Generation Development, The Next Hub24?

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Could Generation Development experience a similar long growth runway as Hub24?

-Morgan Stanley thinks Generation Development can mimic Hub24 in years ahead
-Fast-growing Managed Accounts, Lonsec’s increasing market share
-Relationship between model managers and platforms

By Mark Woodruff

In new research released by Morgan Stanley, the analysts claim specialist provider of innovative tax-effective investment solutions Generation Development ((GDG)) could be the next Hub24 ((HUB)), a notable assertion considering Hub24’s 7.5-fold share price increase since June 2020.

Anticipating “excellent” shareholder returns for Generation Development, the broker cites Hub24’s success as evidence Australian wealth-exposed businesses with industry-leading value propositions in structural growth segments can achieve sustained high earnings growth over long periods.

Generation Development owns Generation Life, which markets Investment Bonds and Annuities, and as of August, holds full ownership of Lonsec (encompassing Managed Accounts and Research) after increasing its stake from the initial 37% acquired in September 2020.

Already, the market leader with approximately 5% market share, Lonsec is positioned to capture a significant portion of the Managed Accounts industry’s growth, the research asserts, via both M&A activity and organic expansion, supported by a doubling of the total addressable market (TAM) to $500m in funds under management (FUM) by FY29.

Financial reporting by segment is split between Generation Life (Investment Bonds), Lonsec (Managed Accounts), Lonsec (Research & Ratings), and Generation Life (Annuities).

Co-existence of platforms and model managers

While investment platforms like Hub24 help implement/facilitate portfolios (e.g. buying/selling securities) and any subsequent rebalances, Model Managers like Lonsec help manage portfolios to meet objectives such as growth and income for the Managed Account.

Morgan Stanley explains financial advisers need both Platforms and Model Managers to use Managed Accounts, noting Platforms are unlikely to vertically integrate given portfolio management is not their core competency, and Model Managers may threaten to move to alternative platforms.

Happily, Managed Account structural tailwinds benefit both Platforms and Model Managers.

Managed Accounts

Managed Accounts will be the company’s fastest growing division with Morgan Stanley forecasting a 22% revenue compound annual growth rate (CAGR) from FY24 to FY29, closely followed by Investment Bonds with an estimated 20% CAGR.

Managed Accounts are benefiting from rising adviser adoption, boosting productivity and efficiency, while Investment Bonds gain from growing demand for tax-efficient growth and alternatives to superannuation, explains the broker.

Managed Accounts have been a key driver in funds under management (FUM) growth for platforms like Hub24 and Netwealth Group ((NWL)).

Investment Bonds

In the case of investment bonds, here the company is already garnering 50% of industry inflows and FUM is proving very sticky given the tax benefits from holding for longer than 10 years.

When initiating its own research on Generation Development back in March, Ord Minnett stated superannuation reform and an ageing population both provide a significant tailwind for demand in Australia.

Appealing to individuals with higher marginal tax rates, investment bonds can hold a broad range of asset classes, with earnings and distributions taxed at a maximum effective rate of 30%, but the actual effective tax rate incurred can be substantially lower, due to tax credits and active tax management strategies.

A dominant market position in Investment Bonds, annuities and Managed Accounts should provide Generation Development a scale advantage, enabling investment in more product innovation, and allowing increasing expenditure in areas like sales and marketing, to drive fixed cost leverage, points out Morgan Stanley.

For the remaining segments, Ord Minnett explains Research offers lower growth potential, yet the estimated 8% CAGR is highly predictable, and while the Annuities segment is loss-making, it gives management high-option value given the large addressable market as more Australians reach retirement age.

Generation Development’s first quarter of FY25

First quarter Investment Bond sales of $209m were a quarterly record for Generation Development, rising by 40% on the previous corresponding period, while Lonsec also experienced 10% sequential asset under management (AUM) growth compared to the year prior.

In the aftermath of the quarterly update, Morgans raised its EPS forecast for FY25 and FY26 by 6% and 10%, respectively, on higher sales/funds under management (FUM) growth expectations in both the Investment Bond franchise and Lonsec.

Potential to significantly accelerate growth has arisen from the full ownership of Lonsec and the roll-out of the new Lifetime annuity product, explained Morgans.

Also upgrading its forecasts, Moelis highlighted solid growth from Lonsec with new product growth underpinned by ongoing expansion of the private market offerings from fund managers.

Management also noted “active financial advisers continue to increase quarter on quarter” and pointed to the launch of five new tailored Managed Account solutions during the quarter and a strong pipeline of new tailored Managed Accounts in development.

Moelis explained legislation changes to superannuation tax for balances of $3m and above are not factored into its current estimates, providing a potential catalyst to further accelerate Investment Bond flows.

Outlook

Back in March, Ord Minnett could see scope for significant operating leverage as scale increases and forecast an EPS compound annual growth rate (CAGR) of 36% over the next three years.

Updating for first quarter results in October, this broker noted key features of the investment case include the Lonsec acquisition, and a strong competitive position in the investment bond market.

Moelis highlighted M&A activity could offer upside potential to its estimates, as the broker currently excludes any contributions from inorganic growth.

After Overweight-rated Morgan Stanley joins the fray with its new coverage, there are now three daily covered brokers in the FNArena database researching Generation Development, including Ord Minnett (Buy) and Morgans on Hold.

The average target price of the three brokers is now $4.05, up from $3.71, given Morgan Stanley begins coverage at $4.75. The average target suggests less than 6% upside to the latest share price (for now).

Outside of daily coverage, Petra Capital and Moelis have Buy ratings and respective targets of $3.91 and $2.95.

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