFL’s profit release in August showed profits down well over 20% despite organic growth in the business but the big issue is they appear to have bought ANZ’s wealth division at the top of the market. The Royal Commission has shone the light on this sector (and rightly so) in a way that will lead to ongoing regulatory costs, with IFL’s patchwork of systems thanks to recent acquisitions making this a more complicated/ costly process for them. That means IFL will find it difficult to achieve the full benefit of recent acquisitions and it seems clear that they’ll look back in time with a grimace in terms of what they paid to acquire scale.

IOOF is trading on a P/E of 12.2x Est 2019 earnings while yielding 6.7% fully franked.

Value is definitely emerging in this out of favour stock however we’re unlikely to be buyers – simply too much complexity at the moment. Technically, we are targeting  $7.50, another 6-7% on the downside

IOOF Holdings Ltd (IFL) Chart

3. AMP Ltd (AMP) $3.28

AMP has been a basket case for years, often mentioned in the same breath as Telstra (TLS) which has suddenly rallied over 25% this financial year.

We reckon the company will need a few years to rebuild after its battering at the royal commission but its healthy dividend arguably makes it worth the wait if the stocks downside is now limited – David Murray (ex CBA) has described his new job as Chairman as the toughest in corporate Australia.

AMP is trading on a P/E of 10.6x Est 2018 earnings while yielding 7.5% fully franked.

We feel the downside momentum in AMP is reducing fast but the stock is unlikely to bounce hard for a while - we can see the stock oscillating between $3 and $3.50 moving forward. MM likes AMP as medium-term aggressive buy ideally a little lower.

AMP Ltd (AMP) Chart

4. Janus Henderson (JHG) $38.79

JHG remains the standout stock in the sector from a value perspective although its recent result did disappoint the market. The dual listed company which operates out of the US and London specialises in both equities and bonds giving it a degree of potential insulation from an aggressive pullback in global stocks.

JHG is trading on a P/E of 9.6x Est 2018 earnings while yielding 4.6% unfranked. We continue to hold our position in JHG primarily from a pure valuation perspective.

Janus Henderson (JHG) Chart

5. Magellan Financial Group (MFG) $27.42

MFG has been a strong performer within the sector especially following an excellent report and increased dividend in August. We do like the business however there is a saturation point in a business like this where their strategy simply cannot handle more $$.  

MFG is trading on a P/E of 16.3x Est 2019 earnings while yielding 4.9% fully franked. MM is bullish MFG with an ideal entry ~$26.75, or only 2% lower, targeting $30.00

Magellan Financial Group (MFG) Chart

Conclusion

We can see MM buying into this battered sector into weakness with potential levels outlined below:

CFG $9.75,  AMP $3.10 and MFG $26.75 while we’ll look at IFL again if it trades down to ~$7.50

NB MFG is the quality end of the scale, while CGF, AMP & IFL would be on valuation grounds.

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