Based on rising operating expenses and regulatory headwinds, we have downgraded our recommendation on T. Rowe Price Group Inc. (TROW) to Neutral from Outperform.
T. Rowe Price’s fourth quarter 2010 earnings came in at 72 cents per share, significantly up from 57 cents reported in the prior-year quarter. Higher-than-expected top-line growth and higher assets under management (AUM), partially offset by higher operating expenses, resulted in improved performance. The quarter’s earnings also outpaced the Zacks Consensus Estimate of 69 cents per share. As of December 31, 2010, the company repurchased 5 million shares of its common stock for $240 million.
T. Rowe Price remains debt free with substantial liquidity that includes cash and mutual fund investment holdings. The company’s sizeable internal equity and fixed income investment research capabilities have helped it strengthen its capital leverage and generate substantially higher return on earnings than the industry average. These growth drivers also pave the way for an industry-leading dividend yield, thereby creating ample investor confidence and scope for investment as well as growth opportunities in the future.
In February 2011, T. Rowe Price’s board of directors approved a 15.0% hike in the company’s quarterly common stock dividend. The revised quarterly dividend now stands at 31 cents per share compared with the previous amount of 27 cents per share. This marks T. Rowe’s 25th consecutive annual dividend increase, reflecting the company’s commitment toward returning value to shareholders with its strong cash generation capabilities.
Despite the recent market downturn and the ongoing volatility, T. Rowe Price continues to outpace its peers in AUM growth through its disciplined and risk-aware investment approach. Besides, the company’s lower fund cost structure, distribution methods, fund shareholder as well as administrative services help to promote stability in mutual fund AUM throughout the market cycles. While the resonance in the global markets will cause higher market valuations and increased income, the company will also be able to capitalize on the increasing savings and investment capacities of its customers.
On the flip side, the financial services industry is already heavily regulated and could be adversely affected by new laws or amendments in any of the jurisdictions in which T. Rowe Price operates. Recently, governments in the U.S. and abroad have intervened on an unprecedented scale, responding to the stresses experienced in the global financial markets. Any kind of stringent regulation could weigh heavily on the company’s financials in the future.
Furthermore, the company incurs significant expenditure to attract investment advisory clients and additional investments from existing clients. These efforts often involve costs that precede any future revenues that may be recognized from an AUM increase. Based on its current strategic projects and plans, T. Rowe Price has estimated 2011 capital expenditures to be nearly $120 million owing to property and equipment additions. These cash expenditures are expected to be funded by internal resources.
Nevertheless, fundamentals remain strong with a debt-free position, higher return on earnings and improving investor sentiment. Relative mutual fund performance was also positive and we expect this to continue in the long run. T. Rowe Price’s financial stability has the potential to take advantage of the improving economy and benefit from the growth opportunities in the domestic and global AUM. However, higher operating expenses and stringent regulatory norms could be causes of concern.
T. Rowe Price currently retains a Zacks # 3 Rank, which translates into a short-term ‘Hold’ rating. However, the company’s closest competitor, BlackRock Inc. (BLK), retains a Zacks # 1 Rank, which translates into a short-term ‘Strong Buy’ rating.
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