The AMP dilemma

By Martin Fowler - September 18, 2019

The share price of AMP Limited has fallen from $5.50 eighteen months ago to $1.60, before recovering somewhat to trade around $1.85. The peak to trough fall during this period was around 70%. In this article we will examine the pros and cons of investing in AMP.

The Company

AMP is a financial services company in Australia and New Zealand providing superannuation and investment products, insurance, financial advice and banking products including home loans and transactional accounts. The company's operating segments include:

  • AMP Capital, which is a diversified investment manager, managing investments across major asset classes including equities, fixed interest, infrastructure, property, diversified funds, multi-manager and multi-asset funds;
  • AMP Bank, which offers residential mortgages, deposits, transactional banking and self-managed superannuation fund (SMSF) products;
  • Australian Wealth Management (AWM), which provides financial advice services, platform administration, unit-linked superannuation, retirement income and managed investment products;
  • Australian wealth protection, which includes individual and group term, disability and income protection insurance products;
  • New Zealand financial services, which provides risk insurance, wealth management and mature book business, and
  • Australian mature business, which includes whole of life, endowment, investment-linked, investment account, retirement savings account, eligible rollover fund, annuity, insurance bonds, personal superannuation and guaranteed savings account products.

The Royal Commission

The Royal Commission into misconduct in the banking, superannuation and financial services industry saw AMP, particularly its wealth management division, face intense scrutiny, leading to its CEO, Chairwoman and other board members resigning. The Royal Commission identified material corporate governance failures and cultural problems, which have significantly reduced the competitive advantage of its brand and vertically integrated business model. A clear consequence of the reputational damage caused by the Royal Commission is that AMP will face elevated compliance costs in the near to medium term as well as continued net cash outflows in its wealth management division.

Whilst the exact financial impact of these events is hard to quantify, AMP is going through a rebuild period involving the appointment of a new board and CEO who has outlined a billion-dollar transformation project to reset the company for future growth.

Interim Results and Share Purchase Plan

At the release of AMP’s interim results, the company announced impairments of approximately $2.35b, leading to a reported loss of $2.3b. AMP Capital remains the main driver of group earnings as its externally managed infrastructure funds continue to generate solid margins because of strong investor demand for real assets. AMP Bank recorded a fall in profit in H1FY19 as stable net interest margins were offset by softer credit growth. The AWM division continues to face headwinds as earnings fell 36% and the cost to income ratio rose from 42.9% to 61.3%.

AMP has recently completed a $650m capital raising, which together with the $650m institutional placement undertaken by the company, aims to implement management’s three-year transformation strategy to reposition and de-risk its three core businesses: AMP Capital, AMP Bank and AWM. The raisings provide balance sheet strength to absorb the uncertainties until the completion of the proposed revised sale of AMP Life (comprising AMP’s wealth protection and mature businesses in Australia and New Zealand) to Resolution Life. AMP group should be in a sound balance sheet position after the capital raising, placement and the successful sale of the Life business.

Outlook

Management envisages that in three to five years AMP Capital will generate approximately 45% of the group's underlying NPAT, whilst AMP Bank is forecast to contribute around 30% and AWM 25%. However, whilst AMP’s Capital’s earnings are likely to remain robust, over the short-term we expect earnings for AMP Bank to be subdued at best, due to a combination of the competitive lending environment and higher funding costs, pressuring net interest margins. We expect continued disruption in AWM, leading to continued net outflows, albeit at a slower rate than that experienced in the recent past. A potential tailwind for the division is that the banks have exited their wealth businesses. AMP intends to fix legacy issues including structuring its financial advice network to have fewer but more productive advisers, have fewer administration systems with a streamlined superannuation offering (the number of master trusts and platforms will be reduced) and stronger governance and compliance processes.

Over the longer term AWM has the potential to benefit from the current mandatory 9.5% superannuation guarantee contribution, increasing to 10% from July 1, 2021, and then progressively increasing to 12% from July 1, 2025. However, the Productivity Commission Report published in January 2019 called for "an independent public inquiry into the role of compulsory superannuation in the broader retirement incomes system" and recommended a delay to this scheduled timeline. A further positive is that increasing complexity in superannuation and taxation rules will likely boost demand for financial advice, and AMP has the largest advisor network in Australia/New Zealand.

Conclusion

Decisive management action is a major step forward in reshaping AMP as a simpler, more focused group, whilst freeing up capital from intensive and less profitable business units. Investments in AMP Capital will be used to continue to grow its global footprint and leverage off the global demand for yield by providing customised real asset solutions. In the more challenging public markets, AMP Capital will focus on simplifying products and focus on high alpha assets like global equities. AMP should benefit from changing demographics and significant forecasted growth within the superannuation sector. The group exhibits robust capitalisation which will provide a backstop to elevated compliance costs and any short-term adverse fluctuations in earnings.

However, as a result of the damage inflicted on the company by the Banking Royal Commission, AMP will be in a period of transition over the next few years as it employs a new leadership team, incurs higher compliance costs, suffers from lower growth due to material reputational damage and more proactive scrutiny from regulators ASIC and APRA, and combats legal proceedings, including class actions. This is likely to lead to a period of tempered growth from an earnings and share price perspective. Whilst management have made their intentions clear in announcing and initiating the execution of a transformational strategy, we believe there is a great deal of uncertainty, and therefore risk, around the successful implementation of this strategy in the stated timeframes and within budget. We therefore did not recommend participation in the Share Purchase Plan and continue to prefer waiting on the sidelines until some “green shoots” can be seen in regards to the strategy gaining traction.

 

Liability limited by a scheme approved under Professional Standards Legislation. Any advice included in this newsletter has been prepared without taking into account your objectives, financial situations or needs. Before acting on the advice you should consider whether it’s appropriate to you, in light of your objectives, financial situation or needs. You should also obtain a copy of and consider the Product Disclosure Statement for any financial product mentioned before making any decisions. Past performance is not a reliable indicator of future performance. Advisors at Pitcher Partner Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth management Pty Ltd, ABN 85 135 817 766, AFS and Credit Licence number 336950.

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