Introduction and Thesis
The coronavirus induced sell off continues to pummel stocks worldwide. This has now been compounded by the oil price war. We are likely to have more down days. But with that said, there are bargains to be had now. One stock that I will likely buy is BlackRock Inc (NYSE:BLK). BlackRock is down over 25% in the past month alone. I have written about BlackRock before in my article entitled “BlackRock’s Global Industry Leadership and Undervaluation Make It A Buy.” BlackRock’s top line and thus bottom line are sensitive to market fluctuations. This likely explains the large drop in stock price in the past month. However, it is one of my two favorite asset managers due to the company’s ability to organically gain assets under management or ‘AUM’. This is driven by market leadership in passive investing, specifically ETFs. But since BlackRock is down over 25% in the past month, the earnings multiple has compressed to about 13.3X, which is much lower than the market average and trailing 5-year average multiple of ~18X. Simultaneously, the dividend, which is seemingly safe, is now yielding ~3.5%. The company is a Dividend Contender having raised the dividend for 11 straight years. I view BlackRock as a long-term buy.
Source: BlackRock
Overview of BlackRock
BlackRock, which was founded in 1988, is the world’s largest asset manager with over $7.4T in AUM at end of 2019. This is broken down into about 51% equities, 31% fixed income, 8% multi-asset class, and 7% in money market funds. The company is one of the market leaders in passive investing and about two-thirds of AUM is in passive strategies. BlackRock’s iShares ETFs are arguably the crown jewel of the company’s product line up and is the global market leader. The other important aspect of BlackRock that is less well-known is its proprietary ‘aladdin’ platform. This is a technology that combines risk analytics, portfolio management, trading execution tools, and investment operations tools.
BlackRock’s Revenue and Margins
BlackRock’s AUM growth over the past 20 years has been phenomenal. The company had about $165B in AUM in 1999 and 20 years later at end of 2019 AUM was over $7.4T. This has supported both top line and bottom line growth. In the past 10 years revenue has increased to over $14.5T supported by organic growth and the acquisition of Barclays Global Investors in 2009. BlackRock is one of the few asset managers that is able to generate positive net flows. This combined with the 10-year bull market has driven the top line despite industrywide fee compression.
Source: TIKR.com
BlackRock’s competitive advantage as the market leader in passive investing especially ETFs and its scale, gives BlackRock the long-term ability to grow AUM through positive net inflows. This is in contrast to many active asset managers who are suffering from net outflows. For instance, in Q4 2019, BlackRock had $$129B in net inflows. In fiscal 2019, net inflows totaled $429B, a number that exceeds the AUM of many small-to-medium sized asset managers.
Source: BlackRock Q4 2019 Earnings Release Supplement
Note that BlackRock gross margins and operating margins have come down since 2015. But since then they are trending up again. It is unlikely that margins will return to pre-2015 averages due to industrywide fee compression. But with that said, BlackRock is a very profitable company. Net profit margins are trending up. This is probably due to the scalability of the passive fund and ETF model. Funds need little in the way of extra incremental costs since these funds only track an index.
BlackRock’s Dividend and Safety
BlackRock’s dividend is well covered by both earnings but safety is less convincing from a free cash flow perspective. Note that BlackRock has grown the quarterly regular dividend in every year since it was first initiated in 2003 except from 2008 to 2009. This was during the Great Recession. The most recent increase in the quarterly regular dividend was approximately 10% to $3.63 per share.
BlackRock’s consensus 2020 earnings per share is $31.60 and the forward annual dividend is only $14.52 giving a payout ratio of ~46%. This is a good value and well below my threshold of 65%. BlackRock has maintained a payout ratio roughly between 40% and 50% over the past 10-years. I expect this to continue into the future. If the dividend increases 6% annually and earnings per share increases 8% annually for the next several years, the payout ratio will range from 42% to 46%. These are decent and acceptable values for me.
