AMP: Result 2016

The blow-up in AMP's wealth protection business last year was fully evident in its final result last week.

Changes to assumptions about future claims rates, amongst other things, knocked $485m from the profits of its Wealth Protection business. That this was $16m better than flagged hardly dulled its impact, and it took the division to an underlying net loss of $371m, compared to a profit of $234m in 2015. At the group level there was an additional writedown of $668m, which meant that 2015's $972m net profit became a $344m loss.

Some medicine has been taken. The new assumptions themselves set a lower hurdle for the future and the company has entered into a reinsurance deal with Munich Re, which will share 50% of the premiums and losses on $750m of premiums in its retail portfolio.

That effectively cedes around a fifth of the division's annual premium (of $2bn), its risks and its profits (which are expected to fall by about $25m a year as a result of the deal). In return, Munich Re paid AMP a one-off payment of $530m.

The deal means that AMP needs about $464m less capital to support the business and, after setting this against a bunch of other comings and goings (profits, dividends, changed loss assumptions and last year's $600m redemption of AXA Notes), it finds it has $500m spare to hand back to shareholders via an on-market share buyback.

Management is hoping to sign on for more reinsurance in due course, but stresses that it depends on market conditions and pricing. From our point of view, the more reinsurance the better, since it saves on Panadol around results time. Almost as importantly, it reduces the potential for surprises and allows us to have a better stab at valuing the company.

Weak fund flows

The headaches continue, however, with AMP's Wealth Management business, where the fund flows can sometimes resemble a bunch of eight-year olds with a large pack of Pokemon cards.

As ever, though, the clear winner was the North platform, which enjoyed total net cash flows of $4.9bn, up from $4.5bn in 2015, and ended 2016 with $27.1bn in assets under management (AUM) compared to $20.9bn at the start. It was helped by the launch of the MyNorth low-cost online product and a preference (from both new and existing customers) over the Flexible Super product, whose net cash inflows fell from $1.5bn to $92m. That was better, though, than AMP's other retail platforms, which between them saw net outflows of $3.6bn compared to net outflows of $2.8bn in 2015.

Including $0.3m of inflows to corporate superannuation products, AMP enjoyed net inflows of $1.8bn, compared to $4.9bn in 2015, and total AUM on AMP investment platforms rose 6% to $110bn.

Management gave market weakness and uncertainty ahead of the new super rules in November as one reason for the weak cash flows and pointed to an improvement in the December quarter. Chief executive Craig Meller noted that markets improved significantly over the year and that 'there tends to be a 9- to 12-month lag between market improvement and investors returning to the marketplace in the retail sector' (he's obviously not talking about Intelligent Investor members).

There's a suspicion, though, that the improvement may just be a temporary kicker from the one-off opportunity for high net worth individuals to put $540k into super before 1 July.

There's also a concern that cash flows are suffering partly as a result of the sharp drop in adviser numbers from 3,657 to 3,087. Management said that about half the fall was due to a tightening of classification criteria, with the other half being retirements. Most of those no longer being counted were not very productive, explained management, so there shouldn't be a major impact on cash flows. It will be worth watching this closely in coming periods.

Fee margins continued their relentless march downwards, falling from 1.12% to 1.07% and management expects them to continue to fall at this rate. This pushed Wealth Management revenue down by 3% to $1,342m, but a 2% fall in costs meant only a 2% fall in divisional net profit to $418m.

AMP capital increases margin

Better news was to be found at AMP Capital, where AUM crept up 3% to $165bn, helped by a particularly strong second half, which benefited from a $1.5bn turnaround in the group's CLAMP joint venture in China (see AMP: Result 2015 for more detail on this).

About 66% of the AUM came from other AMP business units (down from about 68% in 2015), with the remainder coming from external mandates. The former attracted fees of about 0.20% (similar to 2015) while the latter generated 0.47%, up from 0.45% helped by a deliberate shift towards higher-margin mandates on property and infrastructure.

Total fee income increased 5%, although this was partly offset by an 8% rise in costs due to the international expansion and a ‘one-off rebasing' of the division's remuneration scheme. All up, AMP Capital increased underlying net profit by 4% to $148m.

AMP Bank on the charge

The New Zealand financial services unit increased underlying net profit by 5% to $145m, while the Australian mature business saw profits fall 4% to $167m.

The star of the show, though, was the business that had been the smallest until last year's insurance blow-up. AMP Bank should pass the compromised wealth protection business this year, and it will soon pass some of the other units if it keeps growing at the current rate: in 2016 it contributed an underlying net profit of $120m, 15% ahead of 2015's $104m and almost double the $61m it made five years ago.

In 2017 it managed to increase its loan book by 13% to $17.1bn, almost all of which is residential mortgages (about three-quarters of which are owner-occupied). To support the growth the bank competed aggressively for deposits, which increased by 20% to $11.5bn, yet it was also able to increase its net interest margin from 1.59% to 1.67% whilst simultaneously tightening credit criteria. Impairments remained at a tiny 0.04% of loans.

Too much 'restructuring'

So there's good and bad in the result, but (absent further insurance problems) the main profit driver will remain the wealth management business. This is showing some worrying signs, in terms of cash flows and adviser numbers, and we're not convinced by management's plans to improve things.

There's too much emphasis, for example, on expensive restructuring programs, which make you wonder what they're doing the rest of the time. Keeping a lid on costs should be a normal part of business.

Other elements of the strategy are also slightly unnerving. If you need to ‘transform … [your] business to centre on customer', for example, then it doesn't say much for where you are now.

The company's proposed new ‘digital spine' is also sensible enough, but it's garnished with a bit too much spin for our liking, as a ‘full omni-channel capability with a robo-advice engine that will support all our channels to provide more channel choice for customers, making advice more accessible and more affordable for them and more efficient and profitable for us and our advisers'.

Transforming a business of this size and complexity would be quite a trick, and that's a key reason that we prefer other more focused players in the financial services industry, notably Perpetual and IOOF.

Price guide

It also doesn't help that AMP's price has now risen to higher than its level just before the October warning. With earnings per share currently expected to land at around 34 cents for 2017, the stock is now on a prospective price-earnings ratio of about 15.

The final dividend was maintained at 14 cents (franked to 90%) for the fourth half in a row. If that's maintained for the next two halves, it'll give a payout ratio for 2017 close to the middle of the target range of 70–90% and a 90%-franked dividend yield of 5.3% (although this is somewhat academic for a company that's splashing cash on share buybacks).

We're putting a price guide back on the stock, but it will be fairly conservative given the issues outlined above, with a Buy price of $4 and a Sell price of $6.00. If further steps are taken to reduce insurance risks or if fund flows continue to improve we may move it higher. Of course the converse also applies. HOLD.