Why we invested in AMP
When you invest in a business like AMP, nobody stops you in the street to tell you what a great investment it is. While the businesses that AMP run may not look very appealing, Simon Mawhinney, Chief Investment Officer at Allan Gray Australia, says it’s the price that you pay for those businesses that looks reasonably appealing.
“You don’t pay very much for the nasty part [of AMP’s businesses]. It may end up not having a particularly bright future, but if you’re not paying for it, you should be agnostic…”
But despite all the well-publicised problems, there are some potential bright spots for the company. Get Simon’s take on why he sees long-term value in AMP in today’s video below, as well as Tim Hillier's thoughts on why AMP could be significantly underpriced.
AMP could be significantly underpriced
AMP is priced at a much lower multiple of current earnings than the broader share market, but it faces a more uncertain future thanks to reputational damage and structural changes. We outline some of these headwinds below and show that a disastrous outcome for the business would make AMP a poor, but not necessarily disastrous, investment. However, if AMP addresses its elevated cost base it could be significantly underpriced.
Today one pays very little for AMP’s most troubled division, Wealth Management, and even a mediocre outcome over time could provide for good investment returns.
A simpler AMP
First, an overview. AMP will have four remaining businesses following the sale of Life:
- Wealth Management provides administration services for $130 billion of superannuation and pension assets on platforms that allow investors to transact and report holdings. It also supports 2,500 financial advisers who, while mostly not employed by AMP, operate under AMP financial services licences.
- AMP Capital is a fund manager with $190 billion of assets under management. 60% of these assets are sourced internally (e.g. from Wealth Management clients) and 40% externally.
- AMP Bank is primarily a residential mortgage lender, with a loan book of $20 billion and no branches.
- AMP has also retained a wealth management business in New Zealand.
In addition to these operations, AMP will have about $1.4 billion of surplus capital and a further $1.4 billion of income-generating assets received as part proceeds from the sale of Life.
The new management team communicated a “rebased” 2018 financial year underlying profit after tax of $461 million, accounting for the sale of Life, an expected rise in compliance costs and fall in platform fees. This implies ongoing earnings of $515 million if we annualise income on investments, and adjust for planned cost reductions and fee reductions.
AMP’s adjusted market capitalisation of $5.6 billion ($6.4 billion, less an expected $0.8 billion return of capital) implies a multiple of 11 times after-tax profit. This is somewhat lower than the market, but given the headwinds AMP faces it might not be the bargain it initially seems.
A street full of buses
It is the bus you don’t see that is most likely to hit you and, in the case of AMP, we are stepping out onto a busy street. Hazards we do see include:
- Reputational damage and adviser departures are likely to elevate outflows from Wealth Management’s administration platforms and AMP Capital’s fund management business.
- AMP faces mounting obligations under its commitment to act as a Buyer of Last Resort (BoLR) for retiring advisers who want to sell their practice. BoLR prices are above common market rates at up to four times revenue. The banning of grandfathered commissions and new educational standards are likely to elevate the number of retirements.
- AMP Bank faces the prospect of a sharp slowdown in credit growth. The bank has also advanced $580 million of loans to financial planning practices whose outlook as a whole has deteriorated.
- AMP’s fund management and platform administration businesses have benefitted from rising asset prices over the last 10 years, as fees are linked to total assets, but cost bases are relatively fixed. Asset prices may not be as favourable in coming years.
- Platform administrators face fee pressures as they compete for scale, and active fund manager fees are being squeezed by the shift towards passive investing.
- AMP is likely to face more class actions with potentially material settlements being made, some of which may not be covered by their insurance policies in place.
How bad could things get?
One of the worst outcomes for the business would be unprecedented outflows from Wealth Management (rendering the platforms unprofitable) and a concurrent outflow of internally-sourced assets from AMP Capital (causing its profits to fall by 60%). In this scenario, AMP may also lose some $500 million of surplus capital as it meets elevated BoLR commitments and write-offs on defaulting practice loans at AMP Bank. AMP is priced at about 20 times the resulting profit after tax of about $300 million.
However, the probability of this outcome would seem low and, with the market as a whole (ex-banks) trading at 17-18 times, AMP may not be a disastrous investment if this represents trough earnings and the remaining business is sustainable.
Given these hazards, why would one consider stepping out onto the street? Only if the prospect on the other side compensates for the risk of crossing.
AMP could be very attractive given its earnings potential
There appears to be significant scope to reduce costs within AMP. For example, AMP’s Wealth Management cost base is approximately 0.47% of the $130 billion of assets under administration (AUA). As seen in Graph 2, this ratio is equivalent to significantly smaller platform administrators Praemium and Hub24. Yet it is almost double that of Netwealth, which administers one sixth of the assets of AMP, but has displayed the benefits of scale as it has grown.
AMP’s costs are elevated by the loss-making arrangements of supporting advisers that operate under its licences. The status quo is unsustainable, as evidenced by Westpac’s recent decision to withdraw from advice. AMP will have to oversee its licensees more effectively and/or recover the costs of these services.
Management have committed to removing $65 million of posttax costs after 2020. Were AMP to halve the efficiency gap to Netwealth, post-tax cost savings of $100 million could be achieved. Such savings could increase AMP’s operating earnings by a quarter, with today’s share price implying a very attractive nine times after tax earnings.
We don’t pay much for any potential upside from Wealth Management
Given AMP’s $6.4 billion market capitalisation we don’t pay much for Wealth Management. Investment assets received from the sale of Life and other surplus capital are valued at $2.7 billion. If we assume AMP’s operating businesses, excluding Wealth Management, are worth 12 times profit after tax, they can be valued at $3.3 to $4 billion. Any future value for Wealth Management is largely upside at today’s market capitalisation. This is shown in Graph 3.
To put this in perspective, Netwealth is valued at approximately $2 billion, despite administering less than 20% of the assets of Wealth Management! We believe the possibility of capturing the upside from a rejuvenated and more efficient Wealth Management business sufficiently compensates for the downside risk that Wealth Management turns out to be worthless. This is what makes us warily attempt to cross a street full of buses, with AMP now 3% of the Equity Strategy.
Going against human instinct and taking a contrarian approach to investing is not for everyone, however there can be great rewards for the patient investor who embraces Allan Gray’s approach. Find out more
This article represents Allan Gray’s views as at 31 March 2019 and provides reasoning or rationale as to why we acquired or sold particular securities for our funds. We may take a different view or position from that stated in this article at any time (and may deal in the securities), including as a result of changes in facts or circumstances. This article contains general advice or information only and does not take into account the investment objectives, financial situation or needs of any person.
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