IOOF Confident Despite Industry Scrutiny

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While IOOF is confident its platform and advice segments can withstand regulatory scrutiny, several brokers are more cautious about dismissing the industry impact from the ongoing Royal Commission.

-ANZ wealth acquisition, despite delays, is expected to drive material growth
-Platform pricing competitive but risks to fees remain
-IOOF currently envisages no need for specific provisions
 

By Eva Brocklehurst

The main focus on IOOF ((IFL)) after its FY18 results stems from the impact of the current Royal Commission into banking and financial advice. While the impact on the business from specific regulatory changes is not considered material, there are lingering concerns for brokers around a larger risk emanating from any fall-out.

FY18 underlying net profit was $191.4m, up 13%. A decline in the gross margin, which fell to 45 basis points from 48 basis points, was offset by cost reductions. Investment management underlying net profit increased 11% year-on-year. Trustee services experienced a 45% improvement in underlying net profit in FY18.

Macquarie believes the company is well-placed to deliver sound earnings growth, supported by cost control and crystallising the potential upside from the ANZ wealth acquisition. Despite the regulatory risks, the broker believes the current multiple does not adequately reflect the potential upside.

While IOOF has underscored its capability and relative position in a changing environment, UBS does not share the company's confident dismissal of the wide-ranging regulatory and competitive challenges. Fee pressure was most acute in advice and the squeeze on margins was worse than expected.

ANZ Wealth

The company has indicated mid-single digit accretion to earnings in FY19 with amassed synergies from the ANZ wealth acquisition pushed out to FY20. Still, Credit Suisse suggests the acquisition will drive material growth and the ultimate point of synergy achievement in FY21 is unchanged.

Under its stewardship, IOOF is expected to be able to re-price the Smart Choice product, part of the ANZ wealth acquisition, upwards by 20-30 basis points while retaining a relatively competitive position.

Credit Suisse suggests management can operate the cost lever when needed and continues to envisage longer-term value in the stock. As it trades at around a -20% PE discount to the market and on a 7-8% dividend yield the broker maintains an Outperform rating.

Macquarie agrees that the current valuation already incorporates a significant discount for potential regulatory reforms and this is not really justified given the earnings growth profile following the completion of the ANZ wealth acquisition.

While history suggests the company can surprise on costs, UBS is more circumspect and believes elevated compliance, system and remediation expenditure has to be acknowledged given the regulatory backdrop.

Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, anticipates further declines in revenue margins to occur, but that IOOF will not be able to cut into its cost base at a similar rate.

The broker notes cash net profit has already fallen for the previous two consecutive half years, when adjusting for net interest. This negative momentum coupled with the regulatory and structural risks are considered reasons to steer clear of the stock. Bell Potter reiterates a Sell rating, with a target of $7.61.

Industry Outlook

IOOF has suggested its platform pricing is competitive. Credit Suisse agrees, to a point, noting pricing pressure is not isolated to the platform, and advice, where large dealer groups share in administration fees, is also at risk.

Credit Suisse allows for a 3.0 basis points reduction in the advice gross margin from the second half of FY19. The broker also expects reductions to prices announced by BT Panorama ((WBC)) are likely to lead to increased competition in platforms and result in a faster rate of decline in revenue margins.

However, IOOF's flagship platform, Pursuit, is considered well-positioned and with generally cheaper pricing versus BT Panorama, HUB24 ((HUB)) and Netwealth ((NWL)).

Although the risks to fees are elevated, Morgan Stanley believes the synergies from the ANZ wealth acquisition will allow the company to navigate the margin headwinds. Moreover, wins in terms of fund flows and advisers continue to surprise to the upside,which suggests the platform and fees are competitive.

Morgan Stanley takes heart in the fact the company, currently, envisages no need for specific provisions regarding fee-for-no-service or inappropriate advice.

Credit Suisse estimates the impact of fee caps for low-balance accounts, which the government legislated in June, could translate to around $7m of revenue for IOOF. This is included in forecasts in FY20 as a headwind. Still, the broker acknowledges its estimates are littered with assumptions and do not account for likely migrations.

The database shows four Buy ratings and one Hold (UBS). The consensus target is $10.86, signalling 24.4% upside to the last share price. The dividend yield on FY19 and FY20 forecasts is 7.2% and 8.1% respectively.

See also, Price War Looming For Wealth Platforms? on July 26, 2018.

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