Ameriprise Financial Stock Pitch

8/2/2019 Ameriprise Financial Stock Pitch

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Indiana University Kelley School of BusinessStock Report for THE KNALL-COHEN INVESTMENT FUND

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Recent positive data emanating from the United States and signs of a broader recovery in the global economy have

made financial services firms very attractive from an investors point of view. Ameriprise Financial has seen its

revenues increase steadily over the last couple of years owing to strong profits in its high margin business segments

like Advice & Wealth Management and Asset Management. AMP has expanded aggressively in the high margin

Asset Management business by taking on new acquisitions and expanding its own footprint. Furthermore, the

company is taking strong support from its more defensive segments like the Annuity and Protection segment, which

focuses on life and health insurance products. Also, the companys balance sheet looks strong with a cash position of

more than $2 Billion. This presents AMP with an opportunity to invest in long-term strategic acquisitions, share

buyback programs and a possible increase in dividend payouts. As equity markets continue to outperform other

markets, there will be an expected increase in demand for asset and wealth management services, and a sustained

push by AMP in this direction is sure to benefit the company in the long run.

Ameriprise faces market risks associated with equity and credit markets worldwide. Any unfavorable impact due to

worsening European credit crisis may lead to outflows, reducing revenues from its wealth and asset management

segments. Also, the industry is very competitive and a less than favorable asset management performance may have

a more than proportional negative impact on the firm. Short term risks associated with increasing costs of IT and ad

spending are present, which may further put pressure on the expected asset management margin of 21%. All in all a

cautious but optimistic outlook is present for Ameriprise in FY12.

Estimates 2010 2011 2012 E 2013 E

Revenue (in mill.) $10,046 $10,239 $10,979 $11866

EPS 4.47 5.00 5.80 6.67

Div/Share 0.72 0.87 1.03 1.2

Valuations 2010 2011 2012 E

P/TBV 1.18x 1.27x 1.67xP/Norm. EPS 13.56 10.35 10.83

52-week Range $64.21- $36.00 Market Cap $12.8 BillionDiv. Yield 1.25% Beta 1.96

1-yr return -8.78%

Ameriprise Financial, Inc. (AMP-NYSE)Price Target: $63 BUY

Sector: Financials Industry: Diversified Financials

Aashish Chatu812-369-9583 | aachatur@india

February 20

Risks:

Investment Thesis:


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I am initiating coverage of Ameriprise Financial, Inc. (AMP) with a BUY rating and a price target of

$62.90/share, representing a premium to its current price of $54/share. The price target was calculated by

using a discounted cash flow analysis model, using a WACC of 8.96%. I also substantiated my target by

using a multiples based valuation model and reached the same price target of $63/share. I believe the

market is ignoring AMPs move towards higher margin segments like Asset Management from Insurance

(Protection) segment as well as its lateral expansion into the more profitable financial advisory segment.

On a macro level, a lower interest rate regime will continue to stimulate the economy which in turn will

boost the returns on equity products as compared to bonds. Finally, AMP can outperform expectations, if

the company uses its strong cash position wisely and invests in new acquisitions, expanding its current

business segments, share buyback programs and/or higher dividend payouts.

Ameriprise Financial is headquartered in Minneapolis, Minnesota and has a large network of

representatives and subsidiary financial firms that cater to the companys different business segments.

Ameriprise Financial operates in five segments: Advice & Wealth Management, Asset Management,

Annuities, Protection and Corporate & Other. Advice & Wealth Management segment provides financial

planning and advice. Asset Management segment provides investment advice and investment products to

retail and institutional clients. Annuities segment provides RiverSource variable and fixed annuity

products. Protection segment provides a range of defensive products like life and health insurance. The

financial product solutions the Company offers through its affiliated advisors include both its own products

and services and the products of other companies. On April 30, 2010, it acquired the long-term assetmanagement business of the Columbia Management Group from Bank of America (the Columbia

Management Acquisition).The Advice & Wealth Management segment is the biggest source of revenue for AMP (accounted for

33.1% of total revenue in 2011), followed by Asset Management (25.5% of revenue). Annuity and

Protection segments formed the other two profit making segments with a share in revenue of 23.1% and

18.2% respectively. Ameriprise saw its Assets Under Management (AUM) increase by 5% in 2011 to $631

Billion. 38.5% of the AUM classified as 4 or 5 star assets, while the Industry average was $250 Billion in

AUM with 41% being 4 or 5 star assets.

