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Summary

  • TROW has well above average ROIC of 70%.
  • Revenue and earnings growth is expected to by 12% and 16%.
  • TROW has above average margins.

T. Rowe Price (NASDAQ:TROW) is attractively priced at 14x forward earnings with 70% return on invested capital (ROIC), 12% revenue growth, 16% eps growth, and above average margins. In this article T. Rowe Price is compared to its peers, Janus (NYSE:JNS), Eaton Vance (NYSE:EV), Franklin Resources (NYSE:BEN), BlackRock (NYSE:BLK), Invesco (NYSE:IVZ) and Legg Mason (NYSE:LM). The measures used for comparison are valuation (forward pe ratio), profit efficiency, growth in revenue, and adjusted operating margin (EBIT as a percentage of investment advisory revenue).

T. Rowe Price has a much higher ROIC (70%) than the other investment managers (average 14%). ROIC is calculated as the ratio of net operating profit after tax (NOPAT) to invested capital (IC). NOPAT is EBIT multiplied by the 1 minus the tax rate. EBIT excludes all investment gains and losses, interest expense, interest income, and special charges, such as impairments. TROW's EBIT for the last year of $1.8B is the sum of the net operating income over the last 4 quarters ($473, $449, $440 and $426 million). Price expects its tax rate to be 38.5%, and this rate is used to calculate NOPAT of $1.1B. On June 30, 2014, TROW has IC of $1.6B. IC is total assets minus net cash and non-interest-bearing current liabilities. The June 30, 2014 balance sheet has total assets of $5.7B. TROW's net cash, $3.7B, is the sum of cash and cash equivalents, investments in sponsored funds and a portion of other investments. The portion of other investments included in net cash is sponsored fund investments by equity method, investments held as trading, and U.S. Treasury note. All of these investments are liquid and could immediately be converted to cash. TROW's ROIC (70%) is NOPAT ($1.1B) by IC ($1.6B).

TROW has grown revenue at the highest rate among its peer group, and its higher growth rate is expected to persist. TROW grew revenue in the most recent quarter and the trailing twelve-month periods by 15.2% and 16.3%, compared to the peer group averages of 7.2% and 8.4%. In addition, the expected revenue growth (from consensus estimates) over the next twelve months is expected to be 12.3% versus the peer average of 7.7%. The reason for the higher revenue growth rate is TROW's ability to grow AUM at a faster rate. Faster growth in AUM can be attributed to several things: good investment performance, equity focus, and low distribution fees. First, TROW has had good investment performance, and it is well known that money follows performance and Morningstar ratings. Second, TROW is mainly an equity shop, and investors have been moving allocation into equities. This trend of increasing equity allocation is expected to continue given the current low interest rate environment and the Fed's ZIRP. Third, TROW is mainly a no-load fund family, and investments are moving away from high-fee funds. Investors understand fees are one reason why investment returns underperform the index. Investors are avoiding higher-fee investments and moving from higher-fees funds toward lower-fees funds. This leads into the discussion regarding distribution fees, which are the main driver of higher fees.

Distribution fees, loads, and 12b-1 fees are paid to the investment manager of the fund, and these fees are passed through to the financial adviser who sells the fund. Distribution fees increase a manager's revenue, but also increase the corresponding distribution expense. Investment managers typically reimburse marketing expenses of their financial adviser network, so income is reduced because distribution fees end up being larger than distribution revenue. The table shows the degree to which the investment manager utilizes the financial adviser network to distribute their funds.

Exp as % of total rev

TROW

JNS

EV

BEN

BLK

IVZ

LM

Average

Compensation

33.2%

39.1%

32.0%

17.9%

34.1%

26.6%

44.0%

32.3%

Advertising

1.5%

1.9%

2.3%

2.1%

Distribution/servicing

3.6%

14.1%

17.8%

37.0%

3.2%

31.8%

21.4%

20.9%

Occupancy/facility/tech

3.7%

4.1%

5.8%

9.9%

6.6%

Other

7.2%

11.7%

13.4%

4.0%

20.3%

5.9%

7.2%

10.4%

All the managers have distribution revenue and fees, but TROW and BlackRock have the lowest by far.

Franklin is an interesting manager because of its heavy use of the financial adviser network. Franklin has the highest level of distribution expense as a percentage of total revenue. Franklin offers many different classes of funds, which are really just different fee structures on the same investment. Franklin cites the large financial adviser network as a competitive advantage to their business because these assets are perceived to be less likely to move as a result of short-term volatility or underperformance. Yet Franklin has difficulty increasing AUM and revenue. Is there a connection between a high distribution fee and a low growth rate in AUM and revenue? I would argue yes, the higher fees make the funds harder to sell. TROW is on the other end of the distribution-fee spectrum with very limited use of financial advisers for distribution. TROW has made a choice not to utilize this distribution, and I believe this results in a higher growth rate of AUM and revenue. Investors are becoming more conscious of fees. TROW is benefitting from this secular trend away from distribution fees.

In order to compare margins of investment managers, the margin should be calculated on the investment advisory revenue rather than the total revenue. By eliminating the distribution revenue and expense, a better picture of the true margin of the manager can be ascertained.

Exp as % of inv adv rev

TROW

JNS

EV

BEN

BLK

IVZ

LM

Average

Compensation

38.2%

42.9%

37.7%

27.3%

38.9%

33.2%

52.1%

38.6%

Occupancy/facility/tech

4.2%

6.3%

7.3%

11.8%

7.4%

Other

8.3%

12.8%

15.8%

6.1%

23.2%

7.4%

8.6%

11.7%

50.6%

55.7%

53.5%

39.8%

62.1%

47.9%

72.4%

54.6%

The table shows TROW has better than average margins, but not the best in the industry.

TROW has a valuation below its peer average at 14x versus 15.5x forward year eps. I expect TROW to earn $4.81 over the coming year, and TROW has $13.80 in net cash per share. I expect TROW to earn $5.30 in 2 years time, and I expect their forward pe multiple to expand from 14x to 15.5x. The 1-year price target of $101 is 25% above today's price of $81. The $101 price target is 15.5x multiplied by earnings of $5.30 plus $13.80 of net cash per share plus $5.05 in free cash flow per share generated over the next year.

In summary, T. Rowe Price has the highest ROIC and growth rate of investment managers, and their business model of no-load funds and low distribution fees creates a competitive advantage. Management is prudent stewards of capital as evidenced by their exemplary ROIC. In addition, management's choice of a low-fee investment offering generates higher growth rate of AUM and revenue. The price target of $101 offers a 25% return and is achievable with 12% revenue growth and 16% earnings growth.

Source: T. Rowe Price Offers 25% Upside