LPL Financial Earnings: Decreasing Fair Value to $273, but Shares Still Undervalued

LPL Financial LPLA reported fairly good revenue and profit growth, but similar to other wealth-management firms, client cash-related revenue that had been a bright spot the previous several quarters is showing signs of slowing down. The company reported net income to common shareholders of $339 million, or $4.24 per diluted share, on $1.02 billion of gross profit. Gross profit increased 52% from the previous year, mainly from client cash-related revenue increasing to $439 million from $85 million the previous year. However, client cash-related revenue was flat sequentially, as higher revenue yields on client cash was offset by about a $10 billion decline in client cash sweep balances. The decline in cash sweep balances is due to clients sorting their cash into higher interest-yielding products and using their cash to invest and isn’t a sign of clients pulling their assets from the company. In fact, LPL Financial had over $20 billion of net new client assets in the quarter.

We are decreasing our fair value estimate for narrow-moat LPL Financial to $273 from $294 per share. Our fair value estimate correlates to a price/forward earnings multiple of 13 times and an enterprise value/EBITDA multiple of 9 times. Of the net $21 decrease in our fair value estimate, it was mainly from assuming a lower net revenue yield on the company’s client cash balances that was partially offset by lowering our cost of capital assumption for the company, as its debt rating was upgraded. We forecast a 10-year compound annual growth rate of around 8% for both revenue and gross profit. We expect operating margins to be in the high teens to potentially a little over 20% over the next couple of years, as the company benefits from high short-term interest rates, and to normalize at about 19%.