Federated Investors, Inc.

Transcription

1 March 04, 2015 Federated Investors, Inc. Current Recommendation Prior Recommendation Underperform Date of Last Change 11/30/2014 Current Price (03/03/15) $33.52 Target Price $35.00 NEUTRAL SUMMARY (FII-NYSE) Federated s fourth-quarter 2014 earnings outpaced the Zacks Consensus Estimate. Improved top-line growth along with higher equity assets was experienced. However, rise in expenses and reduced assets under management (AUM) were on the downside. The company with its moderately liquid balance sheet and a diversified asset as well as product mix has good growth prospects going forward. Yet, stringent regulatory pressures, slow global economic growth and a low interest rate environment are expected to keep Federated s earnings under pressure in the coming quarters. SUMMARY DATA 52-Week High $ Week Low $26.84 One-Year Return (%) Beta 1.30 Average Daily Volume (sh) 486,994 Shares Outstanding (mil) 105 Market Capitalization ($mil) $3,520 Short Interest Ratio (days) Institutional Ownership (%) 79 Insider Ownership (%) 11 Annual Cash Dividend $1.00 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) -3.5 Earnings Per Share (%) -4.0 Dividend (%) 1.0 using TTM EPS 23.4 using 2015 Estimate 19.2 using 2016 Estimate 14.8 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page Risk Level * Below Avg., Type of Stock Large-Growth Industry Fin-Invest Mgmt Zacks Industry Rank * 115 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) A 224 A 211 A 215 A 878 A A 213 A 217 A 218 A 859 A E 243 E 263 E 288 E 1019 E ,218 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.41 A $0.39 A $0.36 A $0.39 A $1.55 A 2014 $0.34 A $0.35 A $0.36 A $0.38 A $1.43 A 2015 $0.37 E $0.42 E $0.47 E $0.49 E $1.75 E 2016 $2.27 E Projected EPS Growth - Next 5 Years % Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW Federated Investors Inc. (FII), which was founded in 1955, is a publicly owned investment management company with headquarters in Pittsburgh, PA. The company, together with its subsidiaries, is one of the major investment managers in the United States, with $362.9 billion in managed assets as of Dec 31, The majority of Federated s revenues are derived from advising and administering Federatedsponsored funds and Separate Accounts in both domestic and international markets. The company also derives revenues from various other mutual fund-related services including distribution, shareholder servicing and retirement plan recordkeeping services. Federated provides comprehensive investment management to around 7,700 institutions and intermediaries, including corporations and government entities. Federated s investment products are primarily distributed in four markets: wealth management and trust (holding 44% of managed assets as of Dec 31, 2014), broker/dealer (34%), institutional (19%) and international (3%). Federated makes its fixed income investments in ultra-short, short-term, and intermediate-term mortgage-backed, U.S. government, U.S. corporate, high-yield and municipal securities. Federated s principal source of revenues is investment advisory fee earned by its various subsidiaries. Additionally, the company generates revenues from administrative service and other service fees. Since its inception, Federated has been expanding through acquisitions. Most recently, in Oct 2012, Federated entered into an agreement with London-based Bury Street Capital to expand its European distribution. In Mar 2014, Federated entered into an agreement with RJ Delta Fund Management, a subsidiary of Raymond James Financial, Inc., to acquire its marketing services and expand its services in Chile. In May 2014, Federated and Huntington Asset Advisors, Inc., an investment adviser subsidiary of The Huntington National Bank completed the deal under which, Federated acquired fixed-income assets worth $300 million from five Huntington fixed-income mutual funds. REASONS TO BUY Federated s non-interest expenses continued to show a declining trend in the last few years. This trend could be witnessed over the last four years as expenses exhibited negative CAGR of 1.3% ( ). We believe that the company is well positioned to maintain the prudent expense management going forward. The company continues to look for more opportunities to strike profitable deals. It is on track to expand globally as evident from investments made in the last few years. Federated expanded its operations in the United Kingdom through the acquisition of London-based Prime Rate Capital Management, LLP and expanded its European distribution capabilities through an agreement with Bury Street Capital, a European distribution firm based in London. Federated also stretched into the Asia-Pacific region by opening an office in Australia. In Mar 2014, in order to strengthen services in Chile, the company inked a deal with RJ Delta Fund Management to acquire its marketing services. We expect all these to augur well for top-line expansion over the long term. Under the prevailing pressure for money market funds owing to the lingering low interest-rate environment and stringent regulations, acquiring money market assets depict buoyancy of the company in the money market business. Over the past three years, Federated acquired more than $5 billion worth of money market assets. In 2014, Federated and Huntington Asset Advisors, Inc., an investment adviser subsidiary of The Huntington National Bank completed a deal under which, Federated acquired fixed-income assets worth $300 million. Increased assets under management will furnish Federated with various new fund offerings that would benefit its clients. Equity Research FII Page 2

