T. Rowe Price: AUM In Trouble But I Am Not Worried

Summary

• T. Rowe Price has already brilliantly overcome phases when AUM was in trouble.
• From a fundamental point of view, this company is out of the ordinary.
• The current price is still too low compared to the fair value.

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It has not been that long since my last article on T. Rowe Price (NASDAQ:TROW), however, I decided to do another one as there are some updates related to the latest quarterly report. Also, unlike the previous one, in this article the valuation will be done by discounted cash flow and not by evaluating price multiples. Finally, to support my bullish thesis, I will use economic/financial data achieved by T. Rowe Price over the past 10 years.

Comment on Q3 2022

The macroeconomic situation remains precarious as the FED continues to aggressively raise interest rates and both the bond and stock markets are struggling. After an encouraging downward CPI for October, the chances of inflation peaking have increased, but there are still many doubts about this. With such uncertainty in the financial markets, we certainly could not expect encouraging data for this Q3 2022 from T. Rowe Price. The stock market euphoria that characterized 2020 and 2021 is now a distant memory, and T. Rowe Price's AUM continues to decline very quickly.

TROW Q3 2022

At the end of 2021 AUM was $1.68 trillion while at the end of September 2022 it reached $1.23 trillion. We are talking about a 27% drop in three quarters, which is certainly not a reassuring result.

TROW Q3 2022

Analyzing in detail what actually resulted in the rapid reduction of AUM in 9M 2022, we note that the most significant item was Net Market Depreciation and Losses totaling $413.20 billion. On the other hand, as far as Net Cash Flows are concerned, only the equity segment had an underwhelming result (-$58.40), a sign that customers' confidence in this company has by no means vanished. The loss of AUM in the equity segment was inevitable given the negative performance of the S&P500 in this 2022, so I consider it neither a surprise nor a problem. One must accept the fact that the equity market has always been volatile, but over the long run it has always eventually touched new highs. This is what matters most.

TROW Q3 2022

This is certainly not the first time T. Rowe Price has faced a bearish market period, it has happened multiple times before and AUM has always recovered. In 2008 the world was collapsing and yet after 1 year AUM had already recovered. These bearish market phases are the best for those who want to buy this company at a discount. When AUM returns to rise it is already too late and the risk is to buy a great but overvalued company.

TROW Q3 2022

Anyway, returning to the Q3 2022 results, T. Rowe Price decided to reduce the investment advisory fee rate by 2.50% compared to Q3 2021. This decision, combined with the reduction in AUM, weighed heavily on the net income.

TROW Q3 2022

In Q3 2022 the company reported a profit of $384.4 million, basically half the profit of $777.2 million in Q3 2021. Certainly, this is a terrible result, but after all we are comparing two quarters obtained in completely different macroeconomic contexts.

Finally, in Q3 2022 $500.90 million was returned to shareholders, considering also the $224.50 million buyback. The financial situation remains more than solid as T. Rowe Price has a net debt of -$1.95 billion.

T. Rowe Price's Fair Value

Before I begin with the evaluation based on discounted cash flow, I would like to briefly summarize the achievements of this company over the past 10 years, as they deserve to be highlighted.

TIKR Terminal

Revenues have increased steadily except in the last 12 months due to a major economic slowdown. Same for operating income and net income.

Free cash flow follows the trend of net income over the long run, except for some years (2016,2017) due to the negative change in trading asset securities. FCF margin tends to be very high and above 25-30%. In 2021, it even reached 41.90%, which is almost comparable to Visa's.

TIKR Terminal

Return on Capital and net income margin have never been below 28% in the past 10 years, and almost always exceeded 30%. The efficiency with which capital is allocated is certainly one of the strengths of this company. But it does not end there.

TIKR Terminal

This company also issues a dividend (3.80% current dividend yield) that has been growing for years, and free cash flow manages to cover it amply. However, the dividend is not the only way the company remunerates its shareholders; in fact, there are often buyback plans.

TIKR Terminal

In the long run, it tends to buy its own shares, but without sacrificing too much total equity, which still shows steady growth. What is more, it has done all this while leaving net debt well below 0. Overall, the soundness of this company is out of the ordinary.

That said, we have seen how this company's numbers are more than good, but that is not enough to justify a purchase. We need to understand what T. Rowe Price's fair value is and compare it to the current price. To do this, I will use a discounted cash flow which will be constructed as follows:

• WACC, or our discount rate, will be equal to the cost of equity since T. Rowe Price has negative net debt.
• The cost of equity was calculated using a beta of 1.26, country market risk premium of 4.20%, risk-free rate of 4% and additional risks of 1%. The result is 10.25%.
• Free cash flow estimates from 2022 to 2026 belong to TIKR Terminal analysts. From 2027 to 2031 I considered a growth rate of 6%, while the perpetual growth rate is 2.50%.
• The source of outstanding shares and net debt is TIKR Terminal.

Discounted cash flow

According to my assumptions, T. Rowe Price is currently undervalued by 22.48%. Theoretically, buying it at this price should provide an annual return of at least 10.25%, which is great. Applying a 20% margin of safety, at the current price it should still prove to be a good investment.

So, beyond high profit margins and a debt-free financial structure, T. Rowe Price also passes the discounted cash flow test. My investment thesis does not change from my previous article, however, I no longer consider this company a "strong buy" but a "buy." The reason for this rating change is simply due to the increase in price per share achieved over the past few weeks. Today there is no longer a high margin of safety as there was when it was trading at only $100 per share, but the company remains undervalued.

Disclosure: I/we have a beneficial long position in the shares of TROW either through stock ownership, options, or other derivatives. 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.