AMP: Value Plus Yield, But What About Risk?

This story features AMP LIMITED. For more info SHARE ANALYSIS: AMP

 – Morgan Stanley sees value in AMP shares
 – Stock is trading around stockbroker's bear case value
 – UBS more cautious given difficult operating conditions
 – Capital position also an issue

By Chris Shaw

At current levels, AMP ((AMP)) shares are trading close to Morgan Stanley's bear case valuation of $3.55 per share. This equates to an earnings multiple of less than 10 times, while the expected yield on the stock is 7.5%, which suggests value at current levels.

Morgan Stanley's bear case valuation assumes severe margin compression, net flows below system levels, lower AXA synergies than expected and a fall in growth assets this year of 8% before flat performance in both FY13 and FY14. As well, the broker's bear case factors in adverse income protection claims and no benefits from the group's growth options.

In Morgan Stanley's view such an outcome is unlikely, as AMP already cleared the decks of some bad news with its FY11 result. This supports the broker's base case, which is for contemporary wealth management net revenue margins to decline to 1.00% in FY16, net flows of 5.5% year-on-year and AXA synergies of $150 million. This would support a valuation of $5.40 per share. Even more positive assumptions generate a bull case valuation of $6.70.

Given the upside on offer even with respect to its base case valuation, Morgan Stanley rates AMP as Overweight within an In-Line industry view. At current levels the broker suggests AMP is trading as a book in run-off, as marking-to-market the embedded value of AMP's financial services business delivers a value of $3.54.

Adding in bearish values for other operations and net shareholder funds generates a value of $4.10. Add in the fact AMP should win its share of large corporate superannuation mandates up for tender, Morgan Stanley sees upside to this run-off valuation.

What should support the share price in coming months are a number of catalysts identified by Morgan Stanley. These include some regulatory finality with respect to MySuper expected this month, greater clarity from a regulatory capital review expected in August, positive second quarter net inflows delivering some green shoots in August and a likely clean interim profit result in the same month. 

Morgan Stanley suggests there could be further good news early in FY13 from synergy upgrades relating to the integration of the AXA business.

There are some risks, which include further weakness in global markets, synergies falling short of expected levels and margin weakness in wealth management from increased competition, but in Morgan Stanley's view these are priced into the stock at current levels.

A further positive for Morgan Stanley is AMP appears to have enough organic capital capacity to address these potential headwinds. This is especially the case as there remains scope for AMP management to more aggressively de-risk AXA to reduce any capital strains or to lower the dividend payout ratio to the lower end of AMP's target range. This lower end would be a payout ratio of around 70%.

Colleague UBS, however, is not as positive on the outlook for AMP, as evidenced by a Neutral rating on the stock. Market volatility is partly to blame for UBS's cautious view, as the broker notes market volatility rarely presents positive surprises for life insurance stocks.

UBS has reviewed its model to account for low fixed interest yields across a range of metrics, with a particular focus on capital and investment earnings. Lower cash rates lead UBS to suggest AMP may struggle to generate anmeaningful earnings retention over the next two years. 

While AMP should be able to maintain a relatively secure capital position over the next couple of years even allowing for lower earnings retention, there is unlikely to be a large buffer for any adverse outcomes.

Given the move to re-base its model for lower cash rates, UBS has trimmed earnings estimates for the insurer/wealth manager. Earnings per share (EPS) have been trimmed by 3.7% this year and by 3.3% in FY13 to 33c and 37c respectively. This compares to consensus EPS forecasts according to the FNArena database of 32.1c and 36.7c respectively, while Morgan Stanley is forecasting underlying EPS of 35c and 39c.

Based on its forecasts UBS has set a price target for AMP of $4.50, which is broadly in line with the consensus target of $4.65. Targets range from Macquarie at $4.22 to BA-Merrill Lynch at $5.20. The database shows AMP is rated as Buy three times and Hold five times.

Credit Suisse sums up the Neutral argument by noting AMP's capital position is somewhat tight and market conditions remain unfavourable. In contrast, the Buy argument is largely a valuation call, though while BA-ML is one to rate the stock a Buy, the broker cautions there are few short-term catalysts to drive the share price.

Shares in AMP today are stronger in a higher market and as at 11.10am were up 6.5c at $3.845. This compares to a range over the past year of $3.61 to $4.99 and implies upside of around 21% relative to the consensus price target in the FNArena database.

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