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Janus Henderson's 7.1% Dividend Yield and 6.2% Buyback Yield Make the Stock Attractive
As a publicly listed mutual fund management company, Janus Henderson Group (JHG) has had a rough few years. But recently its assets under management have begun rising again, despite negative assets sales (i.e. redemptions exceeding sales) because of fund performance. As a result, its free cash flow has returned to positive territory from negative last quarter. Its high dividend yield of 7.15% is more than covered by free cash flow.
In addition, management committed on its earnings call to finishing the $200 million buyback program by the end of this year, along with an estimated $38 million in buybacks related to sterilizing stock-based compensation. My estimate is that there is $132 million in total buybacks remaining this year out of a total $238 million buyback program. This gives JHG stock a 6.2% annual buyback yield going forward, bringing the total yield to over 13.3%. This is very attractive for investors. My estimate comparing JHG with its peers is that stock is worth $25.64, or 27.4% higher than today's price.
AUM Rose in H1 Despite Fund Outflows
Assets under management ("AUM") rose 9.5% in Q1 and Q2 to $359.8 billion as of June 30, 2019. This was despite fund outflows, which have been falling. This can be seen in the table and charts below.
Source: Hake, from company documents
Net fund flows for Q2 were -$9.2 billion, mostly from some specific, non-generalized mutual fund areas, like quantitative and global emerging markets:
This shows that in Q2 there were $25.4 billion in redemptions, and $15.6 billion in sales of new mutual fund assets, for a net outflow of $9.8 billion. That's up from $7.4 billion in net outflows in Q1. Also, you can see that JHG has had almost 2 full years of net outflows. Nevertheless, as pointed out above, the quarter-end AUM is still up $31.3 billion to $359.8 billion from $328.5 billion at the end of 2018.
How did AUM rise, if fund outflows have been net negative? Simple. The market rose and pushed up the valuation of the remaining AUM. A major reason is that over two-thirds of JHG's AUM are in either equities or quantitative equities:
So, in effect, JHG stock acts as a long-term option, if you will, on the market in general. More on this theme below.
The net fund outflows are bad news. Management thinks this is going to turn around and spent most of the conference call and presentation explaining how that would happen. The main point they made is that fund outflows came from non-general funds that they manage. For example, Global Emerging Markets lost half its AUM when a team managing the funds left this quarter. But management is acting on their promises. On August 28, 2019, JHG made an announcement that it had hired an emerging markets team from Putnam. So maybe that leak will be stopped up.
Here is the good news.
Janus Henderson's Free Cash Flow Is Very Strong
It turns out that money management firms like JHG are very profitable. JHG reported strong Q2 free cash flow ("FCF"). JHG earned a 25% FCF margin in Q2 (i.e., FCF / Adjusted Revenue). Net income was also strong at $109.4 million, and FCF was $110.4 million, up from a loss in Q1. This can be seen in the table I put together below:
Source: Hake compilation from JHG reports, including Hake estimate
Note that I am projecting full-year 2019 FCF of $306 million based on a normalized 25% FCF margin for H2 2019. (Note that in Q1 FCF was adversely affected by a one-time "other accrual" of -$169 million which made FCF negative in that quarter, but has not occurred either before or since then - management had no comment about this). In fact, you can see from JHG's history that its normal margins range from 23% to 34%. This augurs well for next year's estimates as well. These projections are based on AUM of $374.1 billion by year-end, an increase of 4% from June 30, and resulting revenue. Here is how I estimated adjusted revenue from the AUM assumption:
Source: Hake estimates
This table shows that I estimate the ending AUM for 2019 will be $374 billion, an increase of 4% over June 30. This feeds into the average AUM for the year of $367 billion, just slightly below last year's average AUM (only $704 million below this). I assumed that distribution expenses will be at the average of the past two quarters, or 19.1%, even though Q2 was lower than Q1. Distribution expenses are fees JHG pays to brokers who sell JHG's funds. This reduces gross revenue and leads to the Adjusted Revenue column. JHG focuses on adjusted revenue. So we do too. For example, FCF is estimated as 25.4% of adjusted revenue in the table before this one above, the same as in Q2.
