Finding the Best of the Undervalued Asset Managers
Invesco still offers the best relative value, but BlackRock is starting to look attractive too.
The best time to build positions in the publicly traded asset managers tends to be during market downturns or periods of market dislocation. It pays to be selective, though, as most of these companies are highly leveraged to the performance of the equity markets. With that in mind, we continue to recommend that long-term investors focus on two companies: Wide-moat BlackRock (BLK) is not only one of the few U.S.-based asset managers generating organic growth right now (driven by its market-leading position in the exchange-traded fund market with iShares) but also broadly diversified and garners most of its assets under management from institutional investors. Wide-moat T. Rowe Price (TROW) has the best and most consistent active investment performance in our coverage and derives two thirds of its AUM from retirement-based products.
While these two rarely get cheap and are currently trading at 49% and 18% premiums, respectively, to the rest of the group on a price/earnings basis (based on consensus estimates for 2018), BlackRock is looking slightly attractive right now on a price/fair value estimate basis, trading at 87% of our $600 fair value estimate. T. Rowe Price’s shares have held their own so far this year, trading at 91% of our $115 fair value estimate, despite having around a third of total AUM invested in equities.
Of the second-tier names in our coverage that have shown an ability to offer up good value during market downturns--wide-moat Eaton Vance , narrow-moat Invesco (IVZ) and Cohen & Steers (CNS), and no-moat Affiliated Managers Group (AMG)--Invesco continues to provide the best relative value, trading at a 17% discount to the group on a price/earnings basis and a 27% discount to our $42 fair value estimate, making it the cheapest name in our coverage, with the group as a whole trading at 87% of our estimates of fair value. Invesco remains our top near-term pick.
When considering investment in the U.S.-based asset managers, it pays to remember that the market tends to reward organic growth and operating profitability. This explains why BlackRock, generating a 4.5% compound annual growth rate for organic growth during 2013-17 (and an estimated organic CAGR of 4.6% during 2018-22) and 39.0% adjusted operating margins on average each of the past five years, and T. Rowe Price, with a 0.0% CAGR for organic growth the past five years (and an expected 1.6% CAGR for organic growth during 2018-22) and annual operating margins of 45.2% on average during 2013-17, have tended to trade at 15%-plus premiums to the group over the past 5- and 10-year time frames.
It also explains why Eaton Vance and Cohen & Steers, which generated 6.7% and 3.8% CAGRs for organic growth, respectively, during 2013-17 (and are expected to generate annualized rates of organic growth of 4.3% and 3.8% going forward) with operating margins averaging 33.1% and 38.6% during the past five years, have traded at decent premiums to the group as well. While AMG had a record of trading at a 30%-plus premium to the group historically, much of that evaporated once its organic growth dropped from a mid- to high-single-digit range during 2010-14 to low single digits during 2015-17, despite its operating margins improving from 27.5% in 2010 to 35.0% last year. Invesco, in the meantime, has tended to trade at a 5%-10% discount to the group on a price/earnings basis.
Much like Invesco, AMG is trading at an 18% discount to the group’s average price/earnings multiple. However, AMG is trading at only a 21% discount to our $224 fair value estimate compared with Invesco at a 27% discount. When we look at forward organic growth rates, AMG has a slight edge, with our estimate for a five-year organic CAGR at 2.1% during 2018-22 compared with 1.8% for Invesco. But looking back over the past five years, Invesco gets higher marks for having one of the lowest standard deviations (1.6%) in the group on its annualized organic growth of 1.8%, with only BlackRock and T. Rowe Price posting lower standard deviations (1.5% and 1.4%, respectively). AMG, meanwhile, had a 4.0% standard deviation around its annualized organic growth rate of 2.9% during 2013-17.
Invesco also continues to impress us with its transformation, reshaping itself into a much tighter organization capable of generating profitability and cash flows on par with the higher-quality names in our asset manager coverage and overcoming any hurdles thrown in its way. The company’s solid equity and fixed-income investment performance over the past 5-10 years has sparked a progression of long-term inflows across its different product platforms, with the company’s average annual organic growth of 1.8% during 2013-17 being impressive for a primarily active manager. For some perspective, the five-year CAGR for all active (equity) managers tracked by Morningstar was negative 0.6% (negative 1.7%) during 2013-17.
Invesco closed out 2017 with $937.6 billion in AUM, up 15.3% year over year, with net long-term inflows of $12.7 billion leading to a 1.7% annual rate of organic growth. While managed assets increased to $945.4 billion during the first two months of 2018, we expect AUM to be more on par with end-of-2017 levels when the company reports its preliminary month-end assets under management for March next week. Our current forecast has Invesco closing out 2018 with $950 billion-$1 trillion in total AUM, which should translate into mid- to high-single-digit top-line growth. With revenue growing in the midsingle digits during 2018-22 and operating margins moving upward while staying in a 26%-28% range, the company should generate more than $1.2 billion in free cash flow annually, much of which will be dedicated to seed investments, acquisitions, dividends, and share repurchases. Its current dividend yield is 3.8%, among the highest in the group right now.
At 10.1 and 9.1 times consensus earnings estimates for 2018 and 2019, respectively, Invesco is trading on par with AMG, as well as Legg Mason , Franklin Resources (BEN), and AllianceBernstein (AB), which have struggled with organic growth and operating profitability. Legg Mason is currently trading at 10.9 times and 10.4 times forward earnings estimates, having generated average annual organic growth of negative 0.1% during 2013-17 (with a standard deviation of 1.8%), with operating margins averaging 16.1% the past five fiscal years. Given that well over half of the company’s AUM is derived from fixed-income products, and the five-year CAGR for actively managed fixed-income funds was positive 1.0% during 2013-17, this was a disappointing result. With organic growth unlikely to improve dramatically the next five years, we’re not too excited about Legg Mason, which is trading at 90% of our $44 fair value estimate with a dividend yield of 2.8%.
Franklin Resources’ shares have traded off since the middle of last week as the stock approached the March 29 record date for the company’s $3 per share special dividend. While Franklin is currently trading at 10.2 times and 9.8 times consensus earnings estimates for fiscal 2018 and 2019, respectively, as well as a 26% discount to our $45 fair value estimate, with a 2.8% regular dividend yield, we prefer Invesco in the near term. For starters, Franklin’s annualized organic growth rate of negative 4.4% (with a standard deviation of 5.2%) during 2013-17 doesn’t look to improve much over the next five years, with our forecast for organic growth being a negative 3.3% CAGR during 2018-22, as the company’s investment performance continues to be well below where it needs to be to generate positive flows.
And while Franklin’s average annual operating margins of 36% the past five fiscal years are much better than Invesco’s, we expect them to be flat to down over the next five years, as the company faces management fee compression in the near to medium term and has to spend more heavily on investment performance and distribution in response to the shifting balance of power in the retail-advised business, where broker/dealers and advisors are being far more selective about the investment products they choose to put into accounts. While we believe Franklin has many of the attributes necessary to right the ship over the long run, we can’t point to any meaningful near-term catalysts that would allow it to improve its fortunes.
AllianceBernstein’s shares are trading at 10.3 times and 9.9 times consensus earnings estimates for 2018 and 2019, respectively, and a slight premium to our $26 fair value estimate. While AB did generate slightly better average annual organic growth of negative 0.2% (with a standard deviation of 2.4%) during 2013-17 and is likely to produce annual organic growth of 1%-2% going forward, the company, much like Legg Mason, has struggled to generate operating margins in excess of 20% since the 2008-09 financial crisis, and we don’t see much that would alter that level of performance going forward. Although AB does have a much higher dividend yield than its peers, this is because it is structured as a limited partnership, required to pay out essentially all of its available cash flows as dividends each year.
While AMG is trading in close proximity to Invesco and has had a slightly better organic growth profile (albeit with a much higher standard deviation) and slightly better operating margins of 32.4% on average the past five years, we have generally had much greater clarity on Invesco’s AUM levels, as the company reports asset levels every month, providing us with a better sense of how things are panning out between quarterly reports. AMG’s dividend yield of 0.7% is also much lower than Invesco’s current yield of 3.8%. With Invesco’s shares trading at a 27% discount to our $42 fair value estimate, we continue to view this as an attractive entry point for investment.
Greggory Warren does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.