Analysts say Legg Mason's ( LM) earnings disappointment and subsequent selloff Monday should not scare shareholders into bailing out of competing asset management companies ahead of this week's earnings announcements. But they might want to lower their expectations, just the same. Legg Mason shares fell 9% Monday after the typically reliable investment services company missed consensus earnings estimates by 9 cents. The company still earned $86.4 million, or $1.14 per share, for the quarter, compared with $58.5, or 83 cents a share, in the year-ago period. (On Tuesday, the company boosted its quarterly dividend from 10 cents to 15 cents a share, while its stock rebounded.) Robert Lee, analyst at Keefe, Bruyette & Woods (KBW), says that Legg's shares might have suffered from overly high expectations and predicts that other asset managers reporting over the next week will post "subdued" results relative to the past few quarters because the markets are treading water. "Companies producing positive flows will still do well, but at a lesser rate," says Lee. His top choice among asset managers is Alliance Capital ( AC) which reports fiscal second-quarter earnings after the market closes Tuesday, July 27. Analysts are expecting the company to earn 57 cents for the quarter, 12% higher than last year's 51 cents. The consensus revenue estimate for the company is $728 million, a 10% increase from last year's $662 million. Lee says Alliance's diversified business model and high net worth customer base should cushion its shares in a downturn better than competitors that rely too heavily on a single stream of revenue. Legg, for example, reported asset management as a highly concentrated 73% of pretax profits, up from 57% a year ago, as assets under management increased 37% to $295 billion. Nevertheless, analysts and investors were more concerned with the 16% decrease in investment banking and other non-asset management revenue.
Lee also calls Alliance a cheaper turnaround play than buying shares of Janus Capital Group ( JNS), another asset manager tarred by the mutual fund scandal. Janus will release its second-quarter financial results before the market opens on Thursday, July 22. (KBW says investors should assume it seeks investment banking business and hold equity positions in the companies they respectively cover.) Mark Lane, an analyst at William Blair, agrees that investors have better options away from Denver-based Janus. Lane says the big question surrounding Janus is when its net flows will turn positive. Last week, the company reported a 0.3% month-over-month decrease in assets under management and long-term net outflows of $1.4 billion for June. Janus' Chairman and CEO Steve Scheid put a positive spin on the results saying that the equity outflows have now been reduced "to the best level we've seen in the last 10 months." But Lane and other analysts say the cost of fixing a damaged brand might prove too great for Janus, especially as growth decelerates for asset managers in what he calls "a mildly difficult environment." Analysts expect Janus to earn 17 cents for the quarter, down from 22 cents a year ago. On the top line, analysts are expecting $264 million in revenue, a 5.5% increase from last year's $250 million. (William Blair says investors should assume the company seeks investment banking business and holds equity positions in the companies covered.) Matt Snowling, an analyst at Friedman Billings Ramsey, says that Janus' "high sensitivity to the market," because of its heavy reliance on equity funds, might enable the company to squeeze out 18 cents, or 1 cent of upside, to the analyst's consensus on Thursday. The S&P 500 was up 1.69% in the second quarter. Snowling says Janus' results might also benefit from the rise in equity inflows in June, which rose $700 million to $18.8 billion, according to Lipper.
Nevertheless, he still rates Janus shares a sell due to the company's inability to effectively recover from the mutual fund scandal. "In this business, you have to gather assets when they are available, like during last year's bull market," says Snowling. "Unfortunately, Janus actually lost ground and that is tremendously difficult to overcome." Unlike Alliance, which quickly settled with both the Securities and Exchange Commission and New York Attorney General Eliot Spitzer in December 2003 over its role in the market-timing scandal, Janus was widely implicated but did not settle with regulators until April 2004. Analysts say the delay was a major factor behind the $6 billion in outflows at the company in the first quarter of 2004. Janus shares most recently traded nearly 20% below their 52-week -- pre-scandal -- high of $18.64. Snowling says he is currently underweight asset managers because he expects inflows and asset growth to moderate going forward. For investors still interested in the sector, he recommends shares of Franklin Resources ( BEN) and T. Rowe Price ( TROW), but not without caution. T. Rowe Price will report second-quarter earnings before the market opens Tuesday, July 27. Snowling, like the consensus view of analysts, expects the company to earn 62 cents for the quarter, 47% higher than last year's 42 cents, but he says he would not be surprised if the company misses since "it's still a tough number to hit." The consensus revenue forecast for the company is $313 million, a 32% increase from last year's $237 million. Franklin will report fiscal third-quarter earnings after the market closes Thursday, July 22. Analysts expect Franklin to earn 75 cents for the quarter, 44% higher than last year's 52 cents. Revenue for the company is expected to be $877 million, a 28% increase from last year's $683 million. (FBR says investors should assume the company pursues investment banking business and holds equity positions in the companies it covers.) T. Rowe and Franklin shares have both declined by more than 17% since hitting their respective one-year highs in March 2004. Unlike Janus, however, the share price of both companies has been helped by their relative absence from the scandal. (T. Rowe was not named and Franklin was singled out for only minor wrongdoings by Massachusetts regulators.) "The market has very high expectations for these two companies and inflows might not be that great," says Snowling.