This is a little technical but helps you see how we derived FCF based on a modest assumption on the increase in AUM. I believe this is conservative since AUM increased 9.5% YTD, despite net fund outflows, and I am only assuming a 4% increase from Q2 to the end of the year.
Let's look at how JHG spends its FCF: on dividends and buybacks.
JHG's FCF Covers Its Dividend Payments and 7.1% Yield
Based on JHG's $0.36 per share quarterly dividend, the payments for dividends last quarter cost $68.6 million. So its Q2 FCF of $110.4 million more than covers the dividend. This makes the 7.15% dividend yield very secure. Moreover, it leaves room for buybacks. My estimate is that the average AUM will increase 4% in the second half, and the total year-end FCF will be $305 million. This will more than cover the full-year dividend spend of $275.4 million. All of this is shown in the table below:
Source: Hake estimates
It is interesting to note in the last table you can see that by Q4 the dividend payment actually falls since the per-share amount is set at $0.36 but the number of shares outstanding is lower, due to buybacks.
Management's Commitment to Doing $200 Million in Buybacks
During the conference call on July 31, 2019, JHG management made it clear that it would complete its $200 million share buyback program, in addition to it normal buybacks related to stock-based compensation which I estimate at $38 million, for $238 million in total. It has already spent $106.1 million in the first half alone. Here is their commentary on this, and the related slide in the Q2 earnings presentation:
Source: Q2 JHG Conference call
Source: JHG Q2 Earnings Presentation
Here is our model of how buybacks fit into the FCF model:
Source: JHG SEC filings and Hake estimates
Notice that JHG returned a total of $461.5 million to shareholders last year, and this year the figure is estimated to be higher at $514 million, including both dividends and share buybacks. This is incredible. The amount this year represents 13.3% of its total market value. That is its total yield to investors. In fact, since JHG has $636 million in net cash on its balance sheet ($954 million in cash and securities less $318 million in debt), it represents 17% of its EV.
This is very important. It will bring very real benefits to shareholders. I address these benefits in my article "Launching the Total Yield Value Guide," on August 30 and a related blog on Sept. 3. You can read in-depth in those articles about the six real benefits that buybacks provide to remaining shareholders.
Note that although the buybacks are so high that they exceed the balance of FCF after dividend payments, JHG has plenty of gross and net cash and securities to finance this excess or overage, if you will. This excess is shown as $170 million in a table I inserted above. In fact, theoretically, JHG could continue these $200 million buybacks (not including compensation related buybacks) for over 5 more years after 2019 (i.e. $954 million / $170 million = 5.6 years). That assumes FCF does not rise, which it likely will as AUM increases.
Let's say that JHG continues this "excess" buyback activity for five years, i.e. $200 million x 5 = $1 billion in buybacks. That would lower the $3.6 billion market cap by 30% or so. This assumes the price wouldn't rise, which is not realistic. So somewhere between 20 and 25% of the shares outstanding would be reduced, assuming further price increases.
That is important because, not only does it increase earnings per share ("EPS") for the same amount of net income, but assuming the same payout ratio, buybacks increase the dividends per share that JHG can pay. Buybacks also increase the remaining shareholders' stakes in the company. So buybacks provide real benefits to shareholders over time. This is a major reason why Buffett likes to buy companies which buy back their shares. It increases the "see-through" share of earnings of the underlying company.
