Some companies get hung up on maintaining their dividends, but we’re pleased to see they don’t include IOOF.
The wealth manager recorded a flat profit for the year, and about 90% of it came through as free cash helping it reduce net debt to $20m. But a maintained final dividend would have stretched the payout ratio to 99%, up from 91% in 2015 and well above the company’s targeted range of 60–90%. So they shaved 7% off the final dividend. No ceremony, simple as that. It brings the payout ratio down to 94% – and if the dividend and profits are maintained in 2017, it’ll fall again to 90%.
Margins fall sharply in second half
Good cost control
EPS down 4%, dividend cut
We’re in a strange world where (some, crazy) people are buying bonds for capital gain and others are buying shares to provide a reliable income. But investors need to remember that companies aren't about paying income; they’re about maximizing shareholder value. The dividend should always remain a secondary consideration, reflecting the state of a company’s finances and the opportunities it sees for reinvestment. When boards get hung up on maintaining dividends bad decisions can be made on both.
If IOOF is able to increase profits a little in 2017, then it would bring the dividend further back into its targeted range. There's a chance of this, since funds under management, administration and advice (FUMA) averaged $103.8bn in 2016, but ended the year above this at $104.1bn – and markets have rocketed since then, with the All Ords gaining 6%. All things being equal (which of course they certainly won’t be) this would provide a higher base from which IOOF can earn its fees – although much of any increase is likely to be offset by a continued decline in margins.
Across the group, the gross margin (GM - net fees as a proportion of average FUMA) fell to 0.51%, from 0.53% in 2015. However, a 2% fall in operating costs meant the net operating margin (NOM - operating profit as a proportion of FUMA) fell only half a basis point, to 0.23%.
|Year to June||2016||2015|| /–
|Avg. FUMA ($bn)||103.8||100.2||4|
|Net fees ($m)||534||535||(0)|
|Other revenue ($m)||39||42||(7)|
|U'lying op. profit ($m)||240||238||1|
|U'lying net profit ($m)||173||174||(1)|
|Final dividend||26c (down 7%),
fully franked, ex date 29 Sep
This is the essence of IOOF’s business – consolidating the wealth management industry and making it more efficient. In recent years customers have seen most of the benefit, but the company is hanging in, helped by the acquisition of Shadforth in 2014 and continuing consolidation, with the move from three flagships to just two in June.
The biggest source of margin compression was the company’s platform business, where the GM fell from 0.66% to 0.64% and the NOM fell from 0.37% to 0.35%. There was a particularly sharp fall in second half, though, which saw the GM slump to 0.62%, from 0.65% in the first half, and the NOM fall from 0.37% to 0.32%.
About half the second half fall in GM, management explained, was due to customers preferring newer platforms with lower fees, but also with lower overheads. This effect would have been exacerbated by the platform consolidation, from which the full cost efficiencies won’t be seen until 2018. The introduction of the government-mandated MySuper product also had a negative impact on margins, with the final tranche of member transfers occurring in February. These had a higher average customer balance which has a disproportionate impact on margins due to MySuper’s mostly flat administration fees.
Looking for acquisitions
Management was also keen to point to the ‘complementary’ performance of Advice, which now matches the Platform business for size (the two of them contributed 81% of profits) and which was able to increase its NOM from 0.21% to 0.24% thanks to further synergies from the acquisition of Shadforth. That’s good to see, although we can't see how margin movements in Platforms and Advice would naturally offset each other. More importantly, though, the integration of Shaforth is now complete and further improvements will need another acquisition.
Management is clearly on the lookout and claimed that the environment for mergers and acquisitions was particularly attractive at the moment, with a wide range of potential opportunities. Chief executive Chris Kelaher wouldn’t be drawn too much on where he was looking, but it clearly includes ‘fintech’ and ‘roboadvice’. He was, however, keen to play down the significance of these buzzwords, explaining that IOOF saw them, respectively, as ‘just a set of tools’ and ‘a mechanized way of accessing information’.
In the absence of any big moves, continued margin compression will likely offset most of the benefits of any rise in FUMA, so we don't expect much if any profit growth in 2017. Longer term, though, we expect IOOF to continue to play its part in consolidating the wealth management industry and to earn its share of the increasing flow of money into superannuation. Given the low interest rate environment, any kind of long-term growth would make the stock look attractive given its free cash flow yield of around 6%. BUY.
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