Please refer to page 16 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures . AUSTRALIA 15 September 2015 Macquarie Securities (Australia) Limited Health Funds & Wealth Mgt Australian Health & Wealth Ranking Event We review and rank the listed Australian Health Funds and Wealth Managers under Macquarie Securities coverage. Impact We rank the stocks on the basis of: 1) growth; 2) margin; 3) capital; 4) regulatory factors; and 5) relative performance, valuation and earnings metrics. We also review the structural position of Health and Wealth stocks. Health Funds have similarities with the Australian superannuation system. Parallels can be drawn between the structure of: the direct to individual compulsory defined contribution private superannuation market, supported by the taxpayer funded Government pension system; and the direct to individual Health Fund sector supported by government policy, operating alongside the taxpayer funded public hospital system. In addition, recent policy changes in both systems have seen government policy target its support away from higher income earners. Both the Health Fund market and the compulsory superannuation system are supported by structural, regulatory and demographic tailwinds. Our Australian Health Funds and Wealth Managers order of ranking is: #1 Challenger (CGF AU, A$6.93, Outperform, TP: $7.95): As the leading retirement products provider, CGF should benefit from: 1) demographic trends; 2) product mix; and 3) removal of retirement income barriers. #2 Medibank (MPL AU, A$2.31, Outperform, TP: $2.65): MPL operational improvement upside and ideally placed to fund growing private health care. #3 IOOF (IFL AU, A$8.88, Outperform, TP: $11.10): IFL’s relative valuation has opened up following media reports on compliance issues. #4 nib (NHF AU, A$3.14, Outperform, TP: $3.70): Modest market underperformance is more pronounced vs MPL and a discount has opened up on this pair. As a health fund in the current volatile market conditions nib should outperform. Also the market does not appear to have updated for additional FY16 outlook detail that should see consensus earnings upgraded. #5 Clearview (CVW AU, A$ 0.92, Outperform, TP: $1.15): CVW is well positioned in the Wealth Management sector. The absence of legacy products and processes support it strategic and product options. #6 AMP (AMP AU, A$ 5.67, Neutral, TP: $6.30): We expect AMP’s organic growth to be broadly in line with overall market driven by FUM with a drag from revenue fee margin pressure resulting from regulatory factors and product mix. Transfer of coverage: We transfer analyst coverage of IFL to Tim Lawson from Bryan Raymond. See review on page 8-9 of this report. Outlook We believe structural support to be most significant for Health Funds and Retirement products and rank #1 CGF and #2 MPL.
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Please refer to page 16 for important disclosures and analyst certification, or on our website
www.macquarie.com/research/disclosures.
AUSTRALIA
15 September 2015 Macquarie Securities (Australia) Limited
Health Funds & Wealth Mgt Australian Health & Wealth Ranking Event
We review and rank the listed Australian Health Funds and Wealth Managers
under Macquarie Securities coverage.
Impact
We rank the stocks on the basis of: 1) growth; 2) margin; 3) capital; 4)
regulatory factors; and 5) relative performance, valuation and earnings
metrics. We also review the structural position of Health and Wealth stocks.
Health Funds have similarities with the Australian superannuation system.
Parallels can be drawn between the structure of:
the direct to individual compulsory defined contribution private
superannuation market, supported by the taxpayer funded Government
pension system; and
the direct to individual Health Fund sector supported by government
policy, operating alongside the taxpayer funded public hospital system.
In addition, recent policy changes in both systems have seen government
policy target its support away from higher income earners. Both the Health
Fund market and the compulsory superannuation system are supported by
structural, regulatory and demographic tailwinds.
Our Australian Health Funds and Wealth Managers order of ranking is:
#1 Challenger (CGF AU, A$6.93, Outperform, TP: $7.95): As the leading
retirement products provider, CGF should benefit from: 1) demographic
trends; 2) product mix; and 3) removal of retirement income barriers.
Macquarie Securities cover the following listed Australian Health Funds and Wealth Managers:
Health Funds: Medibank and nib.
Wealth Managers: AMP, Challenger, Clearview and IOOF.
We have adopted a non-traditional grouping of Health Funds and Wealth Managers (Life and
Health is more typical) for our ranking purposes. We believe that listed Australian health and
wealth stocks have similarities across growth, margin, regulatory and capital factors.
In addition, ranking Australian Health Funds and Wealth Managers is more valuable than
comparing Health Funds and General Insurance stocks as the claims risk reduces the
comparability across these groupings and results in different capital requirements. The growth
outlook is also fundamentally different for General Insurance and Health Funds.
