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Why the IOOF Holdings Limited share price cratered today

The IOOF Holdings Limited (ASX: IOF) share price dropped 8.5% in trade today after the group reported a weaker-than-expected profit for the six-month period ending December 31 2016. Below is a summary of the result.

  • Underlying net profit after tax of $79.4 million, down 17%
  • Statutory net profit down 45% to $74.2 million
  • Interim dividend of 26 cents per share fully franked, flat on pcp
  • Total funds under management or advice (FUMA) increased to $109.4 billion
  • Cost-to-income ratio of 58.9%
  • Positive net fund inflows of $1.4 billion, up 46% over the pcp

It seems the market is not happy with the steep fall in underlying profit for a business that should have been enjoying strong equity markets and the tailwinds of the growing superannuation sector.

IOOF’s core business is in providing financial advice and platforms through which retail clients can generally plan for retirement by investing. In that sense it competes with the likes of the private advisory business of Perpetual Limited (ASX: PPT) or financial planning giant AMP Limited (ASX: AMP).

The provision of advice and savings administration can be quite low margin work and in a competitive sector reputation counts for a lot, as there can be little to differentiate between large-scale planners.

I wrote back in 2015 about how IOOF had been busted brushing compliance breaches under the carpet and the hangover from this episode may be feeding through into the results for the six-month period ending December 31 2016 as costs rise and revenues slide.

In today’s update the group championed its “ClientFirst” strategy that has evolved in response to the problems, although it still has work ahead to fully recover its reputation judging by the fact that it’s core financial advice and platform businesses posted the steepest falls in earnings.

Other explanations for the big falls in statutory profit are partly related to the group divesting some non-core financial advice businesses over the period.

Outlook

The group does have demographic trends in its favour, but in my opinion the relatively high-cost-to-income ratio (58.9%) and lack of any real competitive advantages prevent it from being investment grade.

When it comes to financial services businesses it’s crucial to look for ones that retain a tight control on costs (the largest cost is staff numbers) as this can give the business the scalability and operating leverage required to consistently drive profits and shareholder returns.

Yesterday, annuities provider Challenger Ltd (ASX: CGF) boasted an impressively low cost-to-income ratio of 32.9% and shares look on a reasonable valuation at $11.60.

However, I would still prefer Magellan Financial Group Ltd (ASX: MFG) as the best mid-cap financial as its founder-led nature means it retains a tight control on recruitment and costs, with heavy insider ownership of the company’s shares.

Consequently it trades on something of a premium valuation at $24.90, but I expect it will post a strong result tomorrow and with leverage to the continued strength of U.S. equity markets it has an attractive outlook.

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Motley Fool contributor Tom Richardson owns shares of Challenger Limited and Magellan Financial Group.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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