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Federated Hermes: Raising Fair Value 14% on Higher Rates and Money Market Fund Flows

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Securities In This Article
Federated Hermes Inc Class B
(FHI)

We’ve increased our fair value estimate for no-moat-rated Federated Hermes FHI to $40 per share from $35 after updating our valuation model to include higher income streams from the company’s money market operations in the near term.

Federated closed out 2022 with $668.9 billion in managed assets, down 13.4% on a year-over-year basis. Net long-term outflows of $8.7 billion during 2022 were driven primarily by the company’s fixed-income ($6.8 billion) and equity ($1.7 billion) operations. The firm also reported market losses in both segments, which was not too surprising given the disruption in both the equity and the bond markets last year.

Federated did, however, see $28.9 billion flow into its money market fund operations during 2022, with the firm also benefiting greatly from rising interest rates, which finally allowed the company to put its fee-waiver problem behind it (as base fee rates rose closer to 15 basis points).

While credit and equity market conditions are expected to be weaker and more volatile in the near term, which would leave Federated’s organic long-term assets under management, or AUM, growth in negative territory, the firm should make up for it with flows into money market funds given both the stair step of rate increases this past year and the flight of capital from bank deposits.

At this point, we expect Federated to generate annual organic long-term AUM growth in a negative 3% to positive 4% range during 2023-27 (a period that includes another major equity market correction midway through our five-year forecast period).

This should allow the firm to produce low- to mid-single-digit AUM annually during 2023-27, with top-line growth being somewhat lower due to ongoing fee compression in actively managed funds. The net result is a positive 1.7% CAGR for revenue during the next five years. As for profitability, we envision Federated producing adjusted GAAP operating margins of 19%-23% during 2023-27 (compared with 23.3% during 2022).

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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About the Author

Greggory Warren, CFA

Strategist
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Greggory Warren, CFA, is a strategist for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He covers the traditional U.S.-and Canadian-based asset managers, as well as Berkshire Hathaway.

Before assuming his current role in 2017, Warren covered the financial-services sector as a senior analyst since late 2008. Prior to that time, he covered non-alcoholic beverage manufacturers and distributors, packaged food firms, food service distributors, and tobacco companies. Before joining Morningstar in 2005, Warren worked as a buy-side equity analyst for more than seven years, covering consumer staples and consumer cyclicals.

Warren holds a bachelor's degree in accounting and English from Augustana College. He also holds the Chartered Financial Analyst® designation and is a member of the CFA Society of Chicago. During 2014-19, Warren was selected to participate on the analyst panel at Berkshire Hathaway’s annual meeting, asking questions directly of Warren Buffett and Charlie Munger. The analyst panel was disbanded ahead of Berkshire’s 2020 annual meeting. Warren also ranked second in the investment services industry in The Wall Street Journal’s annual “Best on the Street” analysts survey in 2013, the last year the survey was conducted.

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