Macquarie rank the stocks on the following basis:
1) growth outlook;
2) margin expectations;
3) capital position;
4) regulatory factors;
5) relative stock performance, valuation and earnings metrics; and
6) structural position (current focus issue).
Based on the above metrics the Macquarie Health and Wealth stock ranking is: #1 CGF, #2 MPL,
#3 IFL, #4 nib, #5 CVW, #6 AMP.
Underpinning our analysis is our expectation that structural support will be most significant in Health
Funds and Wealth Retirement products, as the demands on government expenditure from these
areas is most significant.
The chart below reflects fiscal impact of increased health utilisation and ageing. The increased
demands from the public pension are less transparent but are no less of an issue for the government
fiscal position as the population ages and individual life expectancy increases.
Fig 1 Change in Aust. Governments’ expenditure (% above CPI & relative to GDPg)
Notes: Categories shown are the 10 largest expenditure categories for 2012-13. ‘Other’ comprises all expenditure not elsewhere included, including (from largest to smallest) community services, government operations, superannuation, disability services, emergency services, foreign affairs, climate change and environment, employment, legal, immigration and customs, arts and sport, housing, emergency services, communications, and water.
Source: Grattan Institute analysis of Commonwealth and State budget papers for 2002-03 and 2012-13.
Macquarie Wealth Management Health Funds & Wealth Mgt
15 September 2015 3
Fig 2 Summary of stock rankings (most preferred to least preferred)
Growth Margin Capital Valuation Structural Position Overly
#1: CGF Retirement incomes: CGF is
well positioned as the leading independent provider of
retirement income products in Australia.
Funds Management: CGF is a top ten Funds Management
group in Australia and is expanding its boutique structure
internationally.
Three years of stable net margins and stable 2H15
product margins versus 1H15 has exceeded market
expectations.
We believe the margin risk remains on the upside.
CGF can improve capital efficiency as it continues to add
longevity risk to its currently investment risk heavy
regulatory capital base and derives a capital aggregation
benefit
CGF ranks as the second most attractive Health and
Wealth stock under our coverage on a relative
composite value measure (PE, PB, Div Yield and
ROE).
We believe that this valuation reflects the
credit risk that CGF takes to achieve the investment
returns necessary to sustain product margins
and is a constant focus of investors.
As the leading independent provider of retirement income product in
Australia CGF should benefit from 1) demographic trends (ageing); 2) product mix; 3) government and
regulator removal of barriers in the retirement income market (as
recommended by the FSI).
#2: MPL For MPL specifically, in the short to medium term we expect
improved operating performance can reduce loss of
market share and support revenue growth.
Over the long term Health Funds are ideally placed to fund
community expectations of health care in a private hospital setting and reduce pressure on the funding of public health care
provision.
As MPL focus on claims management and improved
management expense efficiency we expect that net
margins should expand to more than 6.0% and stay at that level
over the medium term.
Health Funds are low capital intensity due to the short tail,
non-catastrophe exposed nature of claims.
MPL ranks as the least attractive Health and
Wealth stock under our coverage on a relative
composite value measure (PE, PB, Div Yield and
ROE).
This relative valuation ranking reflects the long term growth of Health
Funds in Australia.
Health Funds are ideally placed to fund community expectations of health care in a private hospital
setting and reduce pressure on the funding of public health care
provision.
The acquisition of Health.com.au by GMHBA indicate that entry by new
start-ups is difficult.
#3: IFL We expect IFL organic growth to be broadly in line with overall
market growth.
Acquisitions may drive IFL growth ahead of overall levels of growth across the Wealth
Management Sector.
We expect IFL cost performance to partially offset the decline in revenue margin. This is expected to moderate
the decline in net margin.
IFL operates a portfolio of low capital intensity businesses.
The acquisitive nature of IFL will either limit the dividend payout
ratio or require new equity capital.
IFL ranks as the most attractive Health and
Wealth stock under our coverage on a relative
composite value measure (PE, PB, Div Yield and
ROE).
This relative valuation has opened up following
media reports on compliance issues.
As a leading independent diversified wealth management business without exposure to legacy life
insurance products and processes, IFL is well placed to participate in the
growth of the sector.
#4: nib For nib specifically, in the short to medium term we expect nib
will continue to win market share. This was evident in the
net new client additions achieved in 2H15.
Over the long term Health Funds are ideally placed to fund
community expectations of health care in Australia in a private hospital setting and
reduce pressure on the funding of public provision of health
care.