Background:

Investment Summary:

SegmentUSD in

mm%

Advice &Wealth

Management 3,761.00 33.10%

Asset

Management 2,900.00 25.50%

Annuities 2,630.00 23.10%

Protection 2,070.00 18.20%

Total* 11,361.00 100.00%


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part of the company and there is a need to be cautious in taking on more debt. In early 2011 we saw

the company further increase its debt load and its current debt to equity ratio stands at 82.14% up 6%

just in the first 9 months of 2011.

Overall, 2010 was an extremely profitable year for AMP as it recorded an increase of 76.23% in

operating profits from 2009 to 2010. The operating profit stood at $1.5B while the net profit was at

$1.09B and it saw an increase of 51.94%. In contrast 2011 has been lackluster but on a standalone

basis 2011 with its 22.5% increase in dividend per share shows that the results continue to be

impressive even on the back of a bonanza year. Higher dividend payout suggests stronger future

earnings and more profitability for the shareholder.

Ratios:

Although the margins for the company have stabilized around the 54% mark for gross margin (2010

57%), one of the major reasons for this is the continued low interest rate situation in the US, also

increased volatility has meant fewer investors have continued to be invested in the markets decreasingfees for A&W and Asset Management segments.

On the other hand the largely improved cash position of Ameriprise can be seen on the current ratio

that stood at 6.8x in 2011 compared to a lowly 1.6x in 2010. The improved short term liquidity

position will allow the company to explore expansion options into other segments or strengthen its

presence in the current ones. Since 2010 was a bonanza year, we will look at 2011s profitability

numbers compounded over two years. Total revenue grew 13.9% (CAGR-2yr), Net income grew by

22.1% (CAGR-2yr) and the Tangible Book Value saw an increase of 14.9% over the same period.

Ameriprise has been consistently beating the broader market over the last few years. Since February

2009 AMP has produced a return of 229% on its stock while S&P 500 has had a 76% return over the

same 3-yr period. Since 2010, AMP has seen an increase of 41% as compared to S&P 500s 23.25%.

Although the returns for last year have been less than impressive, it presents an opportunity for

investors to enter a stock that is currently underperforming compared to the S&P 500 but has had a

better historic performance overall.

AMP:

3-YR 2-YR 1-YR


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There are a number of risks that may affect AMPs performance and could affect the future share

price of the company:

Changing business for Ameriprise may expose the company to new risks of volatility anduncertainty. The company, through recent acquisitions deals, has displayed a consistent interest in the

Asset Management segment of its diversified financials business. This signals a move away from the

defensive annuity and protection (insurance) business which means a more fee-based approach to

earnings. As fees are based on factors that are beyond AMPs control; broader market performance,

macro effects of interest rates and external implications like competition, may lead to increased

earnings volatility for AMP.

The continuing deterioration of the European debt situation will likely have a major impact on thefinancial sector on this side of the pond. A European default will likely impact credit and equitymarkets, both will have a major impact on AMPs business. The companys financial performance

now has relatively large exposure to equity markets. The exposure is generated mainly from its

variable annuity business which forms almost a fifth of the companys revenues. In this segment sales

are usually stronger in times of superior performance in equity markets than in times of weak

performance. AMPs shift to asset management will also increase its exposure to equity markets,

making its earnings forecast highly volatile.

Increased competition in AMPs core business of Investment Management will continue tocompress margins and put pressure on costs of operation. Historically, the industry has had low

barriers to entry and with the presence of almost 700 domestic and international firms operating in thisbusiness, there is very little chance of margin expansion. The competition in the fund managers

market will only lead to further competition, which is why AMP has to aggressively pursue

acquisition deals in the asset management business to get consolidation benefits.

