The market reacted negatively to IOOF’s fiscal 2016 update, with...

The market reacted negatively to IOOF’s fiscal 2016 update, with the share price down over 7%. IOOF expects underlying NPAT of AUD 173 million-AUD 176 million, broadly in line with AUD 173.8 million last year. While only 2%-3.7% below our AUD 179.6 million forecast, guidance is 4.4%-6% below consensus. Revenue is being affected by weaker equity markets; this hurts the value of funds under management, advice and administration, or FUMA. We estimate that so far during second-half fiscal 2016, the ASX All Ordinaries Index has on average been 10% lower than the average for second-half fiscal 2015. While Australian equities represented only 39% of FUMA as at Dec. 31, operating leverage within the business accentuates the impact of lower revenue on the bottom line. Gross margins and operating costs are reportedly unchanged in second-half fiscal 2016 from first-half fiscal 2016. Our narrow moat rating, underpinned by brand and switching costs, is unchanged.

We expected that second-half fiscal 2016 earnings would be approximately 10% lower than second-half fiscal 2015 earnings on account of market weakness. Our reduced fiscal 2016 earnings forecast of AUD 174.5 million now implies a 15% fall. Our long-term forecasts are largely unchanged, with our AUD 11 fair value estimate intact. Market volatility will continue to drive short-term earnings, but we expect that over the long term, inflows and investment returns will outweigh lower gross margins and drive a five-year EPS CAGR of 3.5%. While leverage to market volatility plays into our high uncertainty rating, issues around compliance and potential brand damage, which could affect FUM retention and growth, remain decisive.

We believe the sharp negative price reaction to the fiscal 2016 guidance illustrates the short-term view often taken by the market. In our view, the small reduction in fiscal 2016 earnings does not justify a AUD 200 million fall in market capitalisation.

Morningstar