We expect nib can continue to deliver net margins of more than 5% over the medium to
long term.
Health Funds are low capital intensity due to the short tail,
non-catastrophe exposed nature of claims.
The FY16 outlook statement has caused nib to modestly underperform the market since the result release (we would expect nib, as predominantly a
health fund to outperform in current volatile market
conditions).
This modest relative underperformance versus
the market is more pronounced versus MPL
and a discount has opened up on this pair
valuation.
Health Funds are ideally placed to fund community expectations of health care in a private hospital
setting and reduce pressure on the funding of public health care
provision.
The acquisition of Health.com.au by GMHBA indicate that entry by new
start-ups is difficult.
#5: CVW The completion of the investment phase being
undertaken by management should support strong growth
over the medium term.
Profitability is currently impacted by ‘expense overruns’ as the business achieves scale.
As a rapidly expanding Life company CVW has relatively high capital requirements to
support growth.
CVW is the fifth most attractive Health and
Wealth stock under our coverage on a relative
composite value measure (PE, PB, Div Yield and
ROE).
The value raking reflects the growth phase of the
business (CVW ranks #1 on earnings momentum).
We believe that CVW is well positioned in the Wealth
Management sector.
The absence of legacy products and processes support it strategic and
product options.
#6: AMP We expect AMP’s organic growth to be broadly in line with overall market growth driven by FUM growth with a drag from revenue fee margin pressure
resulting from regulatory factors and product mix.
Improved operational efficiency has been a consistent focus
and is necessary to moderate net margin pressure.
Low capital intensity, with the exception of the Life company.
AMP is the third most attractive Health and
Wealth stock under our coverage on a relative
composite value measure (PE, PB, Div Yield and
ROE).
AMP is broadly exposed to the attractive Australian Wealth
Management sector.
Source: Macquarie Research, September 2015
Macquarie Wealth Management Health Funds & Wealth Mgt
15 September 2015 4
Focus issue: Structural position Health, Wealth and General Insurance
As we have noted above we have adopted a non-traditional grouping of Health Funds and Wealth
Managers (Life and Health is more typical) for our ranking purposes. We believe that listed Australian
health and wealth stocks have similarities across growth, margin, regulatory and capital factors. In
addition, ranking Australian Health Funds and Wealth Managers is more valuable than comparing
Health Funds and General Insurance stocks. We expand on these comments below, considering the
structural position on the sectors across various metrics.
The Australian Health Fund sector has some similarities with the Australian superannuation
system worth highlighting. Parallels can be drawn between the structure of:
the direct to individual compulsory defined contribution private superannuation market in
Australia, supported by the taxpayer funded Government pension system; and
the direct to individual Health Fund sector in Australia, operating alongside the available to all
taxpayer funded public hospital system.
In addition, recent policy changes in both systems have seen government policy target its support
for the respective systems away from higher income earners.
Both the Health Fund market and the compulsory superannuation system in Australian are
supported by structural, regulatory and demographic tailwinds.
Fig 3 Summary of Health, Wealth and General Insurance structural position
Health Funds Wealth Managers General Insurance Conclusion
Growth Outlook
Health funds play an integral role in funding individual private hospital health
care in Australia with Government legislation ensuring high (~47%) health
fund membership.
We expect that Government policy will continue to support high levels of health funds membership and this will support growth in total premiums over the long
term.
Growth in Wealth Management FUM is positive for the Wealth Management
sector and government policy will continue to be supportive.
Consistent with the factors driving Health Funds growth and supported by recommendations from the Financial
Services Inquiry we expect that stocks positioned in the retirement income
market (e.g. Challenger) will experience the most supportive FUM growth.
Compulsory Third Party (CTP) and Workers Compensation (WC)
statutory schemes are the only Government mandated insurance
programs.
Not all states or territories have privatised their CTP and WC
statutory schemes, although we expect privatisation to be likely in
the Medium term.
All other major lines of insurance are not government mandated.
We expect that growth will be limited in the relatively mature Australian and New Zealand General Insurance markets.
We expect that government policy will be most supportive of growth in: 1#
Health Funds, 2# Wealth Management and #3 General Insurance.
The support for Health Insurance reflects fiscal impact of increased
health utilisation and ageing that is evident in the chart presented earlier.
Within the Wealth Management sector stocks positioned in the retirement
income market (e.g. Challenger) will experience the most supportive FUM
growth among Wealth Managers.
Margin Expectations
Management Expenses: We expect that increased operational efficiency will deliver 60bps improvement in the Management Expense Ratio for
Medibank.
