Company Reports

The proposed acquisition of narrow-moat Perpetual’s wealth management and corporate trust businesses by KKR, unanimously recommended by its board, vindicates our view that their values are not reflected in the current Perpetual stock price. The face value of the offer is above our expectations and represents a step toward a capital return to shareholders. However, the lack of cost details on the transaction, the separation, and the capital gains tax make it difficult to ascertain whether or not the deal is accretive to our current intrinsic assessment. We retain our stand-alone fair value estimate of AUD 26 per share for now.

Narrow-moat Perpetual’s latest funds under management, or FUM, update was uninspiring, with net outflows more than expected. This contrasts with the generally improving flows reported by other asset managers and investment platforms in the March quarter of fiscal 2024, driven by prospects of interest-rate cuts.

Perpetual has three business units: as an asset manager, a private wealth advisor, and a corporate trust service provider. Acquisitions form part of the group’s strategy to build scale and expand its products and services.

This note replaces the original version that accompanied our report "Industry Pulse - Australian Asset Managers: 2024 Q1," published March 14, 2024. We were recently made aware of inaccuracies in the net flow data for certain unlisted managers in that original report. As for our investment conclusions, we stand by our key assessments: the fair value estimates, moat, uncertainty, capital allocation, and star ratings for our Asset Manager coverage.

We recently published our inaugural Industry Pulse: Australian Asset Managers 2024 Q1. It has come to our attention that some the detailed industry data we presented may not be accurate, namely around asset manager inflows and outflows. As far as our investment conclusions are concerned, we stand by our key assessments, namely the fair value estimates and moat, uncertainty, capital allocation, and star ratings for our asset manager coverage. Key data for the companies we cover is captured separately and directly from the relevant companies, and we have no reason to believe it is incorrect. However, while we investigate to confirm the accuracy and presentation of the detailed underlying data, we have retracted the report from our products. We will seek to reissue a corrected report, along with an explanatory accompanying note, as soon as practical.

Share prices of ASX-listed asset managers fell for most of 2023 but broadly rebounded late in the year in anticipation of lower interest rates. Stabilizing interest rates generally enhances investor risk appetite, thus boosting fund flows, asset prices, and earnings for asset managers. Globally, net annual fund flows into open-ended, money market, and exchange-traded funds turned positive in March 2023 after close to six months of net outflows. This reflects a stabilizing US federal-funds rate and an increased likelihood of rate cuts in 2024. In Australia, the prospect of cuts in the Reserve Bank of Australia’s cash rate in the near term is likely positive for flows into Australian-domiciled funds—consisting of ETFs, industry funds, and active managers.

Narrow-moat Perpetual’s first-half fiscal 2024 net profit after tax of AUD 98 million fell short of our forecast despite being up 46% from the previous corresponding period with the inclusion of Pendal. EBITDA of AUD 206 million slightly exceeded our expectations due to effective cost containment, but higher depreciation/amortization, share-based payments, and interest costs dampened overall earnings. Regardless, we maintain our confidence in the core business' ability to deliver maintainable earnings growth and stabilize margins. This will be supported by recovering fund flows from market disruptions in 2022-23 and realizing cost synergies that are also currently ahead of schedule.

Perpetual has three business units: as an asset manager, a private wealth advisor, and a corporate trust service provider. Acquisitions form part of the group’s strategy to build scale and expand its products and services.

The indicative proposal from Washington H. Soul Pattinson, or WHSP, to acquire narrow-moat-rated Perpetual is at a price broadly in line with our AUD 27.50 per share fair value estimate on a stand-alone basis. The proposal was unsurprisingly rejected by Perpetual’s board on the same day, given the lack of any control premium.

Our conviction in the thesis for listed wealth managers, asset managers, and their related service providers has strengthened after gathering insights from the recent 2023 Super & Wealth Summit, hosted by the Australian Financial Review. These firms are influenced by similar business drivers and industry trends. Most derive their revenue from funds under management and/or administration, or FUMA, which are driven by asset price movements and new fund flows from clients, and management fees or commissions on these FUMA.

We lower our fair value estimate for narrow-moat Perpetual by 10% to AUD 27.50 per share, due to reduced projected base fee margins in the asset management business. Our prior forecast fee compression was too gradual and did not fully reflect competitive pressures from passive options and unlisted investments. However, despite our fair value cut, Perpetual remains substantially undervalued.

Perpetual has three business units: as an asset manager, a private wealth advisor, and a corporate trust service provider. Acquisitions form part of the group’s strategy to build scale and expand its products and services.

