AMP shares closed last week at levels of March 2003. This abysmal outcome is nearly incredible after 14 years of population growth, GDP growth, low and falling interest rates, rising house prices and household wealth, compulsory superannuation and ownership of one of Australia’s most-recognised heritage brands. Capital intensity, competition, legislative and regulatory change, AMP’s complex internal economics, the difficulty of driving change in such a large company with legacy businesses, the GFC and its aftermath are all responsible.
Last week’s interim result did not help either. Admittedly in a market spooked by bellicose rhetorical exchanges between Donald Trump and Kim Jong Un, AMP shares closed down five per cent for the week partly over disappointment at the decision to “pause” the $500 million share buyback after completion of just $200 million. The reason given was AMP’s need to invest to grow, which is reasonable, so we question the thinking behind announcing a $500 million total buyback in February in the first place. This inept messaging has now needlessly cost shareholders some of their wealth and does not inspire confidence management can plan its capital allocation. It would have been more shareholder-friendly to announce smaller buybacks in stages, carefully coordinating them with the business units’ need for capital to grow. Now we are told there will be no further announcements about capital management until the full-year result in February. This creates a six-month information vacuum – and markets do not like uncertainty. Worse for some investors, there has been a shift in the strategy to inorganic (via acquisitions) growth. Institutional investors do not yet trust AMP management to grow by acquisition.
AMP could also be more transparent in explaining how much capital it has to return to shareholders. This is one of the only large listed financial companies that don’t provide a capital target range, which creates confusion about what is returnable capital – especially given management’s stated intention for AMP to become “capital-light” is now somewhat contradicted. AMP has surplus capital above regulatory minimums but the uninformed market expectations about how much of this could be returned to shareholders have been disappointed.
The underlying interim result was also ordinary, with divisional results boosted by one-off items including investment performance fees and better than expected life insurance claims. Some key operating metrics will be deteriorate in the second half. Superannuation inflows will probably decrease after strength in the June half ahead of reductions to contribution limits from 30 June. Performance fees will be seasonally lower and life policy lapse rates will be seasonally higher. Equity markets could also be headed into a more difficult period as full earnings multiples collide with rising military tensions between the US and North Korea and the first reductions in the US Federal Reserve’s holdings of government bonds.
But all these disappointments and headwinds could create opportunistic entry points to AMP in coming months. We can value AMP at $5.50 if management executes well, which means the stock is interesting below $5.00 and cheap at $4.50. We support the strategy to tilt investment to higher-growth, less capital-intensive businesses; de-weight life insurance and New Zealand; grow wealth management revenues by increasing contributions from advice and SMSF while investing in product and platform development; roll out a purposeful, goals-based framework for clients across all touchpoints; grow AMP Capital internationally; and restrain costs. We are confident value will eventually be realised in the second half of 2018 and full-year 2019, which suggests investors should be set by the end of 2017.
Last week’s decision to reinsure some two thirds of new life insurance policies from 1 November is a landmark change that should have been made 10 years ago. This derisking releases $500 million of capital and is worth the extra reinsurance premiums because it reduces exposure to the volatility in income protection claims which has dogged the sector for over 10 years. Ideally AMP would go further and divest its life insurance books as some major banks seek to but the new reinsurance cover is a welcome start. Over the last 10 years income protection claims due mainly to disability (mental illness) have surged way above actuarial expectations because policyholders have turned to their policies for cashflow support in the patchy economy. Premiums are catching up now but the sector remains capital-intensive, price-competitive and vulnerable to regulatory/legislative change. It is a dog for ASX investors.
Two words of caution. First, AMP will need stable investment markets to eventually perform. Second, investors should ensure their expectations for further buybacks are realistic. AMP’s aspirations to double volumes through the bank and grow China earnings to $50 million are capital-intensive. The $500 million buyback program will probably not be increased in February and could be cut while the capital released by reinsuring the life book is more likely to be reinvested than returned to shareholders.
This means shareholder value can be created only by growing earnings faster than shareholder equity, thus lifting returns on equity. That is hard. Management’s strategy has to work, there is little margin for error and last week’s confusion over capital has compromised management’s reputation and credibility somewhat. This is why short positions in the stock have increased.