As AMP looks to expand its A&W segment, we see increased IT expenses for platform upgradesfor wealth advisors. Also a new advertising campaign has already made an impact on Q411 results

and this could continue into 2012 if cost cutting measures arent adopted. Also, advisor recruitment

may have a negative effect as AMP looks to hire more experienced advisors instead of new recruits,

which may have downward pressure on expenses.

The financial industry is set to face extensive regulation under new federal and state laws. Lastyear the US Govt. enacted a financial services reform act called the Dodd-Frank Act. As a holding

company of Ameriprise Bank, Ameriprise Financial will be subject to oversight by the Governors of

the Federal Reserve Board. Also under the new regulation, its brokerage subsidiaries will belong to

the Securities Investment Protection Corporation. This will add to the expenses as AMP will have to

maintain a certain level of funds to escape paying excessive penalties. Overall the new regulatory

environment will make compliance more complex and raise compliance costs for the firm.

Risks:


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I have used two models, a Discounted Cash Flow model and a Multiples-based Comparable

valuation model to reach a price target of $63/share for AMP. Thus, the stock will produce a return of

17% on its current price level.To prepare the DCF model I calculated a WACC of 8.96% and the following assumptions were made

to reach this figure:

Risk-free rate = 1.96% Cost of debt = 2.74% Weight of debt = 20.82% Cost of Equity = 10.60% Weight of equity = 79.18% Risk premium = 5.50% Terminal Growth Rate = 3%

Full model is enclosed at the end of the report.

A few notes on this model:

A yearly return was used to forecast the future revenues into 2012, 2013 and 2014. This figurewas taken from Bloomberg research.

Valuation:


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For finding the WACC I have made some key assumptions as I mentioned earlier. A 5-yr Betawas adopted for AMP, to give a more long-term color to the WACC figure. Risk free rates

were used from the 10-yr yields trading at 1.96% currently.

I used a 3% terminal growth figure, which is an extremely conservative estimate to make inthe current market scenario. With the low interest rates doing its job in accelerating theeconomy, there is a greater chance of inflationary tendencies to kick into a fast growing

economy. If you include past inflation figures and a moderate growth rate 6% would be a

reasonable number. Also, with the short forecast period (2012-2014), a higher growth rate

would be more reasonable. The biggest reason though for this slower growth rate continues to

be the threat of a Eurozone collapse in the near term. Such an eventuality will have

catastrophic effects as mentioned earlier and will definitely hamper growth for financial firms

including AMP.

Revenue growth YoY is less than 10% a year between 2011 and 2014. Again, this isconservative figure as past revenue growth far outpaces the single digit growth I have adopted

in this model.

Although I have presented a drilled-down version of COGS in my model, I have primarilyused an operating expense margin factor to predict costs going forward. I believe this is more

reliable because of its conservative nature. Over time the company will become more efficient

and improve its operating margin, but in this model the margin remains the same at 83% of

the revenues.

Also, I took an average of CAPEX between 2007 and 2011, and applied it to the remainingforecasted years of 2012-2014. Being a financial services firm, AMP requires low levels of

physical assets, thus an average CAPEX of last four years seems like a reasonable figure.

With a DCF I reached a price target of$63.21/share.

In order to prepare a comprehensive analysis of the stock I also used the multiples valuation model to

reach a similar price target. For this purpose I used a trailing and forward looking Price-To-Earnings

model and applied the PEG ratio to see if the current price of the security was over or under-valued.

AMP trades at a P/E multiple of close to 13x earnings, this model uses its peer group ratio to reach a

more conservative multiple of 12.56x earnings. The following numbers were used to compute the

multiples and reach the share price target:

Comparable P/E Trailing: 12.56x Comparable P/E F1: 8.72x Firm EPS1: $5 Firm EPS2: $6.60 Firm EPS growth rate: 12.4% Firm EPS growth rate Range: 18%-9%

A few notes on the model:


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For the purposes of comparing the multiples and reaching a more comprehensive figure, Iused a peer group of 10 comparable companies that had a diverse sales figure, market cap,

enterprise value but similar operations in the diversified financial services sector.

