EUR 850.00 For Business Accounts Only

Morningstar | Pendal Delivers a Positive, Clean 2018 Result; U.S. Growth Option Unappreciated; FVE Intact. See Updated Analyst Note from 08 Nov 2018

Narrow-moat rated global asset manager Pendal Group delivered a clean, positive fiscal year 2018 result. Cash NPAT increased 17% to AUD 201.6 million compared with fiscal 2017, beating our forecast by 5%. We particularly liked the 10% increase in average funds under management, or FUM, the 14% increase in revenue, and the 16% increase in dividends. The 15% franked final dividend of AUD 30 cents per share takes total dividends to AUD 52 cents per share, equivalent to a dividend yield just over 6% before franking. The fiscal year 2019 dividend is expected to be franked in the 10%-15% range. At current prices the stock is undervalued, trading 22% below our AUD 11 per share fair value estimate.

Despite falling slightly short of our expectations, closing total FUM of AUD 101.6 billion was up AUD 5.6 billion on the year and should continue its long-term positive trajectory given its diversity across asset classes, geography, and currency. We have trimmed our FUM assumptions but not materially enough to impact our valuation. The benefits of this diversification are seen in Pendal reporting positive net FUM movements since 2013 where each year’s composition between alpha, currency, and flows are often different to the year prior. We assume positive annual FUM movements through our forecast period, owing largely to this diversification. Our 2019 end-of-year FUM assumption falls 2% to AUD 108 billion.

Base management fee performance across the businesses remained stable, with the group base management fee margin up 1 basis point to 0.51%. Although this was slightly above our declining base management fee assumption, we believe it’s a reflection of Pendal’s diversified business model and intangible strengths--both supporting factors to our narrow moat rating on the fund manager. Our base management fee forecasts remain unchanged, trending downward through our forecast period toward 0.48% in 2023 as we continue to see structural fee pressure on the industry.

JO Hambro continues to generate impressive average base management fees of 66 basis points compared with just 33 basis points for the Australian operations. JO Hambro contributed 88% of group profit in fiscal 2018 and we expect another strong performance for fiscal 2019. The strong increase in performance fee income to AUD 54.5 million was previously announced, driven by the London based JO Hambro business, which contributed a majority of AUD 47.5 million. Lacklustre investment performance during calendar 2018 will drive a sharp fall in JO Hambro performance fees in fiscal 2019, with just AUD 8.1 million calculated for the 9 months to September. JO Hambro performance fees are struck as at 31 December each year while Pendal Australia performance fees are determined at 30 June each year.

As the business continues to benefit from its global footprint, we are confident in management’s expectation the U.S. market lurks as the driver of long-term earnings growth. Although Pendal remains in the early stages of its expansion into the massive U.S. funds management industry, it has made a strong start. U.S. based FUM has increased impressively from AUD 5.0 billion at September 2014 to AUD 15.6 billion at September 2018. Additional investment in U.S. based investment professionals, distribution staff and upgraded premises is clearly the start of a long-term strategy to tap into the significant opportunities available. It would not surprise to see Pendal compliment organic growth with a meaningful U.S. based acquisition in the coming years given it certainly has the balance sheet firepower to do so.

Although profitability of fund managers is inherently volatile, Pendal continues to display a strong financial profile, supported by a solid balance sheet and healthy cash flow generation given the capital light nature of the business. With no on balance sheet debt, the net cash balance was a healthy AUD 164 million, a decrease on the year of about AUD 14 million as management ramped up capital allocation toward seed capital investments. The level of capital spend toward seed investments will slow in fiscal 2019 after an 83% increase in fiscal 2018 to AUD 238 million, which should bode well for future FUM growth. Aside from seed capital investments, Pendal’s financial flexibility allows it to consider bolt on acquisitions to support their growth ambitions should they be deemed suitable and cash balances strong enough at the time. A scenario we consider a distinct possibility in the coming years, particularly in the U.S. Alternatively, we expect management to return a rising cash balance to shareholders in the form of higher dividends should no suitable acquisitions arise.

Nevertheless, we remain concerned that headwinds in both Australia and the U.K could continue to pressure fund flows, particularly in the face of intensifying competition from both active and passive management strategies. Fiscal 2018 net outflows from the Australian business represented AUD 3.7 billion and AUD 2.3 billion from the JO Hambro wholesale business. The Australian outflows were heavily skewed toward noncore Westpac redemptions of AUD 5.5 billion as its transition away from the major bank continues. Outside of the Westpac redemptions, Pendal’s core funds actually had net inflows of AUD 1.8 billion, providing some positive news, and hope, on future net flow prospects.

We view the outlook for Pendal Group, as with any of its domestic peers, as increasingly challenged. In its favour are strong brands in Australia and the U.K. and an admirable record of performance and continued commitment to investing in the business. We also note the particularly impressive low level of investment staff turnover in the business, which has averaged about 3% over the last five years. When we overlay this with the favourable long term dynamics of mandated retirement savings in Australia and an ageing global population, there is no denying the favourable tailwinds to the business. On the other hand, the fund management industry finds itself amid intensifying competition with risks to fee generation and operating margins. On balance, we believe the firm, like its competitors, will likely have to tolerate lower profitability metrics to maintain and grow funds under management.