BlackRock Holds Up Better Than Peers

Wide-moat-rated

BlackRock returned to positive flows during the third quarter, picking up $11.4 billion in flows from its actively managed funds (including $875 million from its equity operations and $8.7 billion from its fixed-income platform) and $23.5 billion from its iShares exchange-traded fund business (which generated $5.3 billion in equity inflows and an impressive $18.2 billion in bond ETF flows). While we were close with our projections for the iShares business, looking for $23.9 billion in inflows, we underestimated the flow contribution from the active business by more than $10 billion and expected $3 billion more in flows from the institutional index business, which generated very little organic growth during the period.

Given the ongoing volatility in the markets as well as the prospect of an increase in interest rates before the end of the year, we're sticking with our more conservative outlook for the fourth quarter, expecting BlackRock to close out the year with just over $4.6 trillion in AUM. With average AUM expected to be up by low single digits during 2015 and the firm's realization rate down year over year on product mix shifts, we're not expecting much more than low-single-digit revenue growth for the full year. Operating margins were squarely within our range of 41%-42% during the first nine months of the year, and we expect BlackRock to close out 2015 with profitability at the lower end of that range. This should allow the firm to generate more than $3.5 billion in free cash flow this year.

Looking more closely at the firm's fund flows, BlackRock saw much stronger organic growth from its equity operations (which account for 50% of its total AUM) than we forecast, picking up $5.6 billion in flows, compared with our forecast for $2.4 billion in inflows. Our forecast of $5.4 billion in inflows for iShares was slightly higher than reported results of $5.3 billion. We were off on our forecast for active equity fund flows, with the firm reporting $875 million in inflows compared with our projection of $4.4 billion in outflows, which was built on results we were seeing for some of the other asset managers we cover that reported monthly AUM results earlier this month. We also expected $1.3 billion in positive flows from BlackRock's institutional index business, which ended up reporting $559 million in outflows. This was still a meaningful improvement over the second quarter, when the firm posted $34.0 billion in institutional equity index outflows, driven primarily by several large clients that were looking to reallocate, rebalance, or raise cash during the period.

BlackRock's fixed-income platform continues to benefit from the rejuvenation of its actively managed bond portfolio, with the firm picking up $8.8 billion in active fixed-income inflows during the third quarter--significantly better than our forecast for $2.0 billion. Institutional index inflows of $668 million, however, were lower than our projection for $2.2 billion. Our forecast of $18.5 billion in inflows for iShares' fixed-income ETFs was also slightly higher than reported results of $18.2 billion. We continue to believe that BlackRock will generate the bulk of its fixed-income AUM growth from its actively managed and ETF platforms, with annual levels of organic growth (expected to be around 7% in 2015) in the 4%-6% range during the next couple of years--even with interest rates going up in the near to medium term.

Generating $23.5 billion in net inflows during the third quarter, iShares recovered from a weak second quarter for flows (when it picked up just $10.3 billion). Organic growth over the last four calendar quarters was 11.7%, above our expectations for high-single-digit to low-double-digit annual organic growth for the firm's ETF platform. BlackRock's ETF operations continue to hold up well, despite pressures from faster-growing platforms at Vanguard, Schwab, and even Deutsche Bank. BlackRock has maintained a 38% share of the market the past several years, and while we do expect this to dip closer to 35% over the long run, we think the firm has successfully navigated a lot of the competition (especially on the pricing front) that has emerged over the past five years.

While we continue to expect iShares to be the spearhead for BlackRock's long-term growth, the firm will get an added boost to its revenue if its actively managed equity and fixed-income funds generate positive performance and organic growth on a much more consistent basis. Any incremental gains that the company can generate on its top line would lead to much higher margins than we currently forecast, due to the amount of operating leverage inherent in BlackRock's asset management operations. For the time being, though, we're sticking with our forecast of 3%-4% annual organic growth for the firm's long-term AUM, with BlackRock's performance over the past three quarters likely to put its full-year results right in the middle of that range.

We continue to believe that the firm will generate more than $3.5 billion in free cash flow this year. BlackRock has already spent $825 million during the first nine months of 2015 on share repurchases and expects to spend $275 million on share buybacks quarterly going forward. The company also increased its quarterly dividend to $2.18 per share in January, reflective of a 13% increase and leaving its current yield at 2.7%. Even with all of the noise in the current period, the company has one of the better and more stable organic growth profiles in our coverage universe, with the potential to generate high-single-digit operating income growth and double-digit earnings growth in each of the next several years--something that cannot be said for most of the other asset managers we cover.