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Morningstar | Perpetual’s FVE Increases After In-Line Fiscal 2018 Results, With the New CEO a Near-Term Catalyst

Narrow-moat Perpetual’s fair value estimate increases moderately to AUD 44.50 per share from AUD 43.90 following in-line fiscal 2018 results. Its fair value increase is mainly driven by the time value of money, with the group’s underlying net profit after tax, or NPAT, of AUD 139.0 million consistent with our forecast of AUD 138.7 million. As expected, earnings growth was generated by its private segment (23% of fiscal 2018 group profit before tax) and its corporate trust segment (21% of PBT), with its investments division (56% of group PBT) negatively affected by fund outflows and higher employee costs. The company also declared a final dividend of AUD 1.40 per share, resulting in a full-year fiscal 2018 fully franked dividend of AUD 2.75 per share.

The 2018 fiscal results underscore the importance of Perpetual’s diversification strategy, with the private segment's PBT growing by 13.9% and corporate trust’s PBT increasing by 16.4% in fiscal 2018. These segments offset 3.4% lower PBT in its core investments division, leading to group underlying NPAT growth of 1.5%. We forecast group underlying NPAT of AUD 136 million in fiscal 2019, with continued but lower expected earnings growth in both its private and corporate trust businesses unlikely to offset further expected lower earnings in its core investments division. However, we believe the company will maintain its dividend at AUD 2.75 per share.

The company confirmed that new CEO Rob Adams will commence on Sept. 24, 2018, and a strong balance sheet provides the new CEO with funding options to deliver future growth. The company’s gearing ratio (corporate debt divided by corporate debt and equity) of 11.6% remains at the lower end of its target gearing of 30%. This provides the new CEO with the opportunity to use Perpetual’s balance sheet to acquire earnings growth, which we otherwise would expect to grow by a CAGR in the low single digits in the next five years.

We expect Perpetual’s core investments division to continue facing the structural headwinds of the move by investors to more passive investment styles and the in-housing of asset management by major institutional superfunds. This has been recently compounded by poor short-term performance, with only 40% of its funds ranking in the first and second quartile over a one-year period, although 92% have reached this ranking over a 10-year period. Notably, its core Australian equities strategies endured net fund outflows of 12.5% in fiscal 2018, primarily driven by the loss of two major mandates. While we do not expect this level of outflows to repeat in fiscal 2019, we nevertheless expect continued net outflows and margin pressures in the next five years to negatively affect earnings. Furthermore, its global equity and fixed-income strategies have failed to compensate for the fund outflows in its Australian equity strategies. On a more positive note, however, its Global Share Fund recently received a “recommended” rating from Lonsec and its Dynamic Fixed Income and High-Grade Treasury Funds received a “recommended” rating from Zenith.

The company has proven more successful in its diversification strategy of providing financial advice to high-net-worth clients in its private segment as well as custodial, responsible entity, and other adjacent services in its corporate trust segment. It's continuing to invest in both segments. In its private segment, it is investing in financial planning software to automate the delivery of statement of advice and technology centralising trustee payments, as well as improvements to customer on-boarding. In its corporate trust business, it's investing in automation tools to improve business processes. Its private business has also not faced any of the direct fallout from the 2018 Royal Commission, and its strong balance sheet may provide the new CEO with new opportunities arising out of the Royal Commission and other regulatory reviews, such as the recent Productivity Commission report on Superannuation and the new comprehensive income product for retirement proposal.