Shares in Standard Life Aberdeen (LSE: SLA) look cheap right now. The former insurance group-turned-asset manager’s share price has fallen by around 25% year-to-date, underperforming the broader FTSE 100 index by 24%. After this decline, the stock trades on a forward P/E of 12, and sports a massive dividend yield of 7.2%.
However, if you are thinking of buying shares in Standard because they look cheap, there are several issues you need to consider first.
For starters, the firm is struggling to attract new customers. Over the past five years, the company has tried to move away from its legacy insurance business, towards asset management. As part of this plan, Standard merged with Aberdeen Asset Management last year, hoping the improved size and scale of the group would attract new customers.
Unfortunately, results have been mixed. In the first half of the year, assets under management and administration for pensions and savings fell £2bn to £90.2bn. Meanwhile, Lloyds Bank has decided to pull its £109bn asset management contract from the group. This exodus is not what you want to see from an asset management firm.
Expectations are falling
As the company loses business, City analysts are revising their forecasts for growth lower. Even though EPS are still expected to expand by 16% for 2018 to 26p, back at the beginning of the year, analysts were predicting growth of around 55%. Once again, this trend is hardly comforting.
Still, while growth expectations have been tempered over the past six months, Standard’s profit margins have jumped. After divesting all of its low-margin, capital-intensive insurance businesses, its operating margin leapt to around 23% last year, up from 4.2% in 2016.
Fat profit margins are great news for investors. It means there’s more capital to return to shareholders and reinvest in the business for growth.
The sale of the company’s insurance businesses, as well as increasing the group’s profit margins, has freed up capital on the balance sheet. Standard is now no longer subject to the strict capital requirements usually applicable to life insurance businesses. This means the firm can return more capital to investors. It hasn’t wasted any time doing so. A few months ago management announced plans to return £1.75bn to investors after the sale of its Phoenix insurance business. The capital return includes a £1bn special dividend through a “B share scheme.”
On top of this, analysts are expecting the company to distribute regular dividends totalling 22.5p per share for 2018, equivalent to a yield of 7%.
Such a high yield suggests investors have their doubts about the sustainability of the payout. In my view, however, with profit margins expanding and a relatively clean balance sheet (the company is using £1.25bn of cash from the Phoenix deal to pay down debt), the business should be able to meet City dividend forecasts.
Considering all of the above, the outlook is uncertain. The company is struggling to grow, but it is highly cash-generative, and it looks as if the market-beating dividend yield of 7% is sustainable.
Personally, I’m a buyer, but you should always be aware of the risks before investing.
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Rupert Hargreaves owns shares in Standard Life Aberdeen. The Motley Fool UK has recommended Lloyds Banking Group and Standard Life Aberdeen. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.