A Growing Opportunity
Although financial services company IOOF Holding’s statutory interim net profit fell due to costs related to the ANZ acquisition and a non-cash goodwill impairment, overall there was plenty to like in the results in our view. Underlying profit grew by a double-digit pace, as did net inflows. Funds under Management, Administration and Advice at the end of the period increased almost 10% year-on-year to $120.0 billion, with this trend beneficial for operating leverage. Cost management was impressive and the cost-to-income ratio improved substantially.
The ANZ Wealth Management acquisition is progressing “as planned” with no change to the targeted completion date, which is expected to be around a year from when it was announced in October 2017. As discussed in our prior coverage we believe this is a transformative deal for IOOF, with a palatable price given the expected cost synergies. We agree with management that strategically the ANZ Wealth Management business will be complimentary for IOOF Holdings (ASX:IFL).
Source: IOOF (ASX:IFL)
We are encouraged by the company’s strong track record of integrating acquisitions and pro-forma gearing at the time the deal was announced was an acceptable 1.3 times forecast combined EBITDA (excluding synergies). Down the track the deal is anticipated to be around 20% accretive to IOOF (ASX:IFL) earnings from the second year following full integration and thereafter.
After deal completion, the ANZ deal will elevate the IOOF pro-forma business to second spot in Australia’s funds under advice ranking, give the combined business the second largest pool of financial advisers and place it in fifth spot in the funds under administration rankings.
From a thematic perspective, we like Australia’s financial services industry as a pool to fish in, as the superannuation market is huge and growing at an impressive pace.
Another appealing aspect of the deal IOOF (ASX:IFL) has struck with ANZ is a 20-year strategic alliance agreement that will see the bank distribute IOOF wealth products through its Australian banking network, which reportedly will provide channels to approximately 5.6 million retail customers and 0.5 million corporate, business and SME customers via ANZ channels – advisers and digital.
IOOF Holding’s CEO Chris Kelaher sounded particularly excited about this part of the deal and said, “It’s the partnership that is the icing on the cake. You can look at existing profit and what you’re purchasing, but it’s the growth piece into the future that’s exciting.”
We consider the recently reported departure of a modest number of advisors from the ANZ wealth business to be natural as part of an ownership transition and view it as unlikely to have any material impact on FUMA.
We note that IOOF (ASX:IFL) hasn’t just thought big when it comes to deal making, but has also selectively directed investment to areas that have attractive growth prospects in our view.
An example is the stake it has taken in Grow Super, a start-up that targets younger corporate super fund members and boasts a ‘fresh’ digital experience, including swiping functionality akin to Tinder. Grow Super’s proprietary technology likely has the potential to be utilised in parts of IOOF’s business in what IOOF has called a “strategic partnership”.
The company’s share price performance since our last review has though been weak, in the main due to volatility in financial markets. This is the flip side of the company’s operating leverage, with softer markets taking its toll on FUMA and thereby underlying earnings. We though see the correction in global markets as nearing its end, and believe the worst case outcome of a global trade war is likely to be averted.
Looking at monthly chart, after reaching a high of $10.98 in May 2015, IOOF Holdings’ share price fell into correction-mode, and in the process, touched a low of $7.34 in February 2016. A move towards fresh all-time highs late last year at $11.94 has since been met with a fall back below previous resistance around $11. A sustained clearance of this level would strengthen the overall long-term technical landscape. In the meantime support exists around the $9.70 region.
Interim results
Turning to the headline numbers for the six months to 31 December 2017 and 1H18 revenue was effectively flat year-on-year at $456.2 million. Statutory net profit after tax (NPAT) took a 39% hair cut to $45.2 million though, largely due to the costs associated with the ANZ acquisition and a non-cash $28.3 million goodwill impairment allocated to the Perennial Investment Partners business.
Source: IOOF (ASX:IFL)
Positively, underlying earnings before interest and amortisation (EBITA) increased $18.7 million, or 17% to $130.3 million and net profit after tax (UNPAT) however increased 19% from a year earlier to come in at $94.8 million in 1H18. This equated to 29.8 cents per share, up 13% from 26.5 cents per share in 1H17. The following table shows the reconciliation between NPAT and UNPAT.
Source: IOOF (ASX:IFL)
The company’s net operating margin expanded 2 basis points year-on-year to 0.23% in 1H18 despite a 3 basis point compression in the gross margin to 0.45%.
Source: IOOF (ASX:IFL)
Average funds under administration and advice (FUMA) of $116.2 billion in 1H18 marked a year-on-year increase of 8.8%, with this attributed to equity market performance and growth in advice and platform funds. Financial advice and distribution (advice) flows of $1,208 million represented a 39.7% increase on a year ago, helped by a “solid performance from aligned advisor groups”, system growth and new advisors joining under the Consultum license. Platform flows of $617 million were up 58.3% on last year. Overall net flows for the period increased 15% to roughly $1.56 billion.
Source: IOOF (ASX:IFL)
The positive impact from higher average funds on gross margin was offset by negative impacts from product mix. The company highlighted the trend for a higher proportion of funds to be directed towards newer platforms with lower fees, but these also have lower overheads. Investment management margins improved compared to a year ago, due to consolidation of fund managers and lower overheads. In the financial advice area, Shadforth margins decreased due to divestment and service impacts, and new business from joining advisors was dilutive on margins overall.
Cost management was a bright point, with operating expenditure falling $8.9 million on a year ago to $156.4 million in 1H18. That drove the cost-to-income ratio down 5.1 percentage points from 58.9% in 1H17 to 53.8% in 1H17.
Source: IOOF (ASX:IFL)
IOOF Holdings (ASX:IFL) declared a fully franked dividend of 27.0 cents per share, marking a 1 cent increase from a year earlier.
Turning to the daily chart, a zone of support between $10.34 and $10.39 has given way in the recent market sell off. The next layer of support exists around the $9.33 region, and a move back above $10 would improve the technical landscape.
Summary
We viewed IOOF Holdings’ interim results in positive light overall and believe the deal to acquire ANZ Bank’s wealth management business is a transformative one that will catapult IOOF up the rankings in the attractive Australian wealth management sector. The price was palatable, especially as the deal has considerable scope for cost synergies.
We remain favourably disposed to an investment in IOOF Holdings’ shares based on our view that the company remains well placed to capitalise on the longer-term growth opportunity within its target markets.
Consequently, we continue to recommend IOOF Holdings (ASX:IFL) as a buy for Members with no exposure to the stock.
Disclosures: IOOF Holdings (ASX:IFL) is held in the Fat Prophets Australian Share Income, Concentrated Australian Share and Small/Mid-Cap Models.
