Is It Yet Safe To Buy AMP?

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

– AMP' wealth management result will be strong
– AMP's wealth protection division will kill the party
– AMP's share price has significantly de-rated
– Is the bottom in place?

By Greg Peel

2013 was a great year for Australian stocks, with fortunes noticeably picking up from July. As a company, if one of your major businesses is wealth management then you should reasonably have expected to have also had a good year in terms of earnings growth and share price appreciation. Unless you’re the AMP ((AMP)).
 

 

In actual fact, AMP Wealth is set for a solid 2013 result, Morgan Stanley suggests. AMP’s major problem in recent years has been that of its wealth protection business. A profit warning based on a downgrade to the embedded value of this business is evident in the chart above at the point the AMP and the ASX 200 parted company.

Back in early January, BA-Merrill Lynch marked AMP’s investments to market and to updated currency assumptions but despite the stock market surge, Merrills’ changes only amounted to net earnings forecast improvement of less than 1%. “We should be more constructive,” the analysts said in their report at the time, but…”

The analysts thought they and the market should by then have been more constructive on AMP given historic underperformance and solid leverage to further market upside. The big “but” was that no one outside the company could form an educated view as to the appropriateness of management’s Life Insurance valuation and the risks therein, as far as Merrills was concerned, and that AMP was yet to deliver on ambitions of earnings growth. It was beholden upon the company to provide investors sufficient detail such that they could gain confidence in future Life Insurance earnings prospects, Merrills wailed, while leaving its rating at Neutral.

Later in the month, Citi, acknowledged AMP’s 2013 result in wealth protection will likely be a weak one. Last year should have marked a bottom, nevertheless, with Citi and the market forecasting steady improvement in divisional profitability to 2015. Citi is actually above consensus, but has also questioned AMP’s disclosure policy. “At the moment,” the analysts noted, “the market seems to be struggling to believe the recovery, and transparency is certainly lacking”.

Citi believes it “reasonably likely” the big adjustments in wealth protection valuation have now been made, and strengthening is a “clear possibility”. AMP’s result release (February 20) should bring greater clarity but is “unlikely to eliminate all uncertainty”. Citi thus stuck to a Neutral rating.

Last week Macquarie noted material rate increases are occurring in AMP’s group Life premiums and individual Life premiums are also selectively being increased, but that “the sector issues are not behind us”. Structural issues are difficult to address, Macquarie noted, lapse rates are still elevated, claims trends are not improving, back-book claims will continue to develop and cyclical risks, such as rising unemployment, remain.

Quite a horror story really. And on that note, the broker upgraded from Underperform to Neutral.

As Macquarie’s litany of issues attests, AMP is not out of the woods, but at a 16% forward price/earnings discount to wealth management peer IOOF Holdings ((IFL)), based on the halving of wealth protection business earnings, the analysts basically think the market’s valuation is now fair.

JP Morgan also acknowledges AMP de-rated in 2013 due to problems in wealth protection but points out over-inflated growth expectations and dilution from capital ratings hurt earnings per share as well. The broker believes earnings volatility will continue in 2014 but also believes the stock may begin to look attractive pending some positive changes in wealth protection towards year-end.

The pain felt in the wealth protection industry in general will bring about structural changes, JP Morgan predicts, towards the end of 2014. Cash flow will improve under such changes before earnings improve, but cost reductions in other divisions can provide some earnings improvement even as revenues remain muted, say the analysts. “The stock may re-rate in such an environment.”

JP Morgan nevertheless retains Neutral. The broker rates stocks on a sector-relative basis, and sees better value elsewhere in the sector.

JP Morgan also raises the issue of the new CEO. The broker implies it’s not always best to jump into a stock until a new leader has settled in. Citi concurs, noting that whenever there is a new CEO at a company there is always a risk of some surprises. However the risk should be mitigated in this instance given the new CEO has been internally promoted and was already in charge of much of the business anyway, Citi points out.

[The risk inherent in a new CEO stems from an age-old practice of immediately slashing guidance or writing down valuations so as to provide more upside risk than downside risk in initial perceived performance, whether those downgrades are warranted or not.]

Morgan Stanley agrees with Citi that Craig Mellor is unlikely to spring any surprises given he previously oversaw the AMPCI operations. Indeed, Morgan Stanley has an Overweight (Buy equivalent) rating on AMP. None of the eight FNArena database brokers are as generous, with seven on Hold or equivalents and one (UBS) on Sell.

Morgan Stanley believes the risk/reward balance on AMP is now attractive given the stock is trading below embedded value which, in AMP’s case, rarely happens. The analysts believe all the Life risks discussed above are already thus reflected in the price and the market is ascribing no enterprise value to future business at a time AMP Wealth is set to record a solid 2013 result.

The analysts expect positive retail inflows to continue and that the 2013 margin will surprise the market, with cost control also strong. And Morgan Stanley expects 50% growth in self-managed superannuation funds (SMSF) under AMP administration (to north of 15,000).

AMP may thus be worth a punt. If you like a punt that is. It should also be noted that while AMP might see a rebound in its Life Insurance earnings, its Wealth Management earnings are leveraged to market performance, which itself can be replicated with an ETF. AMP has both customers and shareholders, both of whom expect a return. But Peter and Paul’s returns both come from the same source so one must be robbed to pay the other.
 

Technical limitations

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