Claims management efficiency should
support net margins expansion to more than 6.0% for MPL and over 5.0% for nib
and stay at that level over the medium term.
Improved operational efficiency has been a consistent focus for companies across the sector and is necessary to moderate
net margin pressure.
Despite commercial premium rate pressure moderating and extensive cost out programs being undertaken
across the sector we expect that margins will decline over the
medium term.
#1: Health Funds. We believe the outlook for margins is most positive for
Health Funds.
2# Wealth Management businesses and then #3 General Insurance.
Capital Position
Health Funds are low capital intensity due to the short tail, community rated and non-catastrophe exposed nature of
claims.
Low capital intensity, with the exception of the Life company operations.
Capital intensity reflects mix of short tail (catastrophe exposed) and long
tail insurance risks.
Health funds reflecting the risk exposures are lower capital intensity than Life and General Insurance risk.
Government policy
Health is one of the largest components of consolidated federal and state
expenditure and is growing faster than GDP growth.
The growth is largely due to the combined impact of ageing, increased utilisation
across all age groups.
We believe that capping of the growth in the PHI rebate reduces the pressure on
government financials and this may facilitate increased private health care
funding over the medium and long term.
While Australia’s superannuation system is supportive of growth in total FUM,
regulatory change that has the impact of reducing revenue margins and the impact
of ‘lost’ tax receipts as income is channelled into a superannuation
environment may see government policy limit the potential growth and profitability
of the sector.
Privatisation of CTP and WC statutory schemes in the medium
term may boost growth.
Otherwise we don’t expect a material impact from government
policy in the short to medium term.
We expect that government policy will be most supportive for Health Funds
versus Wealth Management and General Insurance.
Claims frequency
High claims frequency. Life: Low claims frequency.
Superannuation: Not applicable
Medium claims frequency. The area where we consider Health Funds and General Insurance
companies are most similar (versus Health and Wealth) is in claims
Source: Macquarie Research, September 2015
Macquarie Wealth Management Health Funds & Wealth Mgt
15 September 2015 5
Australian Wealth and Health: Stock Ranking
The tables below rank Health Funds (Medibank and nib) and Wealth Managers (AMP,
Challenger, Clearview and IOOF) and on the following metrics:
momentum (price);
value (PE, PB, Div Yield and ROE);
earnings change; and
earnings momentum.
Based on these metrics, and incorporating an overly of fundamental factors and consideration of
structural position, we rank the listed Australian Wealth and Health stocks: #1 CGF, #2 MPL, #3 IFL,
#4 nib, #5 CVW, #6 AMP.
As we have noted previously in this report we apply a fundamental and structural overlay to nib
and CVW to increase their rank in the Macquarie Health and Wealth stock ranking.
Overall stock ranking (pre-overly of fundamental factors and consideration of structural
position): The overall stock ranking is a composite of: 1) Momentum (price), 2) Value (P/E, P/B, Div
Yield and ROE), 3) Earnings change and 4) Earnings momentum.
Overall, Challenger ranks first in the Macquarie comparative sheet driven by consistently high
rankings (top 3) across Momentum (price), Value, Earnings change and Earnings momentum.
Overall, Medibank ranks second in the Macquarie comparative sheet driven by the top ranking in
relative price performance and the top ranking in Earnings change. The relative value ranking of
6th is not enough to mark Medibank down.
Fig 4 Summary of rankings for Australian Health and Wealth
Source: FactSet, Macquarie Research, September 2015
Momentum: Composite 3, 6 and 12 month price performance.
Medibank is the best performing listed Health and Wealth stock in Australia based on a 3, 6 and
12 month price performance composite (note that MPL has been listed for less than 12 months),
largely as a result of strong outperformance in the past month (i.e. following the release of the
FY15 result).
Challenger has also performed well on a 3 and 6 month basis, again largely as a result of strong
out performance in the past month (i.e. following the release of the FY15 result).
