Looking beyond the headline numbers
IOOF Holding’s (ASX:IFL) statutory FY18 profit was heavily impacted by one-off items. However, on an underlying basis we were content with the overall performance. We like the company’s ability to control costs and attract inflows in a market with a long runway of growth. Regulatory concerns are a headwind for sentiment near-term, but we believe the industry will emerge on the other side stronger and more trusted by users after some structural change.
We view the acquisition of ANZ’s wealth management businesses to be a transformative one and the price palatable. This will increase IOOF Holding’s leverage to the huge, growing
Australian pension system, which is forecast to hit $9.5 trillion by 2035.
Much has been made in the press of BT Financial Group’s decision to cut fees on its Panorama platform, and potentially declare an industry price war. However, it is not all about price, and if that is the case, recent share price weakness in the likes of IOOF and the other platform stocks is overdone. The changes to fees need to be taken in context, with the impact for all investors not necessarily the same. Chief executive of IOOF Chris Kelaher has voiced a similar view, saying it was important for user to look beyond BT’s headline fee cuts, to other changes such as cash accounts.
FY18 snapshot
Turning to the headline numbers and FY18 revenue from shareholder activities ticked up 1% to $919.1 million, driven by a 2% increase in management and service fees revenue to $777.6 million. Statutory net profit after tax (NPAT) declined 24% to $88.3 million though, largely due to a string of one-off items including a $44.25 million charge linked to settling legal claims. Other costs include acquisition-linked costs, termination payments, goodwill impairment ($28.3 million allocated to the Perennial Investment Partners business), onerous contracts and profit on the divestment of subsidiaries.
The underlying numbers were positive, with underlying earnings before interest and amortisation (EBITA) increasing 9% year-on-year to $263 million. Underlying net profit after tax (UNPAT) increased 13% year-on-year to $191.4 million.
Source: IOOF Holdings (ASX:IFL)
That equated to underlying earnings per share of 57.3 cents per share. That was only a marginal 1.4% increase, but a strong result in our view given the increase in the share base linked to the acquisitions of wealth management businesses from ANZ. The final dividend was maintained at 27.0 cents per share, but combined with the interim that marked a 1 cent per share increase to 54.0 cents per share for the full year.
The following table shows the many items reconciling NPAT and UNPAT between FY17 and FY18. Combined significant items and amortisation summed to a whopping $103.1 million, compared to $53.4 million in FY17.
Source: IOOF Holdings (ASX:IFL)
The company’s net operating margin declined 1 basis points year-on-year to 0.23% in 2H18 as the gross margin slipped 4 basis points to 0.44%.
Source: IOOF Holdings (ASX:IFL)
Average Funds under Management, Administration and advice (FUMA) in FY18 were $118.9 billion, marking a year-on-year increase of 8.6%, with this attributed to equity market performance and growth in advice and platform funds.
Financial advice flows of $4.4 billion represented a 48.3% increase on a year ago,
helped by system growth and new advisors joining under the Consultum license. Platform flows of $1.6 billion were up 33.7% on last year. Overall net inflows for the period increased 28% to roughly $5.8 billion.
Source: IOOF Holdings (ASX:IFL)
The positive impact from higher average funds on gross margin was offset by more rapid growth in products with lower margins. Overall, the gross profit (margin) for the company increased $9.4 million, or about 2% to $533.8 million.
Cost management was again bright spot, with operating expenses declining $9.4 million, or 3% to $308.5 million. The company’s cost-to-income ratio improved 3 percentage points to 53.1%.
Source: IOOF Holdings (ASX:IFL)
Turning to the daily chart, a zone of support between $10.34 and $10.39 has given way in this year’s sell off. The next layer of support existed around the $9.33 region, and has also been breached. A move back above this level, and also $9.13 (the 50 day moving average) is needed to improve the outlook.
Looking at the 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 levels at $11 and subsequently $9.70. Prices have also fallen below support at $9.08 being the 78.6% Fibonacci retracement. The upward sloping green trend-line has been a buttress, and prices flirting around this level have increased our near-term caution.
Summary
Overall, we viewed IOOF Holdings’ underlying FY18 numbers positively. The company has shown strong recent traction in net inflows and we believe the deal to acquire ANZ Bank’s wealth management business is a transformative one. The price was palatable, especially as the deal has considerable scope for cost synergies. It is expected to drive meaningful earnings per share growth from the first full year.
Margin pressures are a headwind, but we are encouraged by IOOF’s ability to control costs and scale up. Regulatory concerns are creating headlines, but ultimately, we believe the industry can adequately cope with changes that arise and these concerns are already reflected in IOOF’s valuation. IOOF management has already flagged that is reviewing its ownership structure considering the strict regulatory scrutiny and revelations in the industry. That may see the company make changes to reduce any risk of conflicted remuneration structures.
On another sentiment-related note, at the time of the full year results, the IOOF CEO did not see the need to provide for remediation costs related to ‘bad advice’ like some others. This could change, but in a response to an analyst question on the topic Mr Kelaher reportedly said, “As we sit at the moment, with all of our audits going on, the answer is no. Can I predict in the future no advisers will do bad things? No, I can’t.”Â
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 large long-term growth opportunity within its target markets. The forecast price to earnings for the fiscal year ending June 2020 is approximately 13.0 times, while the projected dividend yield the same year is 6.9%.
IOOF Holdings (ASX:IFL) will remain held in the Fat Prophets portfolio.
Disclosures: IOOF Holdings (ASX:IFL) is held in the Fat Prophets Australian Share Income managed account portfolios.
