AB - AllianceBernstein: Fortress Balance Sheet And Incrementalism Support Long-Term Expansion

2023-05-31 00:45:00 ET

Summary

• AllianceBernstein is undervalued by 31% and rated a 'strong buy' due to its heavy undervaluation, expansion capabilities, and strong financial position.
• AB's integrated platform and incrementalistic growth strategy, including expansion into high-growth industries and geographic regions, support its long-term growth potential.
• Risks include continued interest rate pressures, potential challenges in expansion plans, and possible dividend reductions.

AllianceBernstein Holding L.P. ( AB ) is a global asset management firm providing investment management and research service products across institutional, high-net-worth, and retail investing levels.

Over the previous year, AB's activities have enabled AUM outperformance of the market, meeting significant organic growth targets in the process. Additionally the firm has expanded into various adjacent industries, moving into active ETFs, developing its ESG footprint, and boosting private alternative asset AUM through its acquisition of CarVal.

In the TTM time period, AB has thus been able to record $313.46mn in free cash flow, alongside a net income of $255.67mn.

The company's heavy undervaluation, expansion capabilities, and strong financial position lead me to rate AB stock a 'strong buy'.

Introduction

The investment opportunity presented by AB can be summed up into a sixfold value proposition; the company maintains strength in its levels of permanent capital, has demonstrated marked margin expansion through fee-related earnings, incrementally scaling margins in the process, has developed into a tax-advantaged partnership-oriented structure, sustains a solid dividend, and has accelerated its organic and inorganic growth capabilities through consistent reinvestment and opportunistic M&A activities.

The pursuit of this value has driven AB's well-diversified $680bn portfolio, which is split between- in order from largest AUM to smallest- Equities, Fixed Income, and Multi-Asset and Alternatives.

Valuation & Financials

General Overview

In the TTM period, AB- down 18.26%- has trailed both the broad market- represented by the S&P 500 ( SPY )- up 3.63%- and the financial services index ( IYG )- down 9.12%.

While the financial services industry in general has been hit hard from the multi-pronged macro impacts of rising interest rates and bank crises, the inherently institution and high-net-worth consumer-facing role of AB diminished its ability to generate cash flows relative to, for example, the lower-rate era of 2021.

Comparable Companies

AB operates in a unique position, not committedly an asset manager like BlackRock ( BLK ) or a financial data company like MSCI ( MSCI ). Thus, AB does not maintain any identical or direct competitors and can most justifiably be compared to financial services companies of a similar size. Such companies can include Focus Financial Partners ( FOCS ), a wealth management fiduciary, Hamilton Lane ( HLNE ), an investment manager with a focus on private markets solutions, and Federated Hermes ( FHI ), an investment manager with a presence in CEF and ETF solutions.

As demonstrated above, AB has experienced the poorest yearly and second-poorest quarterly performance relative to peers. Said underperformance comes in spite of superior value-based multiples as well as superior capital return potential.

For example, when AB maintains the second-lowest trailing and forward P/E ratio after Federated Hermes, the firm maintains the lowest P/S, P/B, and the highest BV/share.

And exemplifying AB's commitment to capital return to shareholders is its 7.69% dividend, enabled by best-in-class ROA and profitability. Although AB's payout ratio is approaching 109%, this is an exception to the norm and can be supported with debt financing, for which AB maintains the fiscal room.

Beyond all that, the state of AB's finances is best illustrated by a lack of debt, positioning the firm for inorganic growth and resilience to macro headwinds.

Valuation

According to my discounted cash flow analysis, the fair value of AB, at its base case, is $43.45, meaning the stock's current price of $34.34 is undervalued by 21%.

My DCF model, calculated over a 5-year period without perpetuity, assumes a discount rate of 8%, reflecting AB's debt-light cap structure while still incorporating the recessionary risk and risks connected with the financial services industry. I additionally built in 2% real revenue growth, lower than both the financial industry CAGR and the company's pre-COVID growth rate.

Alpha Spread's multiples-based relative valuation tool calculates a 74% undervaluation, projecting fair value to be $133.86.

Though this more than supports my theory on undervaluation, I believe Alpha Spread's model does not take a holistic enough approach, neglecting to account for AB's significant dividend and payout ratio when calculating its fair value.

As such, taking a weighted average skewed towards my DCF, the fair value of AB is $49.42, a 31% undervaluation from today.

Integrated Platform & Incrementalistic Growth Strategy Are Peerless

AB has concentrated on combining its market advantages to pursue maximal scale and margin growth. This has involved comprehensive data provision efforts across global regions and localities, segueing to its advisory and institutional services products. And with its expanded foray into sustainable platforms, AB has both expanded its appeal to a broader set of consumers whilst increasing its already eminent brand-presence across global finance.

The company has furthermore involved itself in flexible, component-centric solutions and providing digital data access for clients.

By taking an integrated approach, AB is seeking to sustain its organic and inorganic growth advantages and participate in various high-growth segments. For instance, its 2022 acquisition of CarVal supported its efforts in private capital and alternatives, by extension supporting private debt objectives. The global private debt market, alongside the active ETF, and retail small managed account market are high growth industries through which AB is fulfilling its growth. Alongside endeavours in a low-beta insurance industry and geographic expansion into China and the EMEA region, the company is effectively prepared to encounter macro headwinds alongside sustained growth.

Through this strategic mix, AB has been able to exceed annualized organic growth rates of peers in all segments bar fixed income. With AB's reinvestment primarily focused upon alternative assets and equities, these growth metrics exemplify the upside involved in AB's businesses.

Wall Street Consensus

Analysts echo my highly positive view on the stock, projecting an average 1Y price increase of 13.57% to a price of $39.00.

Even at the minimum projected price, analysts predict a 1.92% single year increase to a price of $35.00. When considering the additional returns afforded by AB's dividend, investors can expect healthy yield.

Risks & Challenges

Continued Interest Rate Pressures

Much of AB's price decline has been predicated upon the reduced demand for its services by institutions and high-net-worth individuals due to the recessionary effects of higher interest rates. Sustained interest levels may reduce the firm's ability to generate adequate cash flows to expand or return capital to investors.

Expansion Plans May Not Pan Out

From its investments into active ETFs to its expansion into ESG, from geographic development into EMEA and China to AB's thematic move into private capital- AB is aiming for multi-sided growth. However, contending with the regulatory, financial, and general complexities of each of those growth segments may harm AB's capabilities in all those segments.

Potential Dividend Reductions

A significant portion of AB's capital return is done through its 7.69% dividend, which has required a payout ratio of 108.97%. As such, if this payout ratio is sustained, AB may be required to cut the dividend- which would materially reduce AB's stock price- or take on debt or equity financing to support its dividend.

Conclusion

In the short term, I expect a demand reversion for AB's services leading to upwards price pressures.

In the long term, I project that AB's segmented and geographic growth segments, alongside a solid financial position, will enable long-run growth.

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