3 REASONS TO SELL Federated is looking forward to many such opportunities in order to provide enhanced services to its clients. We view Federated as a sound asset for yield-seeking investors based on its capital deployment activities. In Jul 2013, Federated declared a 4% hike in its quarterly dividend. Further, during the 2014, the company paid $104.8 million as cash dividends and bought back 0.9 million shares of common stock for $26.9 million. Based on its competitive financial performance and earnings, Federated is on track to fulfill its commitment of returning shareholders value. RECENT NEWS Net Investment Advisory Fees contribute a substantial portion to the total revenue of Federated, comprising about 64% in These fees are based on the value of managed assets and vary with the type of asset being managed, with higher fees generally earned on equity products than on fixed-income and money market products and a liquidation portfolio. Significant fluctuations in the fair value of securities held by, or the level of redemptions from, the funds or other products advised by Federated may materially affect the amount of managed assets thus posing a hindrance to Federated s revenues and profitability. Volatile equity markets and sluggish global economic growth are expected to keep assets under management, asset flows and margins under pressure for Federated. Also, stringent regulations are expected to significantly affect the company s financials. In Jul 2014, the Securities and Exchange Commission (SEC) adopted a new body of regulations for the $2.6 trillion money market fund business. The new plan requires the prime money market funds to float the value of their shares and also imposes a withdrawal fees. These reforms, undertaken to restrict investors from fleeing the money funds industry during a period of financial stress, are expected to be detrimental to Federated's money market fund business and significantly affect its business operations. Notably, Federated recently announced its plan to reorganize its product line of money market funds in order to meet clients needs and to comply with the Jul 2014 rules. Management expects implementation of the necessary adjustments to its product line before the final mandatory compliance date for the rules in Oct In certain money market funds, the gross yield is not enough to cover all of the fund s normal operating expenses due to historically low short-term interest rates. For several years, the Federal Reserve left the near-zero federal funds rate unchanged and short-term interest rates continued to be at their all-time low. Since fourth-quarter 2008, Federated voluntarily waived fees in certain money market funds in order to enable certain funds to maintain positive or zero net yields. Changes in asset mix along with lower yields on instruments held by the money market funds caused an increase in these fee waivers. Moreover, assuming asset levels and mix to remain constant and based on recent market conditions, fee waivers for first-quarter 2015 will likely result in a negative pre-tax impact of about $28 million. Federated Q4 Earnings Beat Estimates on High Revenues Jan 22, 2015 Driven by strong top-line performance, Federated reported fourth-quarter 2014 earnings of $0.39 per share, beating the Zacks Consensus Estimate by 2.6%. However, results compared unfavorably with the prior-year quarter earnings of $0.40 per share. Equity Research FII Page 3

4 Increased revenues, coupled with record high-equity assets, acted as tailwinds for the quarter. However, higher expenses and decline in AUM were the dampeners. Excluding the income available to unvested restricted shareholders, net income for the quarter came in at $39.6 million or $0.38 per share, compared with $41.1 million or $0.39 per share in the prior-year quarter. For 2014, excluding the income available to unvested restricted shareholders of $5.8 million, net income amounted to $149.2 million, down 8% from the prior-year net income of $162.2 million. Performance in Detail Total revenue for the fourth quarter inched up 1% year over year to $217.9 million. The reported figure was, however, 1.6% below the Zacks Consensus Estimate of $221.5 million. Total revenue for 2014 came in at $859.3 million, missing the Zacks Consensus Estimate of $874 million. Moreover, it was 2.2% below the year-ago total. Despite a year-over-year fall in revenues for 2014, the company witnessed a record high of $4.3 billion in the year The upsurge in the fourth-quarter revenues was attributable to a rise in average equity assets under management, partially offset by reduced average money market assets. Moreover, net investment advisory fees recorded a 4% year-over-year increase to $143.6 million, while other net revenue rose 40% to stand at $1.3 million. Further, the quarter witnessed a decline in voluntary fee waivers. During the reported quarter, Federated derived 31% of its revenues from money market assets, 69% from fluctuating assets (46% from equity assets and 23% from fixed-income assets). Non-operating income (expenses) plummeted nearly 88% year over year to $523 million, primarily due to a fall in gains realized from investments. Total operating expenses ascended 1% on a year-over-year basis to $156.2 million in the quarter. The rise in expenses primarily reflects elevated compensation and related costs, along with increased office and occupancy, and systems and communication expenses. These were, however, partially offset by a fall in professional fees, travel and related costs, and promotional expenses. Assets Position As of Dec 31, 2014, total AUM was $362.9 billion, down 3.5% from $376.1 billion as of Dec 31, Average managed assets were $351.9 billion, down 3.9% from $366.2 billion in the prior-year quarter. Money market assets were $258.8 billion, down 6.2% on a year-over-year basis. Money market mutual fund assets came in at $225.5 billion, down 6% year over year. However, both equity and fixed income assets witnessed increases during the quarter. While equity assets came in at $51.4 billion, up 16.5% year over year; fixed-income assets rose 5.1% year over year to $52.7 billion. Moreover, as of Dec 31, 2014, cash and other investments were $297.3 million, up from $292.2 million as of Dec 31, Total long-term debt was $216.8 million, up from $198.3 million as of Dec 31, Equity Research FII Page 4

