Indiana University Kelley School of Business

Stock Report for THE KNALL-COHEN INVESTMENT FUND

Ameriprise Financial, Inc. (AMP-NYSE)

Price Target: $63 Sector: Financials
Estimates Revenue (in mill.) EPS Div/Share Valuations P/TBV P/Norm. EPS 52-week Range Div. Yield

Aashish Chaturvedi 812-369-9583 | aachatur@indiana.edu

BUY Industry: Diversified Financials

2010 $10,046 4.47 0.72 2010 1.18x 13.56 $64.21- $36.00 1.25% 2011 $10,239 5.00 0.87 2011 1.27x 10.35 2012 E $10,979 5.80 1.03 2012 E 1.67x 10.83 $12.8 Billion 1.96 -8.78% 2013 E $11866 6.67 1.2 February 20, 2012

Market Cap Beta 1-yr return

Investment Thesis:
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.

Risks:
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.

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Investment Summary:
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.

Background:
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 asset management 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.
Segment Advice & Wealth Management Asset Management Annuities Protection Total* USD in mm %

3,761.00 2,900.00 2,630.00

33.10% 25.50%

23.10% 2|Page 2,070.00 18.20% 11,361.00 100.00%

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Market scenario:
Recent economic data coming out of United States suggests a stronger recovery than anticipated earlier last year. Unemployment is down to 8.3% of the workforce which is at the lowest point this year1. The industrial production index is back to pre-recession levels and this boost in industrial activity has been consistent throughout the year growing at a uniform 3.6% on an YTY% basis. With the overall macro situation improving at home, corporations in America will be willing to spend more than they have in the past few years and investor confidence will return. For companies closely related to equity sensitive products this will result in higher volumes and provide the required impetus for growth and higher returns. Although there are enough signs of recovery in the US economy, the Federal Reserve is expected to continue with its low interest rate regime, which may have a negative impact on financial companies that have earnings based on fees and sensitive margins. Low interest rates might also impact companys ability to earn profits on investment income which will impact the overall profitability of financial firms. However, there are also positives of a continued lower interest rate structure. If we apply the Gordon Growth Model we see that the lower interest rates will mean higher long-term growth for the economy and companies, resulting in better stock performance. Also it will signal more demand for equities as investors will look for substitutes to the low yielding bonds. This will be priced into the stock performance which will push the prices of the stock higher. Finally, a sudden reaction to Europes continuing debt crisis will have a profound impact on capital markets across the world. A default-like situation in any Eurozone constituent may result in a contagion of financial doom in the developed world. The exposure that financial firms in the US have of Eurozone securities may impact the liquidity of the market as well as increase credit risk. Overall such a scenario would be disastrous for the financial markets across the world, including in America.

Recent Performance:
Ameriprise Financial has increased its Assets Under Management (AUM) significantly over the last two years. From $458 B in 2009 it increased the assets by 43% to $653 B. In 2011 this figure increased by another 5% to $680 B. This has primarily been a result of the firms recent activity in the Asset Management segment where it acquired Columbia Management from Bank of America and Threadneedle in Europe. These two funds have greatly increased AMPs exposure to international markets and have greatly diversified AMPs Asset Management operations. Threadneedles acquisition added $14B to the total AUM figure for AMP and this translated into a 4% increase in earnings in 2011. But these acquisitions have come at a cost for the company as AMP saw its total debt burgeon in 2010 by almost 266% to $8.2 B. This in turn increased the debt-to-equity ratio of AMP from 24.2% in 2009 to 76.2% in 2010. This leads to fears of unsustainable expansion on the
1

Unemployment Rate, US Bureau of Labor Statistics. Source: Thomson Reuters DataStream

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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 decreasing fees 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.

AMP:
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.

3-YR

2-YR

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Here, we look at the return over 1-year for stocks in its peer group, and we notice that AMP has outperformed most competitors and beat the average return for the overall industry in 2011. This shows the relative strength of the stock as compared to its peer-group. Also, this return is on the back of a solid financial performance in the prior financial year which displays the resilience and inherent strength of the stock.

Return 1-yr '11

0% -10% -20% -30% -40% -50% -60% (11.75%) (24.45%) (28.17%) (2.19%) (12.16%) (21.16%) (29.34%) (41.04%) (50.15%) (19.18%)

(37.15%)

AMP has seen its equity driven funds outperform its peers over the last one year. Ameriprise Financial has steadily increased its exposure to equity securities over the last couple years and almost 80% of its earnings now are derived from equity-market sensitive instruments. These include its capital market funds (Columbia) as well as asset management operations worldwide in Threadneedle and Liverpool asset fund. Together these funds had a substantial outflow this year but their acquisition meant a 5% increase in Assets Under Management for AMP which in turn translated to a 3.6% increase in earnings for the particular year.

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Risks:
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 and uncertainty. 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 the financial sector on this side of the pond. A European default will likely impact credit and equity markets, 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 to compress 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 this business, 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 upgrades for 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. Last year 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.
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Valuation:
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 figure was taken from Bloomberg research.

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For finding the WACC I have made some key assumptions as I mentioned earlier. A 5-yr Beta was 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 in the current market scenario. With the low interest rates doing its job in accelerating the economy, 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 is conservative 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 primarily used 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 remaining forecasted 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, I used 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 changes made to include the changes that had occurred since the time the analysts made their recommendations. A few companies with abnormal results for particular quarters were disregarded to keep the model 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 for AMP and a more appropriate figure to manage the sensitivity of the earnings from Year-ToYear.

EPS estimates

Price Target estimates

By using a consensus earnings estimate of $5.00 for year 0 and a trailing P/E multiple of 12.56 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 the peer 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 also decided 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.
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In order to find the PEG ratio we find the relative Price to Earnings ratio and then divide it by growth 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 analyst estimates for a long term growth rate for AMP. This ratio of less than 1 concedes that company's stock is undervalued, which means it's trading 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.

Competition:
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 stretches beyond 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 will require some inspired cost cutting and streamlining of operations as well as an aggressive expansion of operations through acquisitions of other firms.

Regulation:
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.
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Appendix:

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