AMP: 2015 result

China's been getting a bad rap at the moment, as an instrument of global sharemarket torture. As discussed in our recent podcast, though, there's still plenty to be excited about as the sleeping dragon awakens – not least a growing middle class that needs to find a home for its savings.

With that in mind, AMP's association with China Life, the country's largest insurance group, institutional investor and corporate pension manager, has been a masterstroke.

The relationship has taken a decade to get to where we are now, and that very likely is a key to its success. AMP began operating in China in 1997 and began its formal alliance with China Life in 2006, when the two companies cooperated in 'Qualified Foreign Institutional Investor' investments and AMP Capital launched its China Growth Fund. Things evidently ran smoothly, leading to a 'memorandum of understanding for strategic cooperation' in 2009.

CLAMPing on the growth

In 2013 the two companies took their relationship a step further, forming a joint venture – China Life AMP Asset Management (CLAMP) – in which AMP's investment management subsidiary AMP Capital took a 15% stake. AMP Capital is itself 15% owned by Japan's Mitsubishi UFJ Trust, so AMP has an effective 12.75% interest in the JV (representing 85% of 15%).

On top of this, in 2014 AMP paid $240m for a 19.9% stake in China Life's pension offshoot, China Life Pension Company, which is the largest pension company in China by assets under management.

CLAMP's contribution to AMP's earnings was negligible in 2015 – due to it still being in its start-up phase – but it should help drive earnings growth in years to come. CLAMP now manages RMB70bn ($14.8bn) for Chinese investors, after launching 19 new mutual funds in 2015, and AMP Capital's share of net inflows from the joint venture in 2015 more than tripled from $0.5bn to $1.7bn.

Even more exciting, though, according to AMP chief executive Craig Meller, is China Life Pension Company, which increased its assets under management (AUM) by 35% in 2015, to RMB301bn ($63.7bn). Meller expects strong growth from this business as the market for enterprise annuities expands, with 42m Chinese public servants being required to contribute 12% of their salaries.

AMP Capital also benefited from a strong performance from its fixed interest and infrastructure funds. Overall, there was a net inflow of $1.3bn, which combined with investment returns of $7.1bn to increase AUM by 6% $159.9bn.

Only 19% of that is in Australian equities, with another 22% in international equities, with the remainder mostly split between fixed interest (38%), property (13%) and infrastructure (6%), so the AUM should be reasonably insensitive to sharemarket movements (although it will still be highly sensitive to interest rates). However, it also means that fee margins are low compared to other, more equity-focused fund managers, at 0.37% (up from 0.35% due largely to an increase in performance fees).

Overall, AMP Capital's fee income rose 14% in 2015, while costs rose 9%, to give a 20% rise in its net profit contribution to $138m (12% of the total).

Wealth management boost

The much bigger influence on AMP's performance, though, remains its Australian Wealth Management (AWM) business, which saw a 10% rise in its net profit contribution to $410m (37% of the total). AWM benefited from a net fund inflow of $2.2bn in 2015, down slightly from $2.3bn last year, with $3.2bn flowing into retail platforms (including $4.5bn into the North platform, down from $5.5bn in 2014), slightly lower than $3.4bn last year but still very respectable.

The fee margin contracted slightly, from 1.17% to 1.12%, due to a shift towards fixed interest and the North platform compared to older more expensive legacy products. As a result, revenue rose only 5%, but a 3% reduction in controllable costs bumped that up to 10% at the net profit line.

The focus for AWM is to 'build a more customer-centric business whilst remaining vigilant on cost control' and to 'expand the methods by which customers can access AMP's products and services'.

The two things seem to be linked. Management was asked in the conference call what, if it is now embarking on a customer-centric strategy, it was doing before. The answer seemed to focus on enabling customers to deal with the company 'online, over the phone, virtually in whatever way they want as well as through the financial advisers'.

Apparently in the connected world customers expect to go to companies for financial products without passing via a financial adviser – and hooray for that. But with its army of 4,265 advisers across Australia and New Zealand (down 4%), this clearly represents a major risk for AMP, and becoming more customer-centric won't necessarily remove it.

Intense mortgage competition

AMP Bank also saw a strong performance, with its net profit contribution rising 14% to $104m. This was largely the result of an increase of 0.18 percentage points, to 1.59%, in the net interest margin on its $15.2bn loan portfolio (96% of which is residential mortgages), despite 'intense' competition in residential mortgage lending 'with continued market-wide discounting'.

The New Zealand financial services business saw a 9% rise in net profit to $120m thanks to higher profit margins and lower insurance claims, and despite a $10m hit to margins in the second half due to changes in NZ taxation of life insurance. Without this, underlying net profit would have risen 22%.

The major disappointment in 2015 was from the Australian Wealth Protection (AWP) business, which saw its net profit contribution fall 2% to $185m mainly due to increased term life assurance claims. Due to the higher volume of such claims, AMP has increased its assumptions and this is expected to knock around 5% from AWP's profit starting in 2016.

The closed Australian life insurance business (aka 'Mature'), also saw a contraction, by 10% to $158m. About half of that was due to the expected portfolio run-off, with the remainder being due to higher claims and large wholesale investor redemptions.

Overall, the net profit from business units rose 6% to $1,115m and, after group costs (down 2%), investment income (down 5%) and interest on corporate debt (down 23%), the underlying profit rose 7% to $1,120m. The corporate debt rose 24% to $1.8bn, but the interest bill is covered a very comfortable 18 times by the segment earnings and more than twice over by investment income.

Management was claiming a strong group-wide costs performance, which is probably fair, but it's easier to manage your costs when you're sticking $66m below the line in 'business efficiency program costs'. There's only $27m more of those to come this year, though, and cost savings will mean more after that.

The profit improvement meant that underlying return on equity rose half a percentage point from 12.7% in 2014 to 13.2%. The company had $2.5bn of surplus capital at the year-end, although that falls to about $1.5bn after the redemption of $600m worth of AXA subordinated notes on 29 March 2016 and the payment of the final dividend.

That final dividend amounts to 14 cents per share, 90% franked, and brings the annual total to 28 cents. The payout ratio for 2015 came to 74%, but the board increased its targeted range from 70–80% to 70–90% apparently to provide flexibility through the cycle, but it's hard to escape the conclusion that the payout ratio will increase a little.

Improved prospects

We've had negative recommendations on AMP for over ten years, in which time the stock has pretty much gone sideways, excepting a brief boom and bust around the global financial crisis. Per share earnings and dividends have also largely gone sideways, from 44c and 32c respectively in 2005 to 38c and 28c in this latest result. With the potential from the China Life partnership in particular, though, AMP's prospects now look better than they have for a while and with a 5.1% dividend yield the stock doesn't look expensive.

It's quite a bit more expensive, though, than IOOF, which sports a 6.9% yield on its (admittedly more vulnerable) dividend, and the prospects probably don't match those of Perpetual. Those two stocks continue to be our preferred exposures to Australian wealth management.

Given the complexity and the risks, we'd need a substantial margin of safety to invest in AMP, but we're happy to upgrade to HOLD, with a Buy below $4.50 and a Sell above $7.50. HOLD.