Waddell & Reed's (NYSE:WDR) share price is down 30% from early April highs as Wall Street became worried about departures of portfolio managers. The company reported another quarter of strong earnings and revenue gains but the stock went down further. All gains since my bullish article was published in late December 2013 have evaporated and the stock is down almost 20% to date. The growth that the company is delivering, dividends, share buybacks and a low valuation given the growth prospects make Waddell & Reed a solid stock to consider buying in the next couple of weeks.
Waddell & Reed reported Q2 EPS of $0.98 which was $0.07 better than consensus estimates and up 60.7% from Q2 2013. Revenue came in slightly below estimates and was up 20.8% over Q2 2013. Assets under management ended the quarter at $135.6 billion, rising 3% sequentially and 30% compared to June 2013. Waddell's CEO Henry John Herrmann stated in the Q2 conference call that "It's worth noting that our annualized organic growth rate during the quarter at 3.7% was on a par with last year second's quarter at 3.6%, and more than twice that of the industry's rate during the period." Since the company announced the departure of the High Income Fund portfolio manager on July 11, redemptions spiked initially and have since moderated, although the impact of the departure is still largely unknown. The fund experienced outflows of approximately $500 million since the announcement. Waddell's management is not pleased with departures of three portfolio managers since November 2013, but they are confident that the company has a deep bench of high quality individuals to take their place. Management also stated that the part of the outflows in these areas is certainly related to market sentiment.
While the outflows signal that there are short-term effects on the company's assets under management, I believe that the long-term effects will not be felt on the company's top and bottom line. This leads me to believe that the market's reaction to these events is out of proportion relative to the effects on the company's fundamentals.
Additional downside is possible
Looking at the company's valuation, there is room for further downside, but the reward/risk currently looks good for long-term oriented investors. However, I would not buy Waddell here, since the bottoming pattern is currently broken, but I would be vigilant to see where the stock will find support. Judging from the previous corrections in Waddell's valuation, the stock could go down 20% to 30% here, but the stock is a great value even now. The share buyback program and a solid dividend yield of 2.2% should serve as protection on the downside. The company has already accelerated its buyback, as it bought 628,000 shares in Q2 as opposed to 280,000 in Q1.
On the other hand, the potential upside is between 30% and 55% based on the target EV/EBITDA ratio of 12 to 13. I believe that it is reasonable to assume that the company could revisit this valuation range, but given the expected growth slowdown going forward (revenue is expected to grow around 10% and earnings around 15% in the next two years), I do not think that expansion beyond an EV/EBITDA ratio of 15 is possible anymore (I have talked about this possibility in my previous article on Waddell & Reed). So, the reward/risk ratio is in bulls' favor right now, but I would wait for the dust to settle and for the stock to reach a permanent bottom in the next couple of weeks before buying. The stock could get support around $50, which may serve as a logical and psychological support area. If Waddell revisits the EV/EBITDA ratio lows of 2012, it would provide a great long-term buying opportunity at $40 to $45. Investors who bought Waddell at an EV/EBITDA of 7 (that has happened on three occasions since 2009) made gains north of 100% in the next two to three years.
Waddell & Reed is having some short-term issues that should not have an adverse effect on its long-term performance. The recent selloff is out of proportion with the impact on the fundamentals. However, I would wait for the dust to settle as there might be additional downside from here as the negative momentum in the market could drive the share price further down. The reward to risk ratio should shift significantly in the bulls' favor if Waddell goes down to $45.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.