There aren't too many companies out there quite like AFP Provida (NYSE:PVD). Provida is part of the Chilean pension system; a system that requires Chilean workers to contribute to privately-run pension plans that manage the money on their behalf for retirement. With a growing population and a lucrative fee-collecting business, Provida is an interesting way for American investors to collect significant dividends from a company heavily levered to economic growth in one of the more stable Latin American economies.
A Weird Mix Of Private And Public
There is nothing especially normal or straightforward about the system in which Provida operates. A long time ago now, the Chilean government decided to scrap its public retirement system in favor of a system that would let private pension companies invest and manage money on behalf of workers.
While there are no limits to the fees that these pension companies can charge for their services, there are requirements regarding minimal performance. These companies are also required to provide life and disability coverage to their clients, which they generally fulfill by buying policies on their behalf.
Not surprising, the Chilean government imposes various rules on these pension companies. Each must hold at least 1% of funds in special mandatory reserves and use those returns to make up the difference if returns fall below a statutory minimum (generally determined on the basis of average returns across the system on a trailing basis). There are also limits imposed regarding what the funds can hold, and in what amounts. Nevertheless, the industry as a whole operates knowing that every employed Chilean must contribute about 10% of their pay every month.
Where Provida Stacks Up
Provida is the largest of the Chilean pension managers, both in terms of participants (where it holds about 40% share) and assets under management (29% share). Oddly enough, fund returns for Provida haven't been all that great. Provida offers five different funds (similar to how American 401(k) plans offer various fund options), but trailing results put its funds near the bottom of the six-firm industry.
Nevertheless, Provida maintains its share and is able to charge fees in the upper half of the industry. On an annual basis, Provida collects about 1.5% of contributors' funds to the mandatory program, while also charging additional fees for contributions to voluntary accounts (Chilean workers can contribute over the statutory minimums and still enjoy certain tax benefits).
Some of Provida's success may be due to the fact that it is backed by (and majority owned by) BBVA (NYSE:BBVA) - the sixth-largest bank in Chile. Not surprisingly, competition is fairly fierce and based upon cost, returns, and fund options. Provida targets more of the "everyman" market and has generally offered a trade-off of lower returns and lower return volatility.
As for the competition, AFP Habitat is the #2 player. Habitat holds about one-quarter of the market and until recently was half-owned by Citigroup (NYSE:C) which subsequently sold its stake to its Chilean partner Invesco (not the Bermuda-based Invesco that trades as IVZ). AFP Capital (owned by ING (NYSE:ING) is #3 with 22% share, while AFP Cuprum flips the Provida model with only 7% share of participants, but 20% share of funds under management.
What Has To Go Right, What Can Go Wrong
In some respects, the business model at Provida is not much different than for T. Rowe Price (NASDAQ:TROW), Fidelity, or Schwab (NYSE:SCHW). Provida needs to deliver solid results relative to client expectations to keep that lucrative stream of fees flowing into the company. At the same time, the company needs to make sure not to run afoul of regulatory minimum returns, nor to lose money investing on its own account.
The Chilean government really doesn't seem to want additional competition in the pension market, so new entrants are not a major risk, apart from the prospect of companies like HSBC (HBC), Santander (STD) and so on buying one of the participants and aggressively seeking to gain share.
At the same time, the state of the Chilean economy and job market is a very significant factor. Fee income is tied to the number of Chileans with jobs and the amount they make.
Chile's economy has been on a good run of late, helped by commodity demand, but it is still an economy that relies heavily on copper and foodstuffs for export earnings. There is also some concern that the domestic investment surge that the AFP system has created a situation where there has been too much capital chasing relatively few worthy ideas within the Chilean economy. Were this to prove to be a bubble, the impact to Provida would be serious indeed.
The Bottom Line
Recent financial results here have been solid. Fee income rose almost 8% for the year, with recurring income up about 12%. Provida did see a significant hit to reported profits earlier in the year from losses in the mandatory reserve fund - losses largely tied to an accounting scandal ("La Polar") that hit the entire Chilean market and the entire AFP sector.
Valuation also looks reasonable on a price/book and P/E basis when compared to U.S. asset management and financial service providers like T. Rowe Price and Schwab, though the price/book comparisons are not as favorable relative to other names like BlackRock (NYSE:BLK) or Legg Mason (NYSE:LM).
There's really no handbook on valuing companies like Provida, but I would argue that an excess returns model is a cogent approach. If Provida can produce 25% return on equity (versus almost 26% in 2011 and 30%-plus in recent years), the stock is worth about $90. If returns drop back to the long-term average (around 20%), the fair value drops to about $71. In the meantime, investors can reap a dividend yield of nearly 8% that is well-covered by present earnings (and this is not a company with significant capex needs).
At the bottom line, Provida is a leveraged play on global financial market performance and the health of the Chilean economy. If those stay relatively strong, Provida should continue to throw off ample dividends and could offer some capital gains as well. If markets stall or fall, or Chile's growth story fades, results, returns, and (eventually) payouts at Provida will suffer.