The dividend is less safe from a free cash flow perspective. In 2019, BlackRock had operating cash flow of $2,884M and capital expenditures of $254M giving free cash flow of $2,630M. In 2018, the regular dividend required roughly $2,096M. This gives a dividend-to-FCF ratio of ~79%, which is above my threshold of 70%. But still, BlackRock’s enormous scale and AUM provides some confidence that free cash flow is sufficient to pay the dividend except during severe market downturns.
BlackRock's balance sheet is also very conservative for a company of its size. Total borrowing at end of fiscal 2019 was $5,150 in long-term debt that was offset by $7,981 in cash, equivalents, and tradable securities. The net cash position adds to the dividend safety and provides confidence that it will be paid in the future even with a severe market downturn.
BlackRock’s Valuation
Now let’s examine the valuation of BlackRock. The forward price-to-earnings ratio based on consensus 2020 adjusted EPS of $31.60 is now about 13.3. This is below the trailing average over the past decade of ~18. It is also much lower than that of the broader market. We will use 17.0 as the earnings multiple accounting for fee compression and market volatility. I obtain a fair value of $537.20. Applying a sensitivity analysis using P/E ratios between 16.0 and 18.0, I obtain a fair value range from $505.60 to $58.80. The current stock price is ~79% to ~89% of my estimated of fair value. The current stock price is ~$419.01 suggesting that the stock is undervalued.
Estimated Current Valuation Based On P/E Ratio
P/E Ratio | |||
16.0 | 17.0 | 18.0 | |
Estimated Value | $505.60 | $537.20 | $568.80 |
% of Estimated Value at Current Stock Price | 83% | 78% | 74% |
Source: dividendpower.org Calculations
How does this compare to other valuation models? Morningstar is known to use a fairly conservative discounted cash low model and provides a fair value of $570. The Gordon Growth Model gives a fair value of $660 assuming a desired return of 8% and dividend growth rate of 6%. An average of these three models is ~$589.07 suggesting that BlackRock is very undervalued at the current price.
How does BlackRock compare to other asset managers? There are really no publicly traded passive asset managers to make a comparison to. Hence, we make the comparison to three other active asset managers: T. Rowe Price (TROW), Blackstone Group (BX), and Franklin Resources (BEN). The comparison indicates that BlackRock is likely undervalued relative to some competitors but not all active asset mangers.
Technical Comparison of Valuations
BlackRock | Blackstone Group | T. Rowe Price | Franklin Resources | |
Price-to-earnings ratio [FWD] | 13.3 | 15.3 | 11.9 | 7.6 |
EV-to-EBITDA [TTM] | 4.6 | -- | 10.5 | 4.6 |
Source: Dividend Power and Seeking Alpha
BlackRock is a reasonably safe stock. The company has the advantage of its scale, iShares platform, and market leadership. But note that this is a volatile stock with a trailing 5-year beta of ~1.5. Morningstar gives it a wide economic moat with a stable trend. Value Line gives the stock a financial strength rating of ‘A+’, a stock price stability of 80, and an earnings predictability of 90. The Dividend Power score is 9.16 [out of a scale of 9.0] due to the double-digit dividend growth, and relatively low valuation payout ratio but offset by the high beta. But with that said, this is a good value.
Final Thoughts On BlackRock
BlackRock is an asset manager that has demonstrated the ability to organically grow AUM. This is unlike most of its competitors due to the trend for retail and institutional investors to prefer passive strategies. This may change in the future but for now the trend is in place. The combination of market leadership, ~3.5% dividend yield, and reasonable dividend safety are attractive characteristics. On the other hand, the stock is volatile and revenue and thus earnings are dependent on the stock market valuation. The downward trend in global stock markets resulting from the coronavirus scare and the large drop in oil prices will likely dent revenue and earnings. But in my opinion, the positives outweigh the negatives for those that are more tolerant of volatility. Hence, I view the stock as a long-term buy.
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