Hard Grind Ahead For AMP

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Brokers are finding it hard to incorporate the fallout from the Royal Commission's interrogation of AMP executives, including potential for net outflows, margin squeeze and higher corporate costs.

-AMP Bank the only division reporting growth in the March quarter
-Significant downside risks make valuations hard to determine
-Margin erosion, fee pressure likely as AMP attempts to retain assets
 

By Eva Brocklehurst

The way ahead will be long and rough for AMP ((AMP)) as it seeks to restore confidence in its brand. This is the view brokers have taken after the Hayne Royal Commission exposed poor governance and treatment of customers.

Brokers are finding it hard to incorporate the fallout from the RC's interrogation of executives, including potential for net outflows, margin squeeze and higher corporate costs.

As Deutsche Bank asserts, given myriad uncertainties on the regulatory landscape, as well as both strategic and operational uncertainties, caution must prevail despite a compelling fundamental valuation.

Three directors, up for re-election at the recently-held AGM, have stepped down, while David Murray has been appointed chairman on the departure of the previous chairman. The CEO and head counsel have also departed and the company still seeks a new CEO. Brokers expect the portfolio review is unlikely to progress much in the current circumstances.

March quarter

AMP reported a soft first quarter, but brokers consider this largely irrelevant, given the trading relates to the period before the Royal Commission proceedings. AMP has flagged potential for higher customer remediation costs and related expenses plus enhancements to its control and governance systems.

Australian wealth management sustained -$200m in net outflows with AMP attributing the weakness to reduced activity in superannuation following the changes to contribution caps from July 1, 2017.

AMP Capital net overflows were -$127m, driven by flows into real estate and infrastructure. The AMP Bank loan book growth of 2% is considered likely to have been above-system growth.

The first quarter update reveals insight into the pre-RC era and, while in theory this should show a healthier organisation, UBS finds little evidence in the cash flows. The broker, the only one with a Sell rating on the FNArena database, points to the outflows in wealth management, with little growth elsewhere. AMP Bank was the only division that reported growth.

Macquarie expects the impact on reputation and the damage to flows stemming from the RC will materialise from the June quarter onwards, and expects little upside for the shares in the near term, downgrading to Neutral.

While recognising the difficulty in quantifying the impact from the RC, the broker increases the expected rate of outflows from the wealth management division. In aggregate, Macquarie forecasts around -$35m of net outflows between FY18 and FY22.

Bell Potter remains very concerned about the implications and envisages a mass exodus from the company's wealth business. Adviser numbers have declined -30% since the numbers peaked in the first half of 2014.

The decline, in the broker's view, illustrates that the vertically integrated advice model is unattractive to advisers, who have begun to favour greater freedom of product choice and a more independent model.

Bell Potter, not one of the eight monitored daily on the FNArena database, asserts that AMP is an ex-growth company and reiterates a Sell rating and target of $3.39.

Division Implications

The broker remains particularly concerned about the four divisions which represent over 80% of FY17 earnings. Many of the advisers are likely to leave wealth management and take the business with them, before there is even a chance for AMP to make changes.

The funds management division, AMP Capital, is likely to suffer outflows as the new norm, as some investors look to extract money from all things branded AMP, particularly if advisers leave. In wealth protection, the broker's concerns centre on the ongoing viability of the company's life insurance book.

One client, VicSuper, is already heading for the departure lounge and this will reduce the book by over -20%. The legacy products division is likely to have accelerating outflows , following the 2018 federal budget intent on making it easier to exit without penalty.

Valuation

Morgans is not surprised by expectations customer remediation costs will increase, or the several class actions being filed against AMP. Higher customer remediation costs are not included in its numbers just yet, given the items are difficult to quantify and will go below the line anyway.

The business remains a long-term turnaround story but the broker assesses, on an FY18 PE of 11x, some value can be found.

The main downside risks to its Add rating, Morgans envisages, are unexpected volatility in equity markets, any further downturn in the Australian life insurance market, fee pressure on wealth management and unfavourable regulatory changes affecting superannuation or life insurance.

Credit Suisse agrees the uncertainty and slowing of growth elsewhere makes it hard to quantify the impact on forecasts. On recently lowered forecasts for earnings, the broker calculates AMP is currently trading at a -30% PE discount to the market.

While it is hard to argue this is not justified in the current circumstances, in the longer term, Credit Suisse finds the valuation appealing and maintains an Outperform rating.

Citi considers the issues to be wide ranging and the implications potentially so significant that value is hard to determine. Still, the broker would have to lower assumptions materially to believe the current share price does not represent value.

Therefore, to account for the uncertainty, its target price is set at a significant discount to valuation, which is now calculated on a slightly more conservative basis.

Macquarie expects margin erosion in the near term as fee pressure is likely to intensify when AMP attempts to retain assets under management, and changes are legislated, such as the 3% cap on passive superannuation announced in the federal budget.

While asset sales and the potential for capital returns underpinned Macquarie's previous investment thesis the recent issues have decreased the likelihood of this occurring in the near term.

Ord Minnett anticipates trust will return, in time, as occurred post the problems in 2003. The broker lowers earnings estimates to reflect weak markets, the impact on flows from adverse publicity stemming from the RC and the increased cost of regulation, as well as some further client remediation.

This has led to a -7% decline in FY19 estimates. The broker reduces its target to $4.84 from $5.90, factoring in a -15% discount to account for the risk that vertical integration is abolished.

FNArena's database shows three Buy ratings, four Hold and one Sell (UBS). The consensus target is $4.53, suggesting 16.0% upside to the last share price. This compares with $5.62 at the start of April, before the RC hearings were underway. Targets range from $3.80 (UBS) to $5.75 (Morgan Stanley). The dividend yield on FY18 and FY19 forecasts is 7.2% and 7.4% respectively.

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