IOOF Holdings: Interim result 2016

Judging by the mauling IOOF shares have received, with their price down 20% since the start of the year, investors were expecting something nasty from its latest interim result. Well they didn't get it. Instead, all we saw was the company getting on with what it does best, integrating acquisitions, consolidating platforms, cutting costs and, best of all, generating cash.

Critics will claim that earnings per share would have fallen without the inclusion of Shadforth Financial Group, acquired in August 2014, but that's a bit like saying Arsenal would lack penetration if they hadn't bought Mesut Ozil. It might be true, but rather misses the point.

Making acquisitions and extracting synergies is part of IOOF's raison d'etre. In some industries this type of thing would make us nervous, but it creates real value in wealth management, taking advantage of economies of scale and enabling best practices and technologies to be adopted across larger groups. IOOF's management has a fantastic track record of achieving all this, starting at Select Managed Funds, and then with the reverse takeovers of Australian Wealth Management and IOOF itself.

The integration of Shadforth is now substantially complete, with management pointing to annualised synergies of $31m – $5m in revenues and $26m on costs – compared to the previous target of $20m. Shadforth also boasted $166m of investment management inflows and $241m of advice inflows in the half and increased its funds under management, advice and administration by 9% to $21.3bn (20% of the total). All up, Shadforth delivered a 57% rise in underlying net profit to $32m in the six months to December.

Ready to do it all again

Perhaps the best news of all, then, is that with net debt down from $74m to just $29m – barely a fifth of the group operating profit – management is clearly ready to do it all again. In the conference call, chief executive Chris Kelaher noted that the platform market was still relatively fragmented and said he saw plenty of opportunities in this and other areas. His recent tilt at HUB24, perhaps makes his point better than any words. Watch this space.

With the help of Shadforth, the financial advice segment increased its underlying net profit by 52% to $40.6m, putting it on a par with Platforms in terms of contribution, each with about 40% of underlying net profit. Investment management contributed about 16% (down 3%, excluding the sold Perennial Growth and Fixed Interest businesses) and Trustee Services (up 8%) chipped in the loose 3%.

Without a boost from Shadforth, the core Platform administration business laid bare the market's concerns about the lack of organic growth. Despite a 5% rise in average funds under administration to $34.6bn, from the prior corresponding period, a fall in the gross margin from 0.67% to 0.65%, despite a 6% rise in operating expenses, meant a fall in the net operating margin from 0.39% to 0.37% and a 1% fall in the underlying net profit.

The good news here, though, is that management expects expenses to 'flat line' at the current level and that, on a sequential basis, the gross margin was unchanged from the six months to June 2015 and the net operating margin actually edged up from 0.36%.

Putting it all together, the underlying net profit rose 18% to $95.4m and earnings per share rose 11% to 31.8 cents (the lag being due to the shares issued to pay for Shadforth). Operating cash flow (before tax) rose 10% to $114.6m – as ever a very healthy 86% of the underlying operating profit.

Dividend up

The board backed its confident view of things with a 14% rise in the interim dividend to a fully franked 28.5 cents. That amounts to 90% of the underlying EPS, which is at the top end of the board's targeted range of 60–90%, but nevertheless pretty comfortable given the strong cash flow and low debt.

If the final dividend merely matches the interim, the payout this year will amount to 57 cents, putting the stock on a forward yield of 7.0%. A yield that high means the market probably sees a dividend cut in IOOF's future but, while that's no doubt a possibility, we still back management to find ways to increase earnings, cash flow and dividends over time – and they don't need to increase them by much to justify that yield. BUY.

Note: The Intelligent Investor Growth and Equity Income portfolios own shares in IOOF. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.