Link: Waddell & Reed Offers Growth at a Nice Price
The asset managers have performed well year to date, and for the most part I have favored the Legg Mason (LM - Get Report) story, given the restructuring and M&A. So when Waddell & Reed Financial (WDR - Get Report) showed up on one of my screens recently, I was intrigued, especially since the stock is off 15% from its April highs and fits my style of "growth at a reasonable price." After doing the analysis, I recommended it as my final trade yesterday on Fast Money Halftime, and I thought I'd expand on my thoughts.
Waddell & Reed is a fundamental research global asset manager based in Overland Park, Kan. It is best known for its equities and asset allocation products, but it offers 20 different strategies which have at least $1 billion in assets. The diversification and strong management bench are among the reasons the company is able to produce above-average organic growth, which has been 8% on average over the last five years.
It distributes its products via wholesale, advisers and institutional. It entered the wholesale market over 10 years ago, and along with its solid performance, it now garners about 2% of sales at many of the U.S. broker-dealers around the country. Growth will come from further penetration of its existing products, new product introductions, expansion of the wholesale market and increasing its penetration in the institutional channel, which accounts for 13% of total assets under management.
This year, the company is expected to grow 8% in assets, 20% in revenue and 25% in earnings. Next year, flows should increase by mid-single digits, with revenue at 9% and earnings of 11%. The asset-flow assumption could prove conservative, considering that the company posted 14% growth in the last two quarters.
I expect organic growth to continue to be above average compared with the industry over the next few years, driven by strong performance, higher asset flows and further momentum in distribution growth at the wholesale level. The 8% growth is particularly impressive when compared with the industry average at 4% and even some declines seen at its competitors, such as Janus Capital Group (JNS - Get Report), T. Rowe Price (TROW) and Manning & Napier (MN - Get Report). Some of the reason is favorable mix, and some of it is solid, consistent fund performance.
On the mix, about 45% of Waddell & Reed's total assets are equities, 36% asset allocation and 19% sector, fixed-income and money markets. I like that it has the least amount of fixed-income exposure, given the risk to rising rates at this stage of the cycle. Also, I am impressed by managements recent goals of diversifying further from the asset-allocation product, the largest product at the company, accounting for one-third of flows.
On the performance side, its top five products, which represent 65% of its total assets, have solid rankings at Lipper, and they include Asset Allocation, which ranks fifth, Core Equity at seventh, High Income at fourth, Science and Technology at third, and Mid Cap Growth at 17. Not only will these rankings help increase its share (and flows), a few other smaller products have upside as well, particularly its Core International Equity product, which ranks in the top Lipper tier but has under $3 billion in assets.
Global Growth will also be a focus of expansion. In fact, international investors account for just 3% of total assets, so I expect this to be a big focus going forward as the company builds out its distribution platform. And finally, the Global Bond Fund also has upside opportunity.
On distribution, the wholesale channel has been gaining momentum after a revamp of its headcount, the strategic focus on smaller and independent broker-dealers as well as a few select national accounts. It is currently a top-20 distributor at large, regional firms, but there is certainly room to run here. While distribution will be the growth engine, the firms proprietary adviser channel remains the cash cow, as it has a steady (and sticky) asset base (due to retail investors) and redemption rates that are one-third of the industry average.
The institutional side remains the challenge, given management's choice to sub- advise more because of the lumpiness of this segment. I'm not counting on huge gains in this channel. Margins are another area where the company sees opportunity as it scales its platform, mainly from increasing its distribution as well as remaining tight on cost controls.
The stock trades at 15x forward estimates and 9x enterprise-value-to-EBITDA and is down 15% from April highs. The reason is that the co-portfolio-manager of Asset Strategy, Ryan Caldwell, announced his resignation to leave the investment management industry. He ran the fund for the last seven years. Caldwell will remain a consultant to the company for two years, and importantly, the current PM, Mike Avery, will remain in place. Avery has been at the firm for 17 years as a PM and/or co-PM on Asset Strategy. He is well regarded and has a team of six players which the company is committed to growing, as well as finding a co-PM replacement.
Since this fund is the largest at the firm, clearly there is reason for pause, and watching the asset flows will be important. But I believe the 15% drop in shares is factoring in a lot of flow loss, as is the 5-point forward multiple decline in that same time frame. I expect that as long as Avery remains in place, the assets should remain intact. Management recently reiterated its strategy on capital allocation: growing the dividend (40%-50% payout), share repurchases and possible special dividends. The company currently offers a 2.1% dividend, and its $300 million in unrestricted cash will most likely be used for shareholder value.