- 8% Dividend Yield which is extremely attractive.
- 4Q20 Net Inflow of $900mn into Diamond Hill’s funds.
- Reported EPS in 4Q20 up 13.8% YoY.
- As of 2020, net cash directly held by Diamond Hill was 41% of market cap.
- Stock repurchases of 5% of shares outstanding in 2020.
8% Dividend Yield, 7x ex-cash P/E, 9% FCF Yield
The Diamond Hill Investment Group (NASDAQ:DHIL) is an active asset manager, with a 20-year history, $26bn in AUM and a value investing philosophy. They had a mixed set of 4Q20 results, which despite a decline in revenues was however offset by higher investment income, leading to a net income attributable to common shareholders gain of +7.1% YoY. Our buy recommendation on the stock is predicated on its consistent fund performance, significant cash on the balance sheet, ability to generate robust free cash flows, attractive and inexpensive valuations. 2020 net cash to market cap [at current prices] stands at 41% and the company generated an estimated 2020 FCF yield of 11.9%.
We have updated our model following the full year 2020 results [see attached], and looking ahead, in 2021/2022 we expect Diamond Hill’s FCF yield to be at 9.3%/9.8%. Given this, a low P/E in 2021/2022 of 12.1x/11.2x, and 2020 expected dividend yield of 8.2%, we think the stock offers a favorable risk-reward scenario for investors. Importantly, ex-cash P/E [after deducting related interest income after tax], looks very attractive for the company and stands at 7.3x and 6.8x for 2021 and 2022 respectively.
$200.00 Target Price Implies 41% Potential Upside
Diamond Hill’s stock has performed well and is up 25% since our initiation in July 2020. We now value Diamond Hill at an ex-cash P/E of 12x, using our 2021 EPS estimate, and add it to current net cash per share [after deducting related interest income after tax] to arrive at a target price of $200.00. This represents a potential upside of 41% from current stock levels. At the $200.00 target price, implied P/E is 16.5x.
Higher Inflows Highlight of 4Q20
Diamond Hill reported 4Q20 numbers with a significant quantum of inflows. For the quarter, net client inflows totaled $900mn, and stood at $1.5bn for the year ended 2020. With this, Diamond Hill’s AUM as at end December 2020 was $26.4bn, though average AUM for the year was meaningfully lower at $21.9bn because of the market downturn in 1Q20. For the year ended 2020, net client inflows have come to fixed income strategies.
AUM [Source: 4Q 10Q]
Revenues for 4Q20 fell 2.4% YoY as the mix of AUM tilted towards lower fee-paying strategies. Reported net operating income too declined by 32.5% YoY on higher operating expenses. A 79.9% YoY jump in investment income led to the 7.1% YoY increase in net income attributable to common shareholders. EPS attributable to common shareholder for 4Q20 was $4.54 against $3.99 in 4Q19. For full year 2020 however, Diamond Hill reported a 24.8% YoY drop in EPS attributable to common shareholders on lower revenues, operating margins and investment income.
Commenting on the results, Heather Brilliant, CFA, President and CEO said:
Operating results were negatively impacted by the severe market downturn in response to the pandemic, as well as a mix shift into lower fee strategies. However, we believe our higher assets under management at year end and positive client flows speaks to the quality experience our investment team and associates deliver for clients.
Brandywine Global to Acquire Diamond Hill's Fund
In February 2021, Diamond Hill had announced that Brandywine Global would acquire the company’s High Yield and Corporate Credit Funds, Brilliant added. The company is now looking to “develop new, long-term oriented investment offerings that meet client objectives and align with their investment principles”. This includes planned 2021 launches in large-cap and micro-cap strategies as well as securitized bond strategies.
AUM Further Breakdown [Source: 4Q 10Q]
Dividends, Special Dividends and Share Repurchases
In 2020, management returned $56.6mn to shareholders in the form of a $12.00/share dividend and a buyback of 5% of stock outstanding which amounted to $18.6mn. Currently, the company pays dividends in the form of special dividends, however, from January 2021, management has instituted a regular quarterly dividend of $1.00/share and at the end of each year, the board will decide whether to pay an additional special dividend. Cash and investments held directly by the company equaled $58.08/share, a 2.2% YoY improvement and representing 41% of market cap.
Attractive dividend yield
Even though the company pays out only a special dividend, this number has been growing steadily over the last five years and represents a very promising dividend yield of 8.2% in 2020. We expect this dividend to at least remain at current levels given the strong cash balance of the company.
Free cash flow
Diamond Hill has been a significant generator of free cash flow over the years with 2019 and 2020 free cash flow yield of 11.7% and11.9% respectively. Looking ahead, we expect free cash flow to continue growing [taking aside that 2020 will be negatively affected by the short-term COVID impact]. Our free cash flow yield estimates for 2021 and 2022 stand at 9.3% and 9.8% respectively.
Significant net cash per share
Diamond Hill has a large net cash per share on its balance sheet [including investments] that is directly held by Diamond Hill Capital Management as at end 2020. This net cash per share amounts to $58.08 in 2020 and represents 41% of the current market cap. This gives us comfort on the balance sheet as well as dividend payments.
Risk of Passive Management
The flow of funds to passive investment products, such as index funds and ETFs, is perhaps the single biggest risk for the entire global asset management industry. This is a topic which has seen a great deal of press and visibility and is a focus for all institutional investors and professional fund managers/analysts.
Poor investment performance and outflow of AUM
The company’s financials are primarily driven by fee income, which is a function of AUM. AUM’s will be negatively impacted by poor investment performance. This could result in negative growth for Diamond Hill. Additionally, weak investment performance as well as negative economic and market sentiment can result in investor outflows from Diamond Hill’s funds.
Pressure on fee income
Any downward pressure fee income from investor demand for passive funds will likely negatively impact Diamond Hill’s financials and business outlook.
Loss of key personnel
Diamond Hill depends significantly on its experienced team of portfolio managers, research analysts and management who have specialized expertise in their areas. Additionally, other than the CEO, employees do not have employment contracts with the company and can terminate their employment at any time. Departures of key personnel from the company can affect fund performance and investor confidence.
Competition from other investment products and firms like asset managers, mutual funds, ETF’s, hedge funds, brokerages, etc. remains high and is a key risk for Diamond Hill.
Cut in dividends
Diamond Hill doesn’t pay out a regular quarterly dividend, preferring instead to only pay out annual special dividends. Any reduction in the dividend per share of $12.00 could negatively impact the company’s stock price.
Despite mixed latest quarterly results, the company still looks to be very attractive on its fundamentals. Diamond Hill’s AUM of $26.4 bn at the end of December 2020 was much higher than the AUM at the beginning of the year, with additional higher investment income to add. From a valuation standpoint, metrics look to be very robust. The company has a 7x ex-cash P/E, significant net cash per share of 41%, and FCF Yield Of 9%. On top of this, the company has been returning its capital to shareholders, with an 8.2% dividend yield and a 5% share repurchase. This will buoy investor confidence and make this stock much more attractive in the long-run.
Our DHIL Model for your reference...
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