JHG Is Very Undervalued Compared to Its Peers
Based on my analysis below, I believe JHG is worth $25.64 per share, or 27.4% higher than today. Here is how I calculated this. First, I looked at the value metrics compared to JHG's peers across five metrics:
Source: Hake estimates, using Yahoo! Finance data for peers
This table shows JHG is cheaper in P/E terms, as well as in terms of EV/Sales and EV/EBITDA. Also, note I did not use adjusted EBITDA, which is significantly higher than EBITDA since non-cash compensation expense is substantial at JHG. Here is how I calculated JHG's EBITDA number:
Source: Hake estimates and Q2 10-Q JHG filing
Next, I use these ratios to compute JHG's true value and then made some adjustments to them:
Source: Hake estimates
Note that I decided to take out the dividend yield comparison to estimate the true value. Part of the reason is that some peers could have much different payout ratios and so theoretically the differences could lead to a skewed valuation for JHG. For example, some might be paying out more than 100% of FCF for dividends, even though JHG isn't. Or they might have a much lower payout ratio. Either way, to simplify things, and to be conservative, I decided to exclude this metric.
Adjustments. Since not all money management firms have the same profitability, and since JHG had net outflows of funds, I made several adjustments to the target price as computed above. The tables below show the basis for these adjustments:
Source: Hake estimates and AUM figures from each co. website
These tables show the basis for the three adjustments. First, JHG has a higher market value / AUM ratio by 33% than the median. So the target price was reduced by 33% since the ratio indicates that JHG is more being priced at a higher valuation than the median. Second, JHG has a higher net income margin than the median, so I increased the target price by 22%. Third, you can see that JHG along with four other fund groups had net outflows of funds. The median though was a 0.3% increase in funds. Since JHG had $9.8 billion in net outflow, which represents 2.7% of its prior AUM, I reduced the target price by the total difference or 3%. These adjustments can be seen below:
Source: Hake estimates
By making these adjustments, the target price for JHG is reduced to $25.64 from $28.47, taking into account these three factors. The bottom line is that JHG is worth 27.4% more than today's price.
What happens with money management stocks is they go down when either the market tanks, as during August 2019, or the results show negative growth in net fund flows like at JHG, and vice versa. In effect, these types of stocks act as long-term options or warrants related to the general direction of the market.
I suspect that when JHG starts showing net positive fund flows, as it rebuilds its global emerging markets and quantitative strategies which caused most of the outflows, the stock will rebound. For example, the new global emerging markets team from Putnam will likely bring in with them loyal client assets from their prior firm. In addition, since JHG's previous team departure accounted for $2.5 billion of the $9.8 billion that left last quarter, and there appears to be another $800 million scheduled to leave, this will help shore up that niche area for JHG. I am confident it will retain those remaining assets.
JHG's largest outflows came from its quantitative equities group called Intech. It represents 13% of AUM and had outflows of $4.1 of the $9.8 total outflows. Management spent a lot of time talking about their performance and indicated their confidence in that team. But they made it clear that further outflows could occur if the performance did not turn around. So this is actually a negative catalyst for the future, but it has a boundary of sorts. The most drastic outflow would be 13% of AUM if all those assets left, which does not seem likely. JHG's net inflows would suffer if those were not made up by other inflows. However, I believe the stock price already reflects the impact of a good portion of those assets leaving, which is not likely to be the case.
Management addressed several questions about the performance at Intech. Here is their best answer on how that division expects to turn around:
Source: JHG Q2 conference call
So management expects that Intech's good YTD performance will essentially help dampen potential outflows in that particular strategy.
Another catalyst is the large dollar amount of buybacks. If you think about it, the large buybacks are a good thing while the stock is cheap, like it is now. This allows more shares to be deducted from the share count for every dollar share repurchase. The also acts as a major buyer for the stock while it's languishing. And I have shown that it leads to higher dividends and EPS.
Summary and Conclusion
Despite net outflows, JHG has had higher AUM levels in Q1 and Q2. Free cash flow is strong, more than covering the high dividend payments and dividend yield. Moreover, JHG has indicated that it will continue its $200 million buyback program, in addition to its normal sterilization buybacks for stock-based compensation. My estimate is that the stock is worth $25.64, or 27% higher than today's price.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.