Brexit Fears Make Invesco More Attractive

We believe that the market is overestimating the impact of Brexit on

While Invesco reported at the end of last year that a 10% decline in the pound would lower its margins by 50 basis points and shave 5%-6% from annual earnings, it has also hedged its currency risk at exchange rates below $1.43 per GBP 1 through the first quarter of next year. We expect the market losses and outflows associated with Brexit, while meaningful in the near term, to be less onerous than the market seems to be implying. As a result, we see the firm closing out 2016 with $715 billion-$755 billion in managed assets (down from our previous estimate of $765 billion-$825 billion), which would leave full-year average AUM down by midsingle digits and total revenue down 10%, due to product mix shifts and the loss of higher fee-generating assets in the European theater. This contrasts with our previous forecast for a low- to mid-single-digit decline in Invesco’s top line during 2016.

At this point, our estimates for Invesco’s revenue and earnings are basically the lowest on the Street, with our $34 fair value estimate implying a price/earnings multiple of 15.7 times our 2016 earnings estimate and 13.8 times our 2017 earnings estimate. This is basically in line with the group multiple that our current fair value estimates for the U.S.-based asset managers are implying, despite the fact that Invesco has a slightly better organic profile that the rest of the group.

The shares are trading at less than 9 times forward earnings, which puts Invesco in the same boat with Legg Mason LM, Waddell & Reed WDR, and Affiliated Managers Group AMG. Of those three, AMG is the only other one we would even consider investing in right now, as Legg Mason has increased its risk profile this year after taking on an additional $1.5 billion in debt to finance several acquisitions and Waddell & Reed continues to struggle with poor performance, manager turnover, and outflows.

On top of that, perennial underperformers like Franklin Resources BEN and Janus Capital Group JNS are trading at higher multiples of 11.5 times and 12.5 times, respectively, and both of those firms have more operational issues to contend with than Invesco does right now. Simply applying their multiples to our 2017 earnings estimate for the firm would imply a price on Invesco of $28-$31 per share.

Invesco came into June with $791.1 billion in total AUM, spread out across its equity (46% of managed assets), balanced (6%), fixed-income (25%), alternative investment (14%), and money market (9%) offerings. The firm sources the majority of its AUM from the United States (66%) but maintains a meaningful presence outside the borders, with close to one third of its total AUM sourced from Canada (3%), the U.K. (13%), continental Europe (10%), and Asia (9%). The company’s investment management services are provided to both retail (66% of AUM) and institutional (34%) clients under the Invesco, Trimark, Perpetual, PowerShares, and WL Ross banners.

The firm has had one of the better organic growth profiles in the group, using net inflows to increase its AUM at a 2.2% compound annual rate during the past five calendar years, compared with a 0.1% average for the 12 asset managers we cover. Only BlackRock BLK (2.2%), Eaton Vance EV (4.1%), and AMG (5.8%) produced equal or better rates of organic growth during 2011-15. Invesco’s results would have been even better had the firm not been dealing with the sale of Atlantic Trust (in April 2013) and the departure of Neil Woodford from Invesco Perpetual (in April 2014), both of which led to the loss of more than $20 billion in AUM.

We’ve noted time and again that Invesco has impressed us with its ability to overcome any hurdle thrown in its way, and while Brexit poses probably the biggest hurdle the firm has faced since Marty Flanagan took the helm more than a decade ago, we expect the company to get through this as well. While we think organic growth will be depressed in the near term (probably declining 3%-5% this year), we still envision the firm generating 2%-3% annual organic growth longer term, built on the five categories it recently highlighted as areas of future growth: factor investing, fixed-income offerings, alternatives and multi-asset products, real estate investments, and global targeted returns.

From a capital-allocation perspective, management has been fairly frugal, sticking to a strategy of reinvesting in the business (including making select acquisitions) while still maintaining financial strength and flexibility and returning a substantial portion of earnings to shareholders through dividends and common stock repurchases. Although Flanagan continues to talk about acquisitions as a way to plug holes in Invesco’s product mix or geographic reach, we expect any future deals to be limited to small, bolt-on acquisitions like the January acquisition of Jemstep, an advisor-oriented financial technology firm.

Invesco raised its quarterly dividend less than 4% (to $0.28 per share) in April, given the market conditions earlier this year and the prospect of a Brexit event. This puts the annual payout at 51% of our earnings estimate (and 48% of the consensus estimate) for 2016, slightly above our forecast of 40%-50% over the next five years. Invesco has been fairly aggressive with share repurchases the past year or so, picking up 15.5 million shares for $549 million during 2015 and another 4.4 million shares for $125 million during the first quarter of 2016. Given the ongoing market weakness, we expect the firm to remain aggressive with share repurchases in the near term, with full-year share repurchases mirroring those from 2015 on a dollar basis.