Well, there are several possible outcomes that can negatively affect future EPS: repricing of platform services (which is already happening), abolition of commission trails for advisers, abolition of vertical integration, etc.
Quantifying the potential impact of each is difficult, but my personal sense is that a 30% decrease in EPS is pretty close to a worst-case scenario.
But, since the Company’s earnings guidance implies cumulative EPS growth by >45% over a three-year period (i.e. from the current ~200m$ to >290m$ by FY21), as a result of the ANZWM integration alone (i.e. before net flows and markets), I still see the benefits from the acquisition as more than compensating for any possible regulatory change, in the medium-long term.
In other words, whatever happens with the RC, I still see IOOF’s EPS as eventually growing above their current level (before net flows and markets are factored in).
In the interest of fairness, when the Company provided their guidance in August, the repricing of platform services hadn’t yet been factored in. Having said that, downward pressure on gross margins is no news in this industry: it has been going on for the whole past decade, and IOOF have nonetheless been able to protect (and actually marginally increase) their Net Operating Margin over time.
So, once the positive long-term impact of net flows (which have structural and secular tailwinds) is factored in as well, I still see IOOF’s EPS as eventually growing above its current level.
The only residual unknown is the general level of markets (i.e. the mark-to-market value of the underlying FUMAS). But, as I have mentioned a couple of times in the past, I have put in place a market hedge (US$-denominated leveraged inverse index tracker) against my IFL holding; therefore, that is not an aspect I am personally worried about.
Now, having decided for myself that IFL’s EPS (and dividend) is highly likely to ultimately grow above its current level, how does that level compare to the prevailing market earnings yield?
On a FY19E basis, the ASX200 is presently trading at a 6.9% EPS yield, whereas IFL’s EPS yield is (if we just take its FY18 results as a reference) 0.56/6.84 = 8.19%.
Given the above-average transparency and dependability of IOOF’s earnings (they are really just a percentage of an observable market “index”, once the rules are set; plus, there is little risk of sudden drops in revenue, as it is the case for the vast majority of ASX200 companies), I see no reason why IFL’s EPS yield wouldn’t eventually at least re-align with the market’s prevailing EPS yield. And that can only mean SP going up, if EPS is not decreasing.
So, to conclude: for those who have a three-year holding horizon in mind, I currently see IFL as being considerably cheap relative to the broader market; and, for those who don’t mind using hedging products to reduce the underlying FUMAS market risk, I see it as being almost a no-brainer.
IMHO & DYOR
IFL Price at posting:
$6.84 Sentiment: Buy Disclosure: Held
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