FinancialsFred's  Instablog

T. Rowe Price's 3Q-11 earnings ended up missing the street as noted on SA. It looks as though some meaningful EPS downgrades could come due. The current consensus 2012e of $3.12 could come under further pressure as several factors trickle through:
(i) Lower AUM in 3Q-11, especially in equities products. Post the 3Q carnage, the firm's ending AUM of $453.5B were -9.5% below their average level during 3Q-11, and down 5.9% from the starting level of 2011. This dynamic creates some earnings comp headwinds going forward that are significant; a strong and sustained equity market bounce would be the counterbalance needed to fix this.
(ii) The sustainabliity of TROW's net flows advantage may be called into question after 3Q reported outflows of -$2.6B (first quarter of outflows since 2008). This issue plays into the P/E multiple expansion versus compression dynamic, which in the case of TROW looks like the risk/reward is skewed towards potential compression since the stock trades at a premium to its peers ($51 share price is 16.3x the 2012e consensus EPS for TROW versus peers trading on 11x-12x range). This article in Barron's notes the street's concern about the stock's premium rating blogs.barrons.com/focusonfunds/2011/10/25/trow-not-immune-from-deteriorating-macro-conditions-in-q3/ 

Where could TROW go from here based on multiple compression and earnings downgrades?
Step-1 - Earnings downgrade potential on 2012e consensus: The current 3.12 EPS figure looks like it's about 10% higher than the annualized 3Q-11 EPS (0.71ps). Assuming that downgrades get 2012e closer to a 6% annualized uplit then you are looking at $3.00 per share.
Step-2 - Applying a lower P/E multiple than the current 16.3x Assuming that TROW's P/E premium compresses relative to the asset manager peer group by reaching a 14x-15x multiple, then the shares could slide towards a $42-$45 range. This zone could become a support zone for TROW as the shares would be yielding closer to 3% (based on $1.24ps annualized DPS) and would be near the lows reached in Q3-11. In the event of significant stock market weakness, then P/E compression towards 12x-14x (more volatility) could also be seen.

On the upside, it looks as though multiple expansion for TROW would require a significant stock market rally, and even then investors and traders might look to take a "wait and see" attitude towards TROW until it next reports earnings and fund inflows (Q4-11 earnings will be due in January 2012).

Met Life shares have been throttled hard this quarter alongside its sector peers

• MET shares are -39% this quarter to 26.8, which compares to the likes of PRU (43.93 = -31%); PFG (22.89 = -25%), AMP (39.77 = -31%), and LNC (15.3 = -46%).

Quite a few macro overhangs are sitting on top of the shares at the moment

1. Weak Equity markets- hurts their large Variable Annuity business, in terms of potential for new sales growth and the adverse effects of mark to market (hits fee revenues and affects any guarantees to policyholders)
2. Low interest rates - hurts the potential to earn adequate interest spread. Although MET are on record as saying they have hedges in place to help weather a low interest rate environment in the coming years, it does look as though the >30% discount to book value shows us the market fears a more prolonged Japan style scenario for future interest rate trends.

Maybe the market is afraid of a repeat of 2008 when the Met Life book value took a -40% hit (falling from 45.44 per share down to 27.33 per share).

Assuming such a scenario repeats itself (although the asset classes such as the MBS/ABS that contributed to the 2008 hit to BV are not replaying identically in 2011) then at 26.8 area, the shares might be closer to about 1x BV.

What is interesting is that MET expect in Q4-11 to have a $4.8B excess capital level for dividend increases and buybacks. If that excess capital level can weather the current capital markets headwinds, then it would be equivalent to 16% of the stock's current market capitalization...which isn't bad, and could set the stock up nicely for any market rebounds either in late 2011 or during 2012.

BlackRock (BLK) reports 3Q-11 earnings this week (Oct. 19th). The stock has been beaten down since the end of 2Q-11, falling -18.7%. This decline has been roughly on par withe the decline in the XLF (-17.9%) and far more severe than the SPY (-11.2%). The stock at 155.9 is trading on 13x 2011e and 11.8x 2012e, multiples that are roughly comparable to the asset-managers sub sector as well as the S&P 500 (i.e. 1224 is roughly 12x a $102 estimate for 2012e.....though this estimate is considered +20-30% optimistic by recession forecasters).

The BLK P/E rating is on EPS estimates that have been shaved by c,-10% in the past 90days, so its safe to say that the street has attempted to factor in the effects of the 3Q-11 stock market tumble on BLK's fee revenues.

During September 2011, BLK traded down to lows seen during the past couple of years.Using a P/E on trailing EPS (to stay away from moving targets on estimates), the recent lows in the $140 range rated the stock on a <13x trailing P/E. The last few years have seen ranges where the trailing P/E got as low as 11.6x

• BLK lows in 2010 138.4 = 18.9x P/E (2009 Adj EPS 7.32) / High 243.8 = 33.3x P/E
  
• BLK lows in 2009 88.91 = 13.6x P/E (2008 Adj EPS 6.52) / High 241.66 = 37.1x P/E
  
• BLK lows in 2008 94.78 = 11.6x P/E (2007 Adj EPS 8.15) / High 249.37 = 41.8x P/E.

If the stock market is telling us that BLK estimates will come down further, then playing the waiting game:
BLK’s 2011 EPS likely to be ahead of 2010 despite market correction so far: BLK adj EPS grew solidly in 1H-11 (+25% YOY to $5.96, AuM +16% YOY) setting up 2H-11 earnings to weather some market weakness before 2011/10 growth is at risk. However, the current 2011e EPS 11.99 (+10% growth) appears to factor < +5% growth in 2H-11/11; this is likely to be downgraded after 3Q-11 EPS (performance fee related earnings are skewed to the 4^th quarter and can be a key swing factor). BLK’s 2012e EPS estimates (EPS 13.17; cut by more than 10% in last 90 days) have borne more of the brunt of the market correction in 3Q-11.

BLK’s financial performance includes typical qualities of a well-run asset management franchise operating at scale: 

• Solid pre-tax profit margins – BLK 1H-11 adjusted margins were 39%, and there’s room for upside longer-term with positive operating leverage available on the non-compensation costs side (non-comp costs = 28% of revenues in 1H-11, down from 37% in 2007). Granted, it’s likely that street estimates account for this as the BLK CEO has publicly stated the goal of 40% margins.
• Diverse management fees profile: 1H-11 revenues mix was 56% equities, 20% fixed income, 24% from multi-asset class/ alternatives/cash management products. 

Fundamental story – where does the future lie for BLK?

• Non-USA remains a future growth opportunity – BLK’s revenues mix remains quite tilted towards the USA (current mix is 68% Americas, 27% Europe, 6% Asia-Pac = quite low), so there is room to grow.
• i-Shares ETFs expected to grow faster than overall mutual fund industry– the ETF industry’s above average  growth remains a secular trend to watch (www.ici.org has some helpful industry factbooks). BLK’s i-shares franchise is leading market player alongside the SPDR ETFs (at STT) and the Powershares ETFs (at IVZ). I-Shares is one of BLK’s best growth engines: contributes 17% of BLK's AUM ($611B/$3.65TR) and 24% of revenues ($1.1B/$4.6B 1H-11) and is growing at a faster pace than the rest of BLK's business.
• Multi-Asset class products have robust growth: BLK’s Multi-Asset Class funds are contributing strong growth alongside the i-shares franchise. Some of the key trends we can see in BLK’s Multi-Asset Funds in 1H-11 include: grew AUM +56% YOY and revenues +31% YOY and represents 10% of overall BLK revenue base. These products appear to earn higher fee-margins than the overall average at BLK (i.e. fees/AUM of 0.40% range vs. BLK’s overall 0.20-0.25% clip).

Looks like an entry in the $140-160 zone could get to 20-30% upside:A steadying of equity markets could see BLK set up for a rebound in its P/E multiple to the mid-teens (somewhere in mid range of P/Es seen in 2009-2010). Assuming about $13.00 of run-rate EPS after absorbing the market correction and staging a bit of a bounce, then a fair value range of $180-210 per share would be in a 14x-16x P/E range, depending on equity markets finding some footing. The upside range is using P/E multiples comparable to where the S&P could trade, however historic P/E ranges above show that when BLK rips to the upside, its P/E can expand to levels well above the 14x-16x range. A buy zone of $140-$160 can produce +20-30% upside into the $180-$210 upside range.

Notable Risks:

• Equities market sensitivity of revenues and earnings: This is a general asset manager stock risk that applies to BLK’s revenues mix (56% equities management fees). Worth noting that in the 2009-08 bear market, BLK’s Equity Funds AUM fell -38% YoY in 1Q-09 (this was in line with the depreciation in the SPY of -38% during the same period).
• ETFs are not without headline risks: The Financial Stability Board (FSB) has warned of potential financial stability issues arising from recent trends in ETFs, in particular the growth of synthetic ETFs that use OTC derivatives. Although BLK’s ETF product line up is more focused on “physical ETFs” than on synthetic ETFs this is an issue/controversy that can be typical of a “growth” story where there is a “fluid situation” that requires careful attention. The recent news about the UBS rogue trader (Delta-1 hedging of synthetic ETFs) is a case in point.
• Hedge Fund performance fees are lumpy and skew to the 4^th quarter: Performance fees contributed 6.3% of BLK’s revenues in 2010, up from 4.3% in 2009 and 3.5% in 2008. August 2011 was cited as one of the weakest performances ever for the hedge fund industry, this is an area capable of producing an earnings “miss” for the street.
• The Usual Macro Risks....since its a Financial Services Stock – a stock like this is market sensitive, so you simply cannot ignore the plethora of macro risks sitting atop equity markets: global economic growth concerns, debt sustainability concerns in USA and Europe, Eurozone existential crisis etc. etc.

DPS yield can provide support if bear market is not too prolonged and severe  At $155.9 BLK is yielding 3.5% ($5.5ps), a decent yield compared to the asset management peers where the only stocks yielding near 3% are IVZ and EV (AB is structured as an LP and has a high yield); BLK's yield also compares nicely to traditional yield stocks like banks where the big cap choices for a yield in the 2-3% range are JPM, WFC and USB.

Sources: Company reports, Capital IQ data on yahoo finance, proprietary work

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.