Narrow-moat Perpetual says it’s not the same struggling asset manager as in fiscal 2019, dedicating its 2020 investor day to its asset management growth plans. The firm aims to broaden distribution to boost inflows, notably to the recently acquired Trillium and Barrow Hanley, or BHMS, businesses. Priorities remain growing its offshore distribution team, client diversification, growing its product suite, and connecting with more asset consultants and research houses. Not much surprised though and our AUD 38.50 fair value estimate is retained.

Perpetual’s struggling investment segment is set to get a boost from the recent acquisitions of Barrow Hanley and Trillium. It is also addressing disappointing earnings in its core equity strategies by also expanding its private segment via acquisitions and attracting new advisors and its trust segment, and diversifying within each segment.

Perpetual’s struggling investment segment (39% of profit before tax in fiscal 2020) is set to get a boost from the recent acquisitions of Barrow Hanley and Trillium. This should help offset net outflows from its struggling Australian equity strategies. Perpetual is also addressing disappointing earnings in its core equity strategies by also expanding its private segment (22% of PBT) via acquisitions and attracting new advisors and its trust segment (39% of PBT) and diversifying within each segment. Its investment segment manages assets employing an active value style, but we note its Australian equity strategies are facing the structural issues of large superfunds managing more Australian equities in-house, and investors increasing allocation to global equities and passive investment styles.

We cut our fair value estimate for Perpetual to AUD 35.50 per share from AUD 43.50 after factoring in higher market losses and greater outflows than we previously assumed. Near-term earnings will likely come under pressure given lower funds under management, or FUM, notably in its investments business. However, we reaffirm our narrow moat, medium fair value uncertainty, and Standard stewardship ratings as we transition coverage to a new analyst. Despite our reduced valuation, shares still screen as undervalued as investors likely underappreciate Perpetual’s increasingly diversified business mix and asset classes, which should support future earnings growth, albeit less than we previously thought. Our new valuation implies a midcycle P/E ratio of 17.3 times and dividend yield of 5.3%.

We’ve increased narrow-moat Perpetual’s fair value estimate to AUD 43.50 per share from AUD 40.00 due to an upgrade to future earnings from fiscal 2021 following two new acquisitions, the onboarding of 16 new financial advisors, and cost out program. We now forecast the group’s underlying net profit after tax, or UNPAT, to increase by about 8% per year over the next five years, from previous 5%. At our fair value estimate, the company has a fiscal 2020 P/E of 19.1 and dividend yield of 5.0%. But given the execution risks in its acquisition strategy, shares screen as moderately expensive.

Equity market volatility has not provided the most accommodative backdrop for active equity fund managers recently, but Perpetual Limited has ridden out fiscal 2016 well. Narrow moat-rated Perpetual's fiscal 2016 underlying profit beat our forecasts, declining 4% to AUD 128.2 million on a 1% fall in revenue. In a classification change worth noting, gains or losses made on the disposal of Perpetual's seed fund investments are now included in underlying profit. Excluding these adjustments, net profit after tax of AUD 125.9 million was down 3.5%, still slightly better than our AUD 123.2 million forecast.

Australian equity managed funds are the bread and butter of Perpetual’s business, making up more than 70% of investment management funds under management, or FUM. This AUD 21.4 billion in FUM is quite lucrative. In fiscal 2015, with average total FUM of AUD 32.2 billion, Perpetual made AUD 240 million in revenue from investment management, with a large EBIT margin of 52% delivering EBIT of AUD 125.6 million. With compulsory superannuation underpinning growth in the asset pool, it is a hotly contested market. Low-cost competitors are trying to wrangle into the space more and more. Low-cost passive investments continue to grow in popularity, which will only be helped by significant investment into robo-advice offerings made across the financial services industry globally. Over the long term, we believe it will become an increasingly difficult market for active managers to maintain fees. We do not believe all managers will be impacted in the same way though. We expect top-performing managers, which typically share common traits of a capable and stable team, robust processes and ability to deliver in different market conditions, to fare better. We believe the good active managers like narrow moat-rated Perpetual will experience modestly lower fees to narrow the gap to passive investment products.

Perpetual's funds under management, or FUM, as at March 31 were slightly softer than expected, but not enough to alter our positive long-term view. The Australian All Ordinaries Index falling 3.6% during the third quarter is an unfavourable backdrop, but given that 19.5% of FUM is in cash and fixed-income strategies, we did not expect FUM to fall to such a large extent. FUM declined 3.6% to AUD 29.8 billion, with net outflows of AUD 400 million and investment performance detracting AUD 700 million.