Perpetual: Interim result 2017

You'd forgive Perpetual Private – the group's wealth advisory business – for feeling a bit like the perennial bridesmaid. Contributing only a fifth of Perpetual's total profits, compared to three-fifths for Perpetual Investments, it's the latter that gets all the attention around results time.

This time around, though, Perpetual Private was firmly in the limelight, with a 9% increase in profit before tax, compared to just 3% for Perpetual Investments (and 1% for the Corporate Trust business). The business added 46 net new clients, with an average of $2.8m of funds under advice (FUA), giving over $0.1bn in net flows. That makes it seven halves in a row that these markers have both been positive, with a cumulative 283 new clients and $1.05bn in flows.

Combined with market movements, funds under advice in Perpetual Private rose 4% to $13.3bn over the period and averaged $13.0bn. A stable margin of 0.85% meant that Perpetual earned $55.7m of ‘market-related' revenue on those funds (up 3%). Meanwhile, ‘non-market related' revenue (from things like tax, accounting and property services) rose 9% to $30.9m, giving total revenues of $86.6m (up 5%).

Expenses grew at the slower rate of 4% (including depreciation, amortisation and equity remuneration), leading to the 9% profit increase.

Ambitious targets

The 9% increase in non-market related revenue was primarily due to the Fordham advisory business, which focuses on providing advice to business owners, and which expanded into NSW last year with the addition of seven new partners, taking the total to 16.

The business was bought for $35m in 2010, with around 14 partners generating $22m in revenue. Initially it disappointed, with revenue falling to $16m in 2013. A recovery over the past three years, however, has seen revenue recover to $20m – generated by the business's nine partners in Victoria – and management says it believes there is the potential to treble this to $60m by 2020.

To achieve that goal, it's aiming to increase partner numbers from the current 16 to ‘over 30', with revenue per partner of ‘over $1.5m'. Simple arithmetic would suggest that one or both of those will need to be ‘well over' to make $60m.

If that target is achieved, it would add about 24% to Perpetual Private's revenue – and 8% to the group total – on its own, and there would be additional benefits for the rest of the group through referrals. It's an ambitious target, though, and we'll be taking it with a pinch of salt for the time being.

Poor (recent) performance

The main driver of profits will remain the funds management business, Perpetual Investments, and here the news is less rosy. Net flows of zero in the half included an outflow of $0.2m from the higher margin retail channel and $0.4m from equities. Market movements, however, meant that funds under management (FUM) rose $2.5bn to $31.9bn, compared to June 2016. Average FUM rose 2% to $30.7m.

The good news was that, despite the outflows in equities and retail, the underlying revenue margin was relatively stable at 0.72%, which increased to 0.74% with the inclusion of performance fees. That gave a 3% rise in revenue compared to the prior corresponding period and a 3% increase in profit before tax.

The concern for this business is that performance has been poor for the past few years, with only 44% of flagship funds in the first and second quartiles over one and three years. Generally speaking we wouldn't be too fussed about such short-term performance (over five and ten years, 87% and 85% of flagship funds are in the top two quartiles), but there have been some personnel changes over the past few years so it's something that we'll be watching.

Growth returning

The final piece of the jigsaw is the Corporate Trust business, which produced a solid result, with funds under administration rising 7% to $644bn over the year. Some of that increase is yet to translate into revenue, which grew only 5%, and a 6% cost increase due to continued business investment meant that profit before tax grew only 1%.

Overall, underlying profit before tax increased 4% and a slightly higher tax rate and a few more shares on issue meant that underlying earnings per share increased only 2% $1.407. Even so, that's a little more than the market was expecting and supports the hope we expressed in our review of Perpetual's 2016 result, that 2017 might see a return to earnings growth.

Something around $2.85–2.90 would represent growth of 3–5% and would put the stock on a price-earnings ratio of 18. That's not expensive for a quality cash-generative business but, with the stock now past our Buy price*, we're downgrading to HOLD.

* We note that the stock is due to trade without entitlement to its $1.30 interim dividend on 1 March and this might bring the stock back to around our Buy price. We'd want to see a bit of space below this level, however, before upgrading again.

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

Disclosure: The author owns shares in Perpetual.