With Invesco (IVZ) trading near its 52-week high after strong performance, long investors are starting to fear that the upside is limited. While I am by and large bullish on financials, I believe that Invesco is only a "hold" right now. Financials carry significant risk, and in Invesco's case, investors have 78% more volatility than that of the broader market. If investors are willing to take on that risk, they ought to earn an abnormally high return if the fundamentals prove strong. Invesco's fundamentals are strong, but I believe they are now fairly valued.
In this article, I will run you through my DCF model on the company and then triangulate the result against a review of the fundamentals at Wells Fargo (WFC) and First Niagara (FNFG). I find that Wells Fargo is the true value play right now.
First, let's begin with an assumption about the top-line. Invesco finished FY2011 with $4.1B in revenue, which represented a 17.3% gain off of the preceding year. I model 13.5% per annum growth over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold as 28% of revenue versus 49% for SG&A and 2.2% for capex. Taxes are estimated at 33% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $24.64, implying just 6% upside.
All of this falls within the context of strong performance:
"[L]ong-term investment performance remained very strong for Invesco across the board in the first quarter. And again, we continue to see some areas of exceptional investment performance. And on the back of the strong investment performance, we contributed to a continued trend of positive long-term net inflows for the firm in spite of the continuing volatility in the marketplace. This is the seventh consecutive quarter of net positive long-term flows for the firm, which we think is quite strong in consideration of the marketplace that we evolve and operating in.
And importantly, during the quarter, we're raising our quarterly dividend 41% to $0.1725 per share, reflecting continued confidence in the fundamentals of our business. And during the quarter, we've repurchased 3.1 million shares for $75 million".
From a multiples perspective, Wells Fargo is cheaper than its peers. Invesco trades at a respective 14.4x and 10.2x past and forward earnings versus 11.5x and 9x and Wells Fargo and 14.6x and 8.4x for First Niagara.
Consensus estimates for Wells Fargo's EPS forecast that it will grow by 16.3% to $3.28 in 2012 and then by 12.2% in both of the following two years. Of the last 19 revisions to EPS, 16 have gone up for a net change of 1.3%. Assuming a multiple of 12.5x and a conservative 2013 EPS of $3.65, the stock would hit $45.63 for 37% upside. With a dividend yield of 2.7%, downside is also fairly limited. Accordingly, the stock is rated a solid "buy" on the Street (source: NASDAQ).
Consensus estimates for First Niagara's EPS forecast that it will decline by 9.2% to $0.89 in 2012 and then grow by 15.7% and 12.6% in the following two years. Assuming a multiple of 12.5x and a conservative 2013 EPS of $1, the stock would hit $12.50 for 44.7% upside. This makes First Niagara a highly attractive stock, especially in light of the 3.7% dividend yield. With that said, all 16 of the last revisions to EPS have gone down for a net change of -6%. The stock is surprisingly less volatile than the broader market and, ultimately, safer than what many bears would have you believe.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer.