T. Rowe Price Group (NASDAQ:TROW) is a traditional asset manager with most of its Assets under Management (AuM) in Equities and with a very good track record, both regarding investment performance and asset growth. However, the traditional asset management industry is currently facing some structural issues, namely the shift from active to passive investing.
This is putting pressure on AuM growth and fees and T. Rowe isn't immune to this threat, despite its above-average historical investment performance. Despite these headwinds, T. Rowe offers a compelling shareholder remuneration through dividends and share buybacks, which is appealing to dividend growth investors.
T. Rowe Price is a Baltimore-based asset management company founded in 1937. It is a global investment management organization, providing a broad array of mutual funds, sub-advisory services, and separate account management for individual and institutional investors, retirement plans and financial intermediaries.
T. Rowe's Initial Public Offer (NYSEARCA:IPO) was in 1986. The firm is listed on the NASDAQ Global Select Market and has a market capitalization of about $16.5 billion. Its main competitor are other global asset managers, like BlackRock (NYSE:BLK), Franklin Resources (NYSE:BEN) or Invesco (NYSE:IVZ).
At the end of 2016, T. Rowe had more than $800 billion in AuM. More than half of its AuMs are in Equities, followed by Asset Allocation while Fixed Income and Retirement date portfolios have smaller weights. The company has 16 offices worldwide, but only about 5% of its AuM come from investors which are domiciled outside of the United States. One of its key goals is to increase its international distribution and increased the weight of international investors within its AuM.
T. Rowe's investment performance is quite good having a strong track record compared to its peers. More than 50% of its funds are in the first quartile of investment performance compared to similar funds in the respective category, measured by long time frames between 3 and 10 years of historical performance. Additionally, more than 80% of its funds have 4 or 5 stars from Morningstar, a very good achievement for the firm.
These two factors traditionally are strong factors that support growth in AuM in the industry and indeed T. Rowe has a very long history of AuMs growth. For instance, in 2012 and 2013 its AuMs increased by about 20% per year, but this has slowed considerably recently due to some structural issues which are affecting the asset management industry.
Asset managers' fund sales are still growing at moderate rates, but the industry is increasingly challenged to find growth. The rise of passive investing is putting structural issues on asset growth and the level of management fees and this trend is not expected to reverse anytime soon. Indeed, investors have increasingly moved funds to passive investing over the past couple of years due to poor performance of active managers. This is also putting pressure on management fees which have decreased globally over the past few years, as investors embrace ETF's and other low-cost products. This is a reality that affects the whole asset management industry and T. Rowe Price isn't immune to it, even though its investment performance has been above-average during the past few years.
This industry landscape would theoretically support consolidation moves among traditional asset managers, but the first meaningful public attempt between Janus (NYSE:JNS) and Henderson (OTCPK:HNDGF) has not been received positively. Investors are skeptical of revenue synergies and consider that it will not address either company's sales or capacity issues. This may limit other public asset managers from following the same route, maintaining the company's focus on organic growth which is looking increasingly difficult to achieve within the asset management industry.
Therefore, asset managers with passive investing operations and more international reach, like Invesco or Blackrock, have better prospects than traditional asset managers, like T. Rowe. The firm acknowledges this weak operating environment and is targeting AuM growth of only 1-3% over the next three to four years, mainly due to headwinds from the shift to passive investing and pressure in the retirement business.
Regarding its financial performance, T. Rowe has delivered relatively good results over the past few years, due to growing AuMs that ultimately lead to higher revenues and profits. Like its asset managers' peers, one of the most important factors for its revenues and earnings growth is net assets inflows or outflows, which leads to higher or lower commissions.
More recently, T. Rowe has delivered relatively good results even though its growth has slowed considerably compared to a few years ago. Its revenues were practically unchanged at $4.2 billion in 2016 compared to the previous year, while its net operating income dropped by 8% due to higher operating expenses. Its net income decreased slightly to $1.2 billion and its earnings-per-share increased a little bit to $4.75, due to a lower number of shares outstanding. Its return on equity (ROE) was about 22%, a very good level of profitability.
Even though T. Rowe has very high levels of profitability, this is being pressured by the increase in costs. This is justified to a large extent due to existing investments in product, distribution and technology, but also because of increasing regulatory complexity and costs. Over the next three years, expenses are expected to increase by 5-10% per year until it stabilizes in 2019. This is another important drag for earnings growth during this period, making organic AuM the most viable source of growth in the coming years.
These results were much weaker than a few years ago, when T. Rowe reported double-digit revenues and earnings growth, but even more worrisome was its net outflows of $5 billion in the last quarter of 2016 and what it means for its future financial prospects. The firm explained that these outflows were largely attributable to institutional and intermediary clients relocating to passive investments. This is a structural shift in the asset allocation for these clients and this trend is not expected to revert soon. Therefore, T. Rowe's AuM growth expectations may be optimistic in the next few quarters or even years, being a strong headwind for revenue and earnings growth in the foreseeable future.
Regarding its balance sheet, T. Rowe has a very strong position given that it is debt-free and has an ample liquidity position. This allows the company to take advantage of attractive growth opportunities, but also provide an attractive shareholder remuneration both through dividends and share buybacks. Indeed, over the past three years, T. Rowe has returned more than $4 billion to shareholders in dividends and share repurchases.
T. Rowe has a very good dividend track record with 30 consecutive years of dividend increases since it is listed, making it quite attractive for dividend growth investors. Over the past five years, its dividend has increased at about 12% per year, a very good growth rate. More recently, T. Rowe has paid special dividends in 2012 and 2015, increasing even further its shareholder remuneration. Its payout ratio including share buybacks is close to 100% of its earnings and this seems to be sustainable given the company's strong balance sheet and liquidity position.
In 2016, its regular dividend was $2.16 per share, an increase of only 3.8% from the previous year. This was a clear slowdown in its growth pace and reflects the issues the firm is facing more recently. Like most U.S. companies, its dividend payment frequency is quarterly and at its current share price its dividend yield is close to 3.2%. According to analysts' estimates, its dividend should continue to grow over the next three years at about 6% per year, but this may be revised downwards in the next few quarters considering the fundamental issues the traditional asset management industry is currently experiencing.
T. Rowe has very good fundamentals and an attractive business profile, but like its peers is suffering from the structural shift from active to passive investing. This has led to a strong decrease in its growth and this situation is not expected to revert in the next few years. Despite this, its good profitability, the potential for international expansion and strong balance sheet enable it to offer an attractive shareholder remuneration policy, which is quite appealing to dividend growth investors.
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