11/23/15 10:00:10 AM
FOCUS STOCK OF THE WEEK
FEDERATED INVESTORS, INC. (FII)
FEDERATED INVESTORS, INC. : (FII)
This week's Focus Stock of the Week is Federated Investors Inc. (FII: $31.05), which carries S&P Capital IQ's highest investment recommendation of 5-STARS, or Strong Buy. We have a 12-month target price of $36 on the shares, based on an above-peers 20X our forward 12-months EPS estimate of $1.81, reflecting FII's stable earnings and relatively high dividend. We expect an 18% total return, which includes FII's attractive 3.2% dividend yield.
We expect FII will benefit from rising interest rates, if the Federal Reserve actually goes ahead with a rate increase. FII is one of the leading providers of money market funds, with $247 billion of assets under management (AUM) in money markets, at September 30, 2015. Since interest rates have been so low, FII has waived management fees on money markets since late 2008, when short term rates plunged to nearly zero.
Fee waivers have been a significant headwind for FII. In the recently-reported third quarter, fee waivers reduced revenue by $83 million (a 26% reduction to pro-forma revenues of $317 million, resulting in revenues of $234 million). Waivers reduced operating income by $22 million (a 23% reduction to pro-forma operating income of $96 million, resulting in operating income of $74 million). In the first nine months of 2015, fee waivers reduced revenue by $262 million (a nearly 28% reduction to pro-forma revenues of $945 million, resulting in revenues of $683 million). In this time period, waivers reduced operating income by $76 million (a 27% reduction to pro-forma operating income of $278 million, resulting in operating income of $202 million). If short-term rates rise, leading to higher money market yields, FII's management fee waivers will decrease.
FII's money market AUM was until recently falling rapidly, with large outflows in mid-2014, and a 9% peak shrinkage rate at September 30 a year ago. Since then, outflows have ebbed, and FII's money market funds grew AUM by a 1% year-over-year rate at September 30, 2015.
We also see FII's equity and fixed-income funds attracting inflows, leading to good revenue growth. FII's other AUM was comprised of $52 billion of fixed-income funds, and $52 billion of equity funds. 45% of assets are managed for institutional clients, and 55% are for retail clients. AUM of FII's equity and fixed-income funds rose 2.5% in the 12-months ended September 30, 2015, as the asset management industry was impacted by the August market meltdown. FII's AUM growth was an above-peers growth rate, as the industry experienced a 4.8% year-over-year decline in the third quarter. For 2016, we expect FII's AUM to grow in-line with our industry forecast of 6.4%.
Several funds managed by FII stand out in terms of past performance, relatively low fund expenses, and lower risk profiles. The largest ones are: the Federated Total Return Bond Fund (FTRBX), the Federated Institutional High Yield Bond Fund (FIHBX), and the Federated International Leaders Fund (FGFLX).
MarketScope Advisor's (MSA) Fund Screener ranks thousands of funds on performance, fund expenses, and risk. In the MSA database are 184 of FII's funds, totaling $62.6 billion in assets, covering 60% of FII's equity and fixed-income September 30, 2015 AUM totaling $104 billion. We screened for 5 star funds, which are those with the highest relative performance, combined with lowest risk and fund expenses. 10 funds (20% by assets) were ranked 5 stars, including the funds listed above. 44 funds (30% by assets) were ranked 4 stars, so that 50% of FII's funds, by assets, in the MSA database earned a 5 or 4 star ranking. Only 30% of the entire MSA fund universe earns a 4 or 5 star ranking.
51 funds (only 9% of FII's funds in the MSA database) were ranked as 1 or 2 star funds, (as compared to 30% for the entire MSA universe). The other 79 funds (41% of assets) are ranked as 3 star funds. The conclusion we draw from this is that FII's family of funds have been, and should remain attractive to fund investors.
As noted earlier, revenues have been held back by money market fee waivers, falling 2% in 2014. For 2015, we see a turn-around to 8.7% growth. For 2016, we see a rapid acceleration to 24% growth, higher than the Capital IQ consensus forecast of 22%. For 2017, we project 22%, above the consensus view of 13%.
FII has also managed expenses well, thus driving operating leverage over many past quarters, a trend we see continuing. Expenses rose 2.7% in the 12-months ended September 30, 2015, compared to 5.2% revenue growth. Looking forward, we expect 2015 expense growth of 6.9% to trail our 8.7% revenue growth forecast. FII's operating margin in the third quarter was 31.7%, above peers, and we project 28.8% for 2015, up from 27.7% in 2014.
We see EPS of $1.58 in 2015, up 10.5%, and we see 2016 EPS of $1.90, up 20%. FII is aggressive about returning capital to shareholders, and we project share repurchases and dividends of $125 million in 2015, about 80% of our $160 million forecast of net income. For 2016, we project net income of $195 million, with $100 million paid out as common stock dividends, at an unchanged quarterly rate $0.25 per share, plus at least $50 million in share repurchases.
Risks to our recommendation, EPS estimates, and target price include persistently low short term interest rates, falling global equity and bond markets, fund underperformance, fund manager departures, and higher regulations.
S&P Capital IQ's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.