BlackRock (BLK) has "enjoyed" the raging bull market as it posted record results for 2017. It was about two years ago when I looked at the prospects for the world's biggest money manager, as I liked the stability of the business and high payout yield to investors (defined as buyback + dividend) in light of the low interest rate environment.
Shares traded at $350 at the time, as I actually initiated a modest stake later that year when shares dipped. Ever since shares have seen great momentum (especially in recent months) as they hit a fresh high of $555, warranting a review of the situation.
BlackRock is a giant in the world of money management and currently manages $6.3 trillion in assets, as it net-gained over $1.1 trillion in assets under management in 2017 alone. Most of this came from rising (equity) markets although the company recorded $367 billion in net flows as well in 2017, indicating that over a billion a day was invested each calendar day last year.
This was driven by the continued success of iShares, responsible for $245 billion in net inflows. Little over half of assets under management are invested in equities, with fixed income products comprising nearly a third of the assets under management.
Despite the trend of pressure on fees, these are growing assets which allow BlackRock to continue to report growing sales and earnings. Sales were up 12% in 2017 to $12.49 billion, equivalent to 0.20% of the assets under management. Revenue growth was aided by rising equity markets as investment advisory performance fees doubled to $594 million. These volatile performance fees make up less than 5% of annual sales, as most of BlackRock's revenue streams are very stable (although they of course move along with fluctuations in the market).
While the revenue/AUM percentage is very small, it is the passive nature of large parts of its business and smart aid of technology which still allow BlackRock to report very impressive margins. In fact, operating profits were up 15% in 2017 to $5.27 billion, for operating margins of more than 42%.
With interest payments totalling $200 million a year, that leaves after-tax earnings of $4.0 billion if we assume a 20% effective tax rate going forward. With 164 million shares outstanding, that works out to earnings power of $24-25 per share. It should furthermore be noted that as of the third quarter, BlackRock operated with a modest net cash position of $1.1 billion, creating a very strong financial base.
While the cash balance is substantial and borrowing power is significant, net cash holdings are relatively limited at nearly $7 per share. Trading at $555 per share, with earnings power seen around $25 per share, multiples of 22 times earnings are pretty steep. This is the case, even if we account for continued inflows and a good start to the year of 2018.
Incredible Growth Story
BlackRock was founded in 1988 and ever since has become a rapidly growing asset management firm. Following rapid growth in the 1990s, the company went public back in 1999 at a mere $14 per share. That means that first-day investors have seen great gains, having increased the value of their investment 40 times (even excluding dividends). This works out to returns of an average of 23% per year, as dividends of $10 per share in 2017 are rapidly approaching the offer price back in 1999! Savvy dealmaking and organic growth made that the company grew quickly and shares rose to $200 ahead of the crisis.
The company did relatively well during the crisis as shares "only" halved in part because the company benefited from the distress at British bank Barclays (NYSE:BCS) and it acquired its lucrative iShares business from that bank. Shares were actually range-bound for quite a while and did not exceed the $200-mark again until 2012. This followed the success of the integration of iShares, the understanding that this was a great deal for BlackRock and the benefit of a recovery in financial markets.
Fair Price For Quality
BlackRock was often trading at market equivalent multiples or a little less, which in the past looked appealing to me given its leadership position, continued asset inflows, natural tendency of markets to rise, strong balance sheet and predictable business model. This was in part offset by concerns about fee pressure in the move towards passive investments.
This appeal has disappeared in 2017 in my eyes. The 22% increase in assets under management and 12% increase in sales in 2017 was more than outpaced by a roughly 45% increase in the share price over the same time period. This makes that multiples have expanded a great deal from 17-18 times earnings to 22 times earnings in the time frame of merely 12 months.
I see that strong performance and continued increase in asset prices, combined with a resilient and stable business model, have now translated into a premium multiple. At these multiples, I think that the valuation is fair or even a bit full despite the leadership and current growth, offset in part by concerns about the rich valuations in asset markets and pressure on fees.
As a result, I think that current levels offer a perfect opportunity to cash out some of my investment, as I am using these fresh highs as a perfect opportunity to take some profits in what remains a great long-term investment case.
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Disclosure: I am/we are long BLK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.