We maintain our Neutral recommendation on Legg Mason Inc. (LM) based on its strong cash position as of the first half of fiscal year 2012 and also better than expected fiscal second-quarter 2012 results. However, asset outflows remain a concern with $17.6 billion in aggregate net client outflows and dispositions of $0.2 billion in the quarter.
In October, Legg Mason reported fiscal second-quarter 2012 earnings of 61 cents per share significantly outpacing the Zacks Consensus Estimate of 38 cents per share. Reported quarter results included special U.K. tax benefit of 13 cents per share and transition-related costs of 7 cents per share.
Earnings were below the prior-year quarter and prior quarter’s earnings of 76 cents and 73 cents per share, respectively. Results declined due to lower revenue and a fall in total AUM, offset by lower operating expenses.
Legg Mason has been strongly working on improving its operating efficiencies through its key initiatives that include offering innovative product solutions to client base, tapping sound investment capacities and expanding distribution relationships. In May 2010, Legg Mason announced an initiative to streamline its business model and reduce costs. The plan, which is scheduled to be completed in fiscal 2012, projects $130-$150 million in expense reductions.
Moreover, Legg Mason remains committed to increase shareholder’s wealth. The company is effectively deploying capital through share repurchase and dividend payment. The company used its cash by announcing a 30% hike in dividend in May 2011. Moreover, in first half of fiscal 2012, Legg Mason completed the company’s plan to buy back $400 million of common stock by the end of fiscal 2012. We expect such measures to instill investors’ confidence on the stock.
On the flip side, during the first half of fiscal 2012, the financial environment in the U.S. continued to be challenging as concerns regarding the sustained economic issues related to the European debt crisis and the downgrade to the U.S. credit rating resulted in a significant decline in the equity markets. As a result, all major U.S. equity market indices decreased. During the September quarter, the Federal Reserve Board held the federal funds rate at 0.25%. Therefore, the current volatility in the financial markets and the government regulations increases the chances of interest rate fluctuation in the funds business of the company. In addition to that, economic challenges are expected to linger.
However, we believe Legg Mason has the potential to outperform its peers in the long run, given its diversified product mix and leverage to the changing market demography. Assets outflows remain a significant headwind in the near term, though trying to improve in the volatile markets. Yet, considering the restructuring initiatives and cost-cutting measures, we expect operating leverage to improve. Share buybacks will also continue inspiring investors’ confidence in the stock.
Legg Mason currently retains its Zacks #3 Rank, which translates into a short-term ‘Hold’ rating. Moreover, Legg Mason’s closest competitor – BlackRock Inc. (BLK) also retains a Zacks #3 Rank.
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