The Outlook For Diversified Financial Stocks

This story features PERPETUAL LIMITED, and other companies. For more info SHARE ANALYSIS: PPT

-Valuations somewhat stretched
-IOOF expected to struggle
-ASX least surprising
 

By Eva Brocklehurst

Brokers have weighed up their recommendations in the diversified financial sector ahead of results season.

BA-Merrill Lynch expects asset managers which can defend their value proposition will outperform those financials simply providing platforms. This favours Perpetual ((PPT)), where the broker considers there's upside risk to the estimated 7-8% earnings accretion that comes from the recent acquisition of Trust Co. On JP Morgan's hot list for surprises is Challenger ((CGF)), where expectations for an upgrade to FY14 guidance may not be met. Citi retains a different view and thinks there's a good chance of an upgrade to Challenger's annuity retail book growth.

JP Morgan sees several stretched valuations across the sector. Risks to the downside lie with IOOF ((IFL)) from margin attrition and regulatory reform costs, while the least risk is with ASX ((ASX)), which doesn't usually surprise at the results season. For Computershare ((CPU)), the focus is on margin income and the quality of results. In the case of Challenger, JP Morgan thinks the market's expectations for an increase in full year guidance may not be met as an unusually high number of annuities will mature in FY14. The broker retains an Underweight rating on Challenger.

Merrills has reinstated coverage of wealth managers Perpetual and IOOF after a four-year break. On the broker's Buy list among the diversified financials is Perpetual, Computershare and Macquarie Group ((MQG)). Challenger is upgraded to Neutral. as the broker does not feel an Underperform rating can be justified with better-than-expected margin outcomes and the recent performance of the funds management division.

The global strategists at Merrills are bullish and expect the great rotation in equities to to continue. Hence, diversified financials are well placed to outperform again. Nonetheless, in line with JP Morgan, the broker finds some valuations are looking a little stretched. The broker is also concerned about IOOF, which attracts an Underperform rating. These concerns centre on the regulatory and competitive pressures which could ultimately erode industry platform margins. IOOF also lacks scale and balance sheet capacity as well as the distribution reach of its larger peers.

On the other side of the scale is Macquarie, upgraded to Buy by Merrills, where the company looks set to benefit from an improving outlook for the advanced economies as well as stronger capital markets activity. Strategic and financial flexibility will enable the company to make accretive acquisitions or distribute capital, as it sees fit. Perpetual derives the bulk of its earnings from asset management and has significant leverage to rising markets. Hence its attraction for the broker. The stock tops Merrills' list among asset managers for now.

Citi's order of preference in the sector is Challenger, IOOF, Henderson ((HGG)), Computershare, Perpetual and ASX. A number of the stocks are considered relatively expensive, such as Perpetual, so the broker has all but Challenger on a Neutral rating. Macquarie is categorised in the banking sector and Citi has a Buy recommendation. Citi's strategists expect the equity market will continue to advance in 2014 and the broker recognises the risk that these stocks could become even more expensive. Perpetual shows some upside risks to Citi's forecasts, especially if the equity market advances. Still, given the flows, the broker is more of the view that it is fully priced.

Challenger is top of the stack in diversified financials as the valuation remains reasonable and Citi thinks there's a good chance for an upgrade to annuity retail book growth and life guidance. Henderson may reveal a turn in institutional flows to the positive side of the ledger in the fourth quarter and Citi suspects the company will beat guidance for second half performance fees. Still, the broker finds the stock expensive despite the strong business momentum.

In terms of IOOF, Citi also expects the company to struggle to achieve organic revenue growth but, if the market is kind in the first half and cost control still evident, then it should still be a solid result. Citi is also seeing upside to the revenue forecasts from Computershare, but thinks the overall outlook remains mixed for the stock. Citi observes Computershare has significant positive leverage to rising short-dated interest rates. The broker thinks ASX is looking more like a high dividend, low growth stock. It doesn't appear to be extracting benefit from rising markets the way it once did. Declining velocity is part of the reason, Citi suspects, but this is being exacerbated by the extension of revenue growth rebates.
 

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