Australia | May 14 2018
Strong first half result aside, brokers suggest Pendal Group is facing weak flows and increasing costs which could depress the outlook.
-Higher fixed cost base reduces earnings leverage if weak market conditions persist
-Continuing to build global asset management business, 20% of FUM now US domiciled
-Some strongly performing strategies considered niche and small
By Eva Brocklehurst
Revenue for Pendal Group ((PDL)), formerly BT Investment Management, rose 22% in the first half because of strong growth in management fees. Higher funds under management drove the increase, while fee margins also expanded because of an improved product mix.
The company's first half profit was up 30% on the prior corresponding half and well above forecasts. However, costs were up 20%, driven by a 28% increase in non-compensation expenses and an 18% increase in compensation costs. An increased fixed cost base is creating downside risk to earnings leverage, brokers suggest, particularly if weaker market conditions persist.
The company increased its FY18 fixed costs growth guidance to 18-20%, from 13-15%, largely because of the impact of the AUD/GBP. Net outflows of -$2.1bn were previously announced, affected by a mandate loss from JO Hambro and transition to MySuper.
On a full year basis, Morgans suspects operating margins will deteriorate by around 70 basis points but believes Pendal is continuing to execute on its strategy to build out a global asset management business. Around 20% of funds under management (FUM) are now US domiciled.
The broker is not concerned about the outflows in JO Hambro, previously flagged, and suggests an improvement in the coming quarter should provide more confidence. In the short term, Morgans acknowledges the prospect of Westpac selling its remaining 10% stake as well as the market volatility that could weigh on performance.
Taking a longer term view, the broker considers the current valuation a solid entry point for the stock and maintains an Add rating.
Macquarie envisages scope for the current discount to unwind as the business continues to perform well. As of March 31 72% of FUM have outperformed the respective benchmarks over the last three years. This compares with 82% at the FY17 result.
The reduction in performance is being driven by fixed income as well as the Asian and global equity strategies. The broker notes Asian equities have been poor performers recently and driving outflows from JO Hambro, and this appears set to continue.
Headwinds
Morgan Stanley acknowledges first half results were better than expected but notes some headwinds emerging in the second half. Westpac's BTFG is redeeming an additional $2.0bn in the second half and this, all else being equal, creates around a -1% earnings headwind.
FY18 fixed cost growth is also up sharply. Morgan Stanley notes around two percentage points of the first half increase involved a one-off re-branding cost. Overall, fixed cost growth is envisaged to be a -4.5% headwind to FY18 earnings.
Noting the upgrade to fixed cost estimates, UBS envisages operating margins will moderate from a first half record level of 45.4%. This view is based on a softer outlook for assets and revenue growth from weaker fund flows and lower performance fees.
The broker's Neutral rating reflects the downside risks to earnings estimates from lower JO Hambro performance fees and flows. UBS suspects that a more mixed performance from the UK and prospect of further outflows may offset the positive flows into US funds.
While Pendal experienced -$1.0bn in net flows because of the outflows largely relating to MySuper changes, traction elsewhere appears to be improving, with $1.2bn added in the first half. Momentum, nonetheless, will need to continue into the second half, UBS suggests, if Pendal is to offset the further $2bn of MySuper outflows recently flagged by Westpac.
Outflows of note in European equity strategies emerged in April, Credit Suisse points out, and the first half was flattered by high seed capital gains. The broker calculates that the increased fixed cost growth guidance is equivalent to 6% of the FY18 operating profit estimate and this could continue into FY19.
Credit Suisse considers the stock inexpensive, as its PE is near five-year lows, but with risks around flows being elevated the case can be easily made for deterioration at this point.
Under a more bullish scenario, the broker can envisage opportunities for new strategies which have hit the three-year track record and a strong performance should attract inflows. There is also potential for greater penetration of the Australian market without the association with BT/Westpac.
Alternatively, the argument could also be made that some of the strongly performing strategies are niche in nature and small in capacity, and could easily be influenced by asset class and risk allocation.
FNArena's database shows three Buy ratings and two Hold. The consensus target is $10.97, suggesting 5.9% upside to the last share price. Targets range from $9.75 (Credit Suisse) to $12.00 (Morgan Stanley). The dividend yield on FY18 and FY19 forecasts is 5.0% and 5.3% respectively.
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