5 Capital Deployment Update In fourth-quarter 2014, Federated repurchased 200,000 shares of Federated class B common stock for $6.2 million. During 2014, the company repurchased 0.9 million shares of common stock for $26.9 million and paid $104.8 million as cash dividends. Concurrent with the earnings release, Federated announced a quarterly dividend of $0.25 per share. The dividend was paid on Feb 13, 2015 to shareholders of record as of Feb 6. Outlook Fee waivers for first-quarter 2015 will likely result in a negative pre-tax impact of about $28 million. However, the company estimates 10 basis points (bps) gain in gross yields from first-quarter 2015 levels to lessen the impact of minimum yield waivers by about 40% and a 25 bps gain in gross yields to reduce the impact by around 65%. The company expects to recover around 75% of minimum yield waiver-related pretax income when money fund yields rises to the point of eliminating these waivers. A fewer number of days in first-quarter 2015 is likely to reduce revenues by $7 million and associated distribution expense is expected to lessen by around $2.5 million for a decline in operating income of around $4.5 million, based on fourth-quarter 2014 asset levels. Owing to seasonality, first-quarter 2015 is likely to experience increased incentive compensation accruals. Compensation and related expense is projected to be around $75 $76 million, increasing $3 $4 million sequentially. The total impact of fewer days and higher estimated compensation related expense is about $8 million as compared with the fourth-quarter level. For 2015, tax rate is estimated around 38%. Federated Builds Treasury Fund on New Buyback Program Feb 19, 2015 Federated recently announced its plan to enhance its treasury fund with a new share repurchase program. The company s board of directors has authorized the buyback of additional 4 million shares of its class B common stock through open market operations. The repurchase will build Federated s treasury fund, which will then be utilized to facilitate employee share-based compensation plans, and prospective mergers and acquisitions. The latest approval adds to nearly 300,000 shares available under Federated s existing share repurchase program as of Feb 5, Both existing and the newly announced buyback programs do not have an associated expiration date. Equity Research FII Page 5

6 VALUATION On price-to-earnings () basis, Federated s shares currently trade at 19.2x the Zacks Consensus Estimate for 2014, which is at 38.1% premium to the industry average of 13.9x. On a price-to-book (P/B) basis, the shares trade at 5.6x, which is at 64.7% premium to the industry average of 3.4x. On both and P/B basis, the valuation looks expensive. Federated has a trailing 12-month ROE of 25.2%, compared with the industry average of 19.9%. This implies that the company reinvests its earnings more efficiently than its industry peers. Our 6-month target price of $35.00 equates to 20.0x the Zacks Consensus Estimate for Combined with a quarterly dividend of $0.25 per share, this target price implies an expected return of about 5.9% over that period. This is consistent with our long-term Neutral recommendation on the shares. Currently, Federated carries a Zacks Rank #3 (Hold). Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Federated Investors, Inc. (FII) Industry Average S&P Janus Capital Group, Inc. (JNS) KKR & Co. L.P. (KKR) NA Artisan Partners Asset Management Inc. (APAM) Prospect Capital Corporation (PSEC) NA TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Federated Investors, Inc. (FII) Industry Average NA S&P NA 2.0 NA Equity Research FII Page 6

7 Earnings Surprise and Estimate Revision History Equity Research FII Page 7

8 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of FII. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1126 companies covered: Outperform %, Neutral %, Underperform 8.2%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Coverage Team QCA Lead Analyst Analyst Copy Editor Content Ed. 11B Kalyan Nandy Priti Dhanuka Anindita Chaudhury Ishani Mukherjee Priti Dhanuka Equity Research FII Page 8