Ameriprise Financial (AMP)

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July 23, 2018

We’ve recently added to our position in Ameriprise Financial. We think the current 9.6x forward PE ratio is a very attractive valuation given Ameriprise’s growing financial advisor business.

We purchased our initial position in Ameriprise in 2016. In 2016, Ameriprise was trading at a low forward PE multiple of 9.5x due to the risk of the proposed DOL Fiduciary Rule. Ameriprise rallied strongly right after the 2016 Presidential Election on the expectation that the new Republican Administration would reduce the burden of the DOL. This market expectation came to pass, and Ameriprise was a strong performer in 2017, rising 56.6%. However, since the start of 2018, Ameriprise has underperformed both the broader market and the Financials sector due to concerns about its LongTerm Care insurance business, which is in run-off. Ameriprise’s valuation has returned to the same multiple as our original purchase, so we’ve added to the position.

Ameriprise Financial is a financial planning firm with several businesses that support the core financial planning business. The other businesses are investment management, life insurance, and property & casualty insurance. Ameriprise became an independent company in September 2005 when it spun-off from American Express. Since coming public, Ameriprise’s stock has outperformed the S&P 500 and the S&P 1500 Financials Index with an annualized compounded return of 13.1% annually versus 8.9% and 3.8% for the respective benchmarks. Ameriprise’s predecessor firm, IDS, was acquired by American Express in 1984.

Here is our investment thesis:

1. We like the economic models of Ameriprise’s financial advisory and investment management businesses – There are many reasons to like the financial advisory and investment management businesses. The business models are very attractive compared to most other financial services companies. Revenues are recurring. The revenues grow with the market due to the assets under management pricing model. Most costs are fixed which leads to operating leverage. The business does not require significant capital and no marginal capital, so all income generated by the business is free to be paid to shareholders or used for accretive acquisitions.
2. We view financial advisors as attractively positioned due to direct client relationships. With the shift from actively managed mutual funds to passive mutual funds and exchange-traded funds (“ETFs”), we believe the financial advisory business is better positioned because they control the client relationships. This compares favorably to investment managers who very often obtain clients through intermediaries. Because financial advisors have direct relationships with their clients, they have less customer churn and more stable pricing than investment advisors. Financial advisors have shifted their compensation from commissions paid by mutual fund companies to charging their clients directly a fee for placing them into the lowest cost version of the same mutual funds or shifting to even lower cost ETFs.
3. Ameriprise is cheap compared to peer Financial Advisors – Ameriprise trades for a 9.6x Price/Earnings multiple (“P/E”) while peers Raymond James trades at 14.0x and LPL Financial trades at 14.2x. We think Ameriprise should trade at a 1x or 2x multiple discount to these two peers because Ameriprise’s insurance subsidiary is a lower multiple business, but we believe the current discount is too wide.
4. Ameriprise is cheap compare to Investment Managers despite being better positioned – Ameriprise trades substantially cheaper than Blackrock (18.2x P/E), T Rowe Price (16.7x P/E), and Eaton Vance (16.7x P/E). Based on this view, we’d argue that both Raymond James and LPL Financial are better values than Blackrock, T Rowe Price and Eaton Vance.
5. Ameriprise has potential earnings upside by launching a bank for its brokerage customers – Ameriprise is planning to launch a bank for its customers. This bank would gather deposits by sweeping the residual cash from its customers’ brokerage accounts. This is a similar strategy used by most of its major competitors such as Raymond James, Morgan Stanley and Stifel Financial. The bank could provide a stable and growing source of earnings.
6. Ameriprise has potential to shut down its low multiple property casualty insurance division – Ameriprise’s insurance divisions drag down its valuation multiple. We believe there is a possibility that Ameriprise could shut down its property & casualty division. Ameriprise’s insurance division has had an uneven record of producing profits. Ameriprise has had an affinity relationship with Costco Wholesale where Costco refers its customers to Ameriprise.
7. Ameriprise has a long history of shareholder-friendly capital management – Ameriprise’s management team has demonstrated a commitment to using free cash flow to repurchase shares. Since the stock consistently trades at a discount to intrinsic value, we believe the share repurchases have created value for shareholders. At the end of 2009, Ameriprise had 255 million shares outstanding. By the end of 2017, the number of shares outstanding had declined to 147 million. The represents a 7% annualized decline in shares outstanding.

Risks

While we believe the investment case for Ameriprise is compelling, there are significant risks to the business. Many of these risks are the reasons for its compelling valuation:

1. Leveraged to stock market – Ameriprise earnings are leveraged to the stock market because its revenues are dependent on stock market values and client flow is positively correlated with a rising market. Over the long-term, Ameriprise benefits from a rising market, but in bear markets, Ameriprise will probably underperform. Over the last 2 years, Ameriprise’s stock has had a beta of 1.75×4 . This is higher than almost all of its peers.
2. Competition for financial advisors is intense – The competition for financial advisors is intense. The intensity has declined marginally over the last 20 years, but it still remains fierce. The individual advisors control the client relationships, so the firm must cater to the advisors. There are limited number of firms for advisor to move to and there is real risk to advisors when they change firms that not all their clients will follow them.
3. Long-Term Care insurance closed block – Long-Term Care Insurance is a very problematic type of insurance due to the very-long tail nature of the business. Insurance companies essentially sell this insurance to 60-year old’s for when they may go into a nursing home at 85. The insurance companies have badly underestimated the number of people who will eventually use the insurance, have over-estimated the number of people who will let their insurance policies lapse before they ever make a claim, and under-estimated the cost of care. These problems have been well-known for years, and many companies have exited the business, but the policies stick around for decades. Ameriprise stopped writing these policies at least 13 years ago and reinsured half of their exposure to another company, Genworth Insurance. Genworth has run into problems of its own, so some market participants have become concerned that Ameriprise will not get full protection from Genworth. We think the market’s over-reaction to this risk has created some of the current opportunity we see in Ameriprise’s shares.
4. Investment Management business faces headwinds – The investment management business is facing significant headwinds from 3 main sources: 1) investors are shifting to lower fee passive portfolios, 2) intermediary firms are exerting their power as gate-keepers to make it difficult for investment management firms to get access to customers, and 3) exchange-traded funds have significant tax-advantages over mutual funds. The stock market has begun to take these headwinds into account as the median investment manager stock is down 14.7% year-to-date.5

Disclaimer: The discussion of any security is meant solely as an illustration of our investment and thought process and should NOT be considered as a recommendation or suggestion to buy or sell any securities. Before you make any investment, do your own research and talk to your own financial adviser. Information in this report is received from external sources. Therefore, we can make no guarantee as to the completeness or accuracy of the information provided.