Fig 5 Momentum metrics for Australian Health and Wealth
Source: FactSet, Macquarie Research, September 2015
Total Shareholders' Equity 7,434 8,090 8,186 8,043 8,194 Recommendation Neutral
$ 5.67
Macquarie Wealth Management Health Funds & Wealth Mgt
15 September 2015 16
Important disclosures:
Recommendation definitions
Macquarie - Australia/New Zealand Outperform – return >3% in excess of benchmark return Neutral – return within 3% of benchmark return Underperform – return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield
Macquarie First South - South Africa Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10%
Macquarie - Canada
Outperform – return >5% in excess of benchmark return Neutral – return within 5% of benchmark return Underperform – return >5% below benchmark return
Macquarie - USA Outperform (Buy) – return >5% in excess of Russell 3000 index return Neutral (Hold) – return within 5% of Russell 3000 index return Underperform (Sell)– return >5% below Russell 3000 index return
Volatility index definition*
This is calculated from the volatility of historical price movements. Very high–highest risk – Stock should be
expected to move up or down 60–100% in a year – investors should be aware this stock is highly speculative. High – stock should be expected to move up or down at least 40–60% in a year – investors should be aware this stock could be speculative. Medium – stock should be expected to move up or down at least 30–40% in a year. Low–medium – stock should be expected to move up or down at least 25–30% in a year. Low – stock should be expected to move up or down at least 15–25% in a year. * Applicable to Asia/Australian/NZ/Canada stocks only
Recommendations – 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations
Financial definitions
All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards).
Recommendation proportions – For quarter ending 30 June 2015
AU/NZ Asia RSA USA CA EUR Outperform 46.23% 58.36% 47.27% 44.20% 60.65% 43.01% (for US coverage by MCUSA, 9.68% of stocks followed are investment banking clients)
Neutral 37.67% 25.65% 29.09% 49.29% 34.19% 40.93% (for US coverage by MCUSA, 5.53% of stocks followed are investment banking clients)
Underperform 16.10% 15.99% 23.64% 6.52% 5.16% 16.06% (for US coverage by MCUSA, 1.38% of stocks followed are investment banking clients)
Company-specific disclosures: Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures.
Analyst certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd (ABN 94 122 169 279, AFSL No. 318062) (“MGL”) and its related entities (the “Macquarie Group”) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. General disclosure: This research has been issued by Macquarie Securities (Australia) Limited (ABN 58 002 832 126, AFSL No. 238947) a Participant of the Australian Securities Exchange (ASX) and Chi-X Australia Pty Limited. This research is distributed in Australia by Macquarie Equities Limited (ABN 41 002 574 923, AFSL No. 237504) ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited (“MENZ”) an NZX Firm. Macquarie Private Wealth’s services in New Zealand are provided by MENZ. Macquarie Bank Limited (ABN 46 008 583 542, AFSL No. 237502) (“MBL”) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. None of MBL, MGL or MENZ is registered as a bank in New Zealand by the Reserve Bank of New Zealand under the Reserve Bank of New Zealand Act 1989. Any MGL subsidiary noted in this research, apart from MBL, is not an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Australia) and that subsidiary’s obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that subsidiary, unless noted otherwise. This research is general advice and does not take account of your objectives, financial situation or needs. Before acting on this general advice, you should consider the appropriateness of the advice having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision. This research has been prepared for the use of the clients of the Macquarie Group and must not be copied, either in whole or in part, or distributed to any other person. If you are not the intended recipient, you must not use or disclose this research in any way. If you received it in error, please tell us immediately by return e-mail and delete the document. We do not guarantee the integrity of any e-mails or attached files and are not responsible for any changes made to them by any other person. Nothing in this research shall be construed as a solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any transaction. This research is based on information obtained from sources believed to be reliable, but the Macquarie Group does not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. The Macquarie Group accepts no liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this research and/or further communication in relation to this research. The Macquarie Group produces a variety of research products, recommendations contained in one type of research product may differ from recommendations contained in other types of research. The Macquarie Group has established and implemented a conflicts policy at group level, which may be revised and updated from time to time, pursuant to regulatory requirements; which sets out how we must seek to identify and manage all material conflicts of interest. The Macquarie Group, its officers and employees may have conflicting roles in the financial products referred to in this research and, as such, may effect transactions which are not consistent with the recommendations (if any) in this research. The Macquarie Group may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case. The Macquarie Group‘s employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research. Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures.
Analyst certification: We hereby certify that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. The Analysts responsible for preparing this report receive compensation from Macquarie that is based upon various factors including Macquarie Group Ltd total revenues, a portion of which are generated by Macquarie Group’s Investment Banking activities. General disclaimers: Macquarie Securities (Australia) Ltd; Macquarie Capital (Europe) Ltd; Macquarie Capital Markets Canada Ltd; Macquarie Capital Markets North America Ltd; Macquarie Capital (USA) Inc; Macquarie Capital Securities Ltd and its Taiwan branch; Macquarie Capital Securities (Singapore) Pte Ltd;
Macquarie Wealth Management Health Funds & Wealth Mgt