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Morningstar | An Acceleration in Fund Inflows and Growth in FUM Drive an Increase in Magellan’s FVE

The transition to a new analyst as well as an acceleration in fund inflows in the first four months of 2019 combine with a rebound in equity markets to drive narrow-moat Magellan Financial Group’s fair value estimate increase to AUD 37.50 per share, from AUD 29.00. The firm’s proven ability to generate above-market returns, with relatively lower volatility and drawdowns than most competitors along with an effective distribution team has helped establish a strong reputation among investors. This has assisted in growing scale in its funds under management or FUM. As at April 30, 2019, it boasts FUM of greater than AUD 83 billion, compared with peer Platinum at AUD 26.6 billion. This scale provides Magellan with the foundation for future earnings growth. Nevertheless, this positive news appears to be priced into the stock, with it trading at a fiscal 2019 P/E of about 22.5 times and dividend yield of 4%. At our fair value estimate the stock trades at a fiscal 2019 P/E of 18.7 times and a dividend yield of 4.8%.

Our forecast for Magellan’s fiscal 2019 underlying NPAT increases to AUD 353 million from AUD 335 million. An escalation in net fund inflows, the rebound in equity markets along with an expected increase in performance fees that management guided to being AUD 42.8 million as at Dec. 31, 2018 produces the increase. The four months to April 30, 2019 generated retail net fund inflows of AUD 697 million, compared with AUD 475 million for the six months to Dec. 31, 2018. Net inflows from institutional clients of AUD 1.543 billion in the first four months of 2019 has been even more impressive and compares with AUD 902 million in the six months to Dec. 31, 2018. While we expect this mix in favour of institutional inflows should see a reduction in margins in fiscal 2019, this should be more than compensated by the enormous circa AUD 12.45 billion increase in FUM from both net inflows and fund performance in the first four months of the year.

The strong earnings growth and its new dividend payout ratio, or DPO, of 90% to 95% of the NPAT of its core funds management business and net crystalised performance fees should see a step increase in dividends in fiscal 2019, which we expect to be AUD 1.80 per share. In August 2018, following its recent acquisitions, management undertook a review of ongoing capital requirements and decided to return more capital to shareholders in the form of a higher DPO. We think its strong balance sheet and its capital light business model which generates an enviably high return on equity and free cash flows should enable the firm to withstand the vicissitudes of the market, and provide it with the flexibility to invest for growth via seeding new funds, while maintaining a high DPO. It has no debt and continues to retain growing cash and cash equivalent balances. As at Dec. 31, 2018, it had cash of about AUD 160 million and financial investments with a net fair value of AUD 281 million invested in its own unlisted funds and other funds and listed shares. This should provide it with enough liquidity to cope with almost any market conditions.

We also believe Magellan’s stated strategy to place the interest of its customers ahead of its shareholders is prescient for what we expect to be a new era of more demanding customers of financial institutions and more proactive regulation of them following recent wealth management scandals and the 2018 Financial Services Royal Commission. We think evidence of this strategy includes it bearing the initial public offering, or IPO, cost of the Magellan Global Trust listing in 2017 to ensure customers did not face a fall in the unit’s net asset value or NAV below the IPO unit price. It also took the initiative of providing its customers and shareholders with loyalty units and bore the cost of those units, which in combination totaled a not insignificant circa AUD 56 million aftertax. It continues to follow through with this strategy by paying into the trust AUD 14.6 million to cover the dilution to existing unit holders from issuing new units at a 5% discount to NAV from the March 2019, AUD 277 million unit purchase plan. Although these costs were borne by shareholders, we think this type of customer-centric approach will help deepen its relationship with clients, generate goodwill for its brand and is therefore ultimately in the long-term interest of shareholders.