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Shifting fortunes as CBA, AMP trim dead wood

Glenn Freeman  |  14 May 2020Text size  Decrease  Increase  |  
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Morningstar is relieved Commonwealth Bank has secured a deal to sell a majority stake in its funds management arm Colonial First State.

On the other hand, Morningstar says the financial position of AMP (ASX: AMP) is more precarious. The crisis has scuppered the company’s plans to divest its New Zealand wealth management arm as it struggles to find the right price for the underperforming asset.

For CBA (ASX: CBA), the $1.7 billion sale to global investment firm KKR is expected to close in the first half of 2021.

The timing of the sale is good for the bank, which reported net profits dipped 40 per cent to $1.3 billion in the third quarter. This was largely due to the bank's $1.5 billion of loan impairment expenses as coronavirus restrictions cause job losses across the country.

Without the loan impairment expenses, Commonwealth Bank's quarterly profit result would have been $2.4 billion, up slightly on the previous two quarters.

"The divestment comes at a good time in providing an injection of additional capital," says Morningstar banks equity analyst Nathan Zaia. The CFS sale won't be included in Zaia's modelling until the deal completes, "but the impact to our fair value estimate is immaterial," he says.

Morningstar's fair value estimate has remained unchanged at $71 after the latest CBA result. At midday on Thursday, the bank's shares were trading at about $59—a 17 per cent discount to Zaia’s fair value estimate.

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Zaia expects CBA and KKR will combine to improve the financial returns of the CFS business, and then the bank will exit entirely once the customer remediation issues are resolved.

Continued growth in the bank's loans book is a key reason for his optimism. He says larger loan balances and cost-savings are encouraging for the bank's longer-term earnings.

Morningstar's fair value estimate is underpinned by:

  • modest annual loan growth of 3.5 per cent over the next five years,
  • net interest margins—a measure of the difference between the interest income generated and the amount of interest paid to lenders—2.05 per cent from 2.15 in fiscal 2019,
  • a cost-to-income ratio of 40 per cent by fiscal 2024.

Dividends should be safe

Zaia doesn't expect the downturn will require CBA to raise capital to continue paying dividends—albeit reduced—which are widely relied upon by Australian investors.
"After paying an interim dividend of $2 a share, we trimmed our second-half dividend forecast to $1.00 from $1.30 previously, which implies a second-half payout ratio of 75 per cent," he says.

"The balance sheet remains in a sound position with capital, funding and liquidity levels well managed."

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AMP vulnerable on costs

AMP’s New Zealand operation contributes less than 10 per cent to group earnings, but has been a drag on profits as its book of assets has declined and financial advisers have exited.
The New Zealand wealth management arm has shrunk to around 60 advisers from a peak of 400. Assets under management of $12.3 billion as of the end of 2019 have dipped 2 per cent annually since 2014.

"As a company, AMP is trying sell off all these businesses that are going downhill … there's no point keeping this business because it's not profitable," says Johannes Faul, a Morningstar equity research director.

During Friday's annual general meeting, which was held online due to covid-19 restrictions, AMP CEO Francesco De Ferrari says he plans to retain and grow the New Zealand wealth arm.

But Faul says the focus both for AMP and CBA is to unload their non-core, less profitable businesses.

"The CEO said 'we can't sell it for a good price currently, we're just going to keep it and grow it for now'. But I expect that at some point in the future, they will sell NZ Wealth Management."

The primary concern is the sale of its life insurance business, AMP Life, and Faul says many shareholders asked during the AGM "what is your back-up plan if you don't sell it?"

"If the sale of AMP life didn't go through, their capital position would still be manageable for now, but leave them vulnerable to unwelcome shocks in costs," Faul says.

Morningstar left its fair value estimate unchanged at $1.60 after the 2020 AGM. But this was cut from $1.95 to $1.60 in mid-April to adjust for the impact of the covid-19 pandemic.
This followed a series of cuts to the fair value estimate in response to the royal commission, which unearthed revelations of mis-selling and price gouging. The result was devastating and cut AMP’s fair value in half from $4 to $2.

"If AMP manages to sell the life business, it doesn't need to hold as much capital and will have more headroom to invest in other parts of the business."

But even if AMP Life isn't sold, the company has enough capital to cover remediations and will still exceed the minimum capital requirements by between $2.5 million and $3 million, Faul says.

AMP's share price rose to $1.46 from $1.40 after the AGM, but has since resettled and closed at $1.401 on Thursday's close. This is down 74 per cent from more than $5 ahead of the royal commission.

AMP management says the group's $673 remediation program, stemming from the royal commission should be 80 per cent complete by the end of 2020 and finalised during 2021.
This preceded a shareholder strike that saw a 67 per cent protest vote against AMP executive salaries. This was despite the cancellation of De Ferrari's generous "recovery incentive" and a $190,000 cut to the fee of AMP Chairman David Murray.

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is senior editor for Morningstar Australia

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