We are initiating coverage on Federated Investors Inc. (FII) with a Neutral recommendation. The company’s fourth-quarter earnings of 51 cents per share missed the Zacks Consensus Estimate by a couple of pennies on money fee waivers and higher operating expenses.
Results reflected an increase in fixed income equity funds, fixed income assets and equity assets, decrease in non-operating expenses and a decline in the amortization of deferred sales commissions. This was partially offset by an increase in voluntary fee waivers, higher operating expenses and lower assets under management (AUM).
Federated’s long-term fund performance and asset inflows are doing well, reflecting higher returns that will provide a strong support to the margins. Moreover, the company’s fixed income and equity products benefit from a strong demand in the current recovering markets. Going ahead, as the recovery of the markets gain momentum, Federated will grow substantially with investors’ desires for high yields.
Despite the economic crisis, Federated has been delivering fluctuating but positive earnings over the last 2 critical years. This is reflected by a higher operating margin and decreased operating expenses. Moreover, the reducing debt position is expected to offload market pressure and add leverage to the company to support the targeted goals in future.
However, Federated has a strong base in a money market where redemptions are at its peak. Redemptions in the money market are led by the historically low interest rates and competing bank products. Moreover, a shift in consumer preference towards direct markets has been experienced, in order to achieve higher rates once the economy regains buoyancy.
Consequently, the outflows and fee waivers in this market are also soaring, shaving substantial revenue and earnings off the company. Given the sluggish economic scenario, redemptions are expected to continue over the near to medium term.
Additionally, Federated’s declaration of a special dividend raises questions amid the proposed money market regulatory changes, which could ultimately require guarantee fund backing for money market funds. Moreover, a special dividend reduces the company’s financial flexibility and relinquishes the accretion that a special share buyback program could have generated, also bringing into question the company’s support of the stock at current depressed valuation levels.
Overall, Federated is one of the largest mutual fund managers in the U.S. Its business mix includes products that are expected to be functional under diverse market conditions. Federated has structured its investment process to meet the requirements of fiduciaries and others who use the company’s products to meet the needs of their customers.
However, the constant cyclical market declines have lowered Federated’s AUM. This has also resulted in a negative organic growth in the core business as investors move cash out of money market funds into higher yielding bank deposits or investments across the fixed income universe and equities. Hence our near-term growth outlook remains clouded unless the company renovates its functional strategy to keep pace with the investors’ needs in the sluggish market scenario.
On Friday, the shares of Federated Investors closed at $24.65, up 1.4%, on the New York Stock Exchange.
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