DHIL - Diamond Hill Should Report Good Numbers But The Worst Is Not Behind

2024-01-16 22:15:08 ET

Summary

• Diamond Hill's share price has stagnated compared to the overall market, with decreasing AUM and potential for more cash outflows.
• DHIL's financial metrics have shown a clear downtrend in revenues and margins, although net margins have improved slightly.
• AUM has been volatile, with periods of net inflows and outflows, leading to a decrease in overall AUM for the company.

Investment Thesis

Diamond Hill ( DHIL ) is going to report its FY23 numbers at the beginning of February. I wanted to take a look at what has happened since I covered the company last, which was March '23 . The company's share price went nowhere compared to the overall market, as the company continued to see its AUM decrease in the recent quarters, however, I would expect much better numbers for Q4 as the overall market saw a decent rally in the last 3 months. Nevertheless, I am sticking to my hold rating for the company, as I believe we will see further volatility in the stock markets and more cash outflows because of it.

Update on Financials

Since I covered the company back in March of '23, the company's share price went nowhere against the S&P500's 25% advance. So, let's see how the company's metrics have developed over the last year almost.

As of Q3 '23 , the company had around $210m in cash and investments (LT investments), which is the same as of the end of FY22. The company has no debt to worry about so that is a positive sign, that should attract many debt-averse investors, but that would not be the only thing that matters in an investment, since I don't mind when companies take on debt to finance their growth and operations, as long as it's manageable.

In terms of revenues, the company's trajectory has been clear. It has had a lot of difficulty maintaining it and we can see a clear downtrend, with no apparent bounce as of the latest quarter, in which the company saw another 7% decrease y/y.

Over the same period, we can see the company's margin has also taken a hit. Gross margins saw a whopping 840bps decrease in one year, EBIT margins saw around 700bps decline, while it seems that net margins have somewhat improved slightly, around 150bps, so it is not all bad. The massive declines in gross and EBIT did not translate to the bottom-line deterioration. It seems that the company managed to navigate the turmoil somewhat successfully as net margins improved.

Continuing on efficiency and profitability, the company's ROE and ROA have slightly improved since March of last year but are on a downtrend over the last two quarters once again, which indicates that the company's assets and shareholder capital are not being used very efficiently, as the harder macroeconomic times persist. Furthermore, the company's return on total capital has seen quite a decline since March, which indicates that the company is losing its competitive edge and its moat, and it doesn't seem to bounce yet.

Overall, the company's performance has been lackluster. It is no wonder that the company's share price also went nowhere basically.

The cause of it all

So, what has happened? The company cannot stop bleeding. Assets under management, or AUM have been experiencing a very volatile time. The first quarter of '23 saw net inflows of around $84m and the market appreciated around the same, however, in the 2nd quarter of the year , DHIL saw net outflows of around $103m, but to counteract that, the market appreciated around $1.2B, so the company still saw its AUM increase. Fast forward to Q3 '23, the company continued to see outflows from their funds increase, and on top of that the market value of the assets declined $740m, giving a total of $1B decrease in AUM for the quarter. These last three periods explain the images above quite nicely. We can see increases at the beginning of the year through Q2, then everything takes a nosedive.

Comments on the Outlook

The company is going to report its 4th quarter at the beginning of February. I am expecting good results in terms of market value appreciation. Russell 2000 ( IWM ) since the end of September '23 is up around 16%, which means that the company should be up similarly more or less. The major indices saw a decent end-of-the-year rally, which boosted many companies and DHIL should report great numbers here.

I would like to see AUM cash outflows come to an end, the macroeconomic environment may make a lot of people skittish, which could bring more cash outflows going forward, until we see some more certainty in the economy, in terms of interest rates, and where they are headed. Whether they are going to be raised more, cut soon, or linger at these levels for much longer. We don't know what's going to happen, which is not what investors like. I like the fact that even with such a drop in gross and EBIT margins, the company managed to maintain a decent bottom line. If the company can continue to navigate such a tough time in the markets, the company should see a recovery within the next year or two, which will all depend on the macroenvironment. If we go into a recession, the stock market will plummet, which DHIL is obviously a part of.

Closing Comments

So clearly, the company is not looking great for now, however, once all the uncertainty in the markets goes away and things start to improve, I would expect the company's performance to improve yet again. My PT for the long run has not changed, which is around $180 a share, however, I am still sticking to my hold rating for now, even though, the company should report decent numbers for FY23. I don't think we have seen the end of it just yet, as the volatility in the markets remains high. Uncertainty is prevalent, and the U.S. economy is still going too strong for the Fed, which means they will do everything it takes to tame inflation, and interest rate hikes are not off the table just yet.

I will tune in to the company's FY23 annual earnings and see what the company sees in the near future.

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