Earnings forecasts were calculated using analyst consensus estimates with a few changesmade to include the changes that had occurred since the time the analysts made theirrecommendations.

A few companies with abnormal results for particular quarters were disregarded to keep themodel symmetric and in line with average figures. After compiling a peer group to compare

the multiples with we reached a mean P/E Trailing multiple of 12.56x earnings. This was

applied to different EPS estimates changing according to earnings growth rate.

An EPS growth rate of 12.4% was used, this is also the long term growth rate of earnings forAMP and a more appropriate figure to manage the sensitivity of the earnings from Year-To-

Year.

By using a consensus earnings estimate of $5.00 for year 0 and a trailing P/E multiple of12.56 we reached a price target of$62.89.

If the earnings were altered for the long term growth rate we saw a price target range of $70-$58. I also looked at the price target from different time period perspectives. I first used a

forward looking multiple comparable of 9.75x earnings and then multiplied it by an estimated

2013EPS of $6.67; leading to a price target of$65.00.

In order to make a more conservative judgment, we used a multiple of 8.72x earnings of thepeer group companies and reached a price target of $59. An average of the conservative

forward looking price target and optimistic forward looking price target resulted in a final

price target of$62.50. All the tweaking pointed to a price target range of $59-$65, leading us

to an average share price for AMP of$63.

In order to substantiate the value judgment based on sheer comparable multiples, I alsodecided to use the PEG ratio analysis. A PEG ratio can be used to ascertain the value of the

company and whether it is over or underpriced. A PEG ratio of more than 1 usually means a

overvalued security where as a PEG ratio of less than 1 indicates a buying opportunity for the

investor.

EPS estimates Price Target estimates


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In order to find the PEG ratio we find the relative Price to Earnings ratio and then divide it bygrowth in earnings. For my analysis I used the YoY earnings growth rate of 18% and applied

the 12.56x earnings multiple to derive a PEG ratio of 0.70. This was comparable to the

consensus estimate of 0.78. With a more conservative 12.4% growth rate we reached a 1.0

PEG Ratio which is equally valued. It is worth noting though that 12.4% is well below analystestimates for a long term growth rate for AMP.

This ratio of less than 1 concedes that company's stock is undervalued, which means it'strading in line with the growth rate and the stock price will increase. It is a good metric to

complement the multiples valuation as it substantiates the underpriced nature of AMP.

The financial services industry is a fragmented and diversified industry with a wide array of firms

competing with each other in various businesses at the same time. AMP is a brand name that stretchesbeyond the investment management industry. With functions in wealth management, annuity and

protection (insurance) markets, AMP is truly a diversified firm with more than one niche. This

exposes the company to a large number of competitors both domestically and internationally. Nearly

700 financial firms from around the world compete in just the US to provide financial services. The

reason behind such a high firm presence is the low barriers to entry and the incentive of making

profits within a short period of time. Increased competition over the last few years has only made the

situation worse by depressing margins and putting further pressure on operating profits.

With the demand for financial securities only increasing, it will be interesting to see how firms react

to the entry of other firms and how they maintain healthy margins in the near future. For AMP, it willrequire some inspired cost cutting and streamlining of operations as well as an aggressive expansion

of operations through acquisitions of other firms.

The Dodd-Frank (D-F) Act of 2010 was enacted to reform and mandate financial services firms in the

aftermath of the 2008 Financial Crisis. Under D-F, AMPs brokerage business will come under the

Consumer Financial Protection Bureau, a commission formed to safeguard the interests of the

customer but for AMP, just another hole leaking its unstable margins. This will increase costs of

compliance for AMP and may affect its margins negatively.

Also, as AMP moves further towards an Asset Management role, the new regulation will not apply

substantially to AMPs operations. Finally, I believe a strong capital position will steer AMP away

from any unexpected financial swings and the company will be able to meet its new capital

requirements for compliance seamlessly.

Competition:

Regulation:


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Appendix:


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Documents

Ameriprise Financial Stock Pitch