2023-09-13 04:08:43 ET
Summary
- BlackRock has had a rocky 2022 and YTD 2023 with the AUM falling from peak of $10.01 to $9.43 trillion, exerting pressure on its Revenue and Operating Margin.
- BLK is experiencing a turnaround with rising equity markets and diminishing recession fears, resulting in AUM growth and promising momentum heading into 2024.
- BLK has compounded its dividend at a 16.2% CAGR over 20 years, with a brief exception in 2008-2009. Currently yielding 2.86%, it's well-positioned for future growth.
- Anticipating a 5.20% CAGR for top-line growth and improved profit margins in the next decade, along with a slight undervaluation, I confidently rate it as a STRONG BUY.
Investment Thesis
BlackRock ( BLK ) is one of most influential asset management firms, managing trillions of dollars in assets on behalf of individual investors, institutions, and governments across the globe. The company is renowned for its expertise in various investment strategies, including index funds, actively managed funds, and alternative investments, catering to a wide range of clients' financial needs. In the last 30 years, BlackRock has played a pivotal role in shaping the financial industry's shift towards passive investing through its iShares ETF platform, which offers a diverse array of low-cost investment options.
As inflation continued to rise in developed nations and central banks worked to bring it down to the long-term targets of 2% for FED and ECB, the market experienced a notable downturn in 2022. Fears of economic destabilization and the looming threat of a recession caused widespread concern. Unfortunately, asset and wealth management firms have not been immune to this trend. Investors have been withdrawing funds from their investments, resulting in a decrease in AUMs for companies such as BlackRock.
As anticipated, BlackRock faced a challenging start to 2023 due to the decline in AUM, which directly impacts the company's earnings, particularly through its Base Fees, constituting 77% of their revenue. With these hurdles, the company reported rather lackluster earnings however, looking ahead, while the remainder of 2023 may still be marked by some turbulence and volatility, I'm optimistic about a robust recovery and gaining momentum as we head into 2024, especially with the prospect of AUM growth once again.
BlackRock has a history of delivering strong and consistent growth, a trend that both analysts and I anticipate will persist over the next decade.
Considering the current valuation, BlackRock presents an interesting investment opportunity. With its strong fundamentals, diversified presence across various geographical regions and product offerings, and a compelling dividend that has exhibited impressive growth over the past 20 years, the company appears poised to continue its dividend growth trajectory, especially with expected profit margin expansion.
Business Update
Allow me to kick off this Business Update by acknowledging that Q2 2023 hasn't been a standout quarter for Blackrock, and 2022 wasn't a stellar year either, with a 7.7% drop in revenue compared to 2021 and a 13.4% decrease in operating margin. It's no secret that the combination of high inflation and the Federal Reserve's aggressive 500 basis point rate hikes have had a significant impact on wealth management firms. This impact is evident via a stock price performance, which has shown increased volatility but has gone virtually nowhere in last 12 months.
That being said, the expectations were already set quite low for Q2 2023 based on the prior year. Despite this, BlackRock, like many others, hasn't delivered impressive results. However, in my opinion, as we move through the remainder of 2023, the outlook may remain challenging, but I see a turning point on the horizon in 2024. With markets recovering, signaling higher inflows into asset management services, which will ultimately boost revenue, whether through equity offerings, constituting roughly 52% of the firm's revenue, or fixed income offerings, which contribute 30% to revenue, I believe that BlackRock is strategically positioned to capitalize on this recovery trend.
In the earlier part of this summer, BlackRock released its Q2 2023 earnings report. The company reported a Revenue of $4.46 billion USD, reflecting a 1% decline compared to the same period in the previous year. Additionally, the company disclosed a 3% decrease in Operating Income, with the GAAP Operating Margin slipping from 36.9% to 36.2%, driven by higher Operating Expenses in relation to the Revenue.
Despite the somewhat underwhelming performance in terms of Revenue and Operating Margin, there was a notable 28% increase in EPS, reaching $9.06. This impressive EPS growth outperformed analysts' expectations by $0.81, largely due to a substantial boost in non-operating income during the current quarter.
I'd like to delve into the quarterly revenue breakdown to shed light on the origins of BlackRock's revenue. The cornerstone of BlackRock's revenue stream lies heavily in the base fees it charges for its Equity and Fixed Income offerings, making the AUM the primary catalyst for these fees. Currently, the company manages approximately $9.43 trillion in AUM, making it the largest asset manager on the planet. It's worth noting that the company's AUM had actually reached its peak in 2021, surpassing $10.01 trillion, but has since declined. However, 2023 signifies a year of recovery , with net inflows totaling $190 billion, indicating a positive trajectory for the company's AUM.
In Q2, the majority of revenue, specifically 77%, was derived from Base Fees, with the remaining 23% generated through sources such as Security Lending, Performance Fees, Technology Service Revenue, and others. Although Base Fees in Q2 decreased by $101 million YoY, there is now visible a reversal in the trend. Since Q1 2023, BlackRock has reported an increase of $92 million in Base Fees, reinforcing my belief in the company's recovery.
What I find particularly appealing is Blackrock's robust diversification across various client types, product offerings, and geographic regions. This diversity underscores the company's strong fundamental position. Notably, AUM are spread out, with 57% attributed to Institutional Investors, 33% in ETFs, and 10% in Retail clients. While the majority of base fees are generated by the ETF offerings and Institutional Clients as expected due to its size, it's intriguing to observe that Retail Clients, despite having the smallest AUM share by far, contribute significantly to the company's overall revenue. This positioning bodes well for BlackRock, especially considering the trend of more individuals entering the market, which initially gained momentum at the onset of the COVID-19 pandemic.
In terms of geographical diversification, the company's footprint is predominantly in the Americas, accounting for 67% of AUM and 65% of Base Fees. Additionally, BlackRock has a presence in the EMEA region, representing 25% of total AUM, and the Asia Pacific region with 8% AUM.
BlackRock has a rich history of pioneering innovation in the financial markets, such as making ETFs more accessible to the general public with exceptionally low fees. Despite my personal reservations about cryptocurrencies, it's noteworthy that BlackRock has recently entered the cryptocurrency arena, causing quite a stir that has captured the attention of investors, regulators, and industry experts alike. Their announcement of a cryptocurrency ETF proposal sent a resounding message that BlackRock is determined to wield a significant influence in shaping the future of digital assets and capitalizing on the opportunity. However, as recent interactions with the SEC have shown, there are challenges on the road ahead, and it may be some time before BlackRock successfully enters this market.
Outlook
BlackRock has been delivering a very reliable and stable performance over the past 10 years, the company has grown its top-line at the rate of CAGR 5.15%. Looking into the next decade the analysts are forecasting that the growth is going to be at the similar rate of CAGR 5.20%. If that comes the fruition, the company is expected to reach $30.18 billion in revenue by the end of 2032, which represents an increase from the expected 2023 year end revenue of 66%.
What particularly excites me about the company is its consistent profitability. In a time when many companies faced earnings volatility, especially in 2022, BlackRock has maintained remarkably stable profit margins . Over the past decade, they've consistently averaged a GAAP Operating Margin of 38%. It's worth noting that 2022 and 2023 were the years that actually brought down this average by roughly -1% due to lower revenue, even though expenses remained relatively constant.
Considering the company's adept management of operating expenses in the face of rising inflation and interest rates, along with the projected single-digit growth over the next 10 years, I anticipate that BlackRock is well-positioned to expand its margins. It's entirely feasible that they could reach an Operating Margin of 40% by 2032, especially since they've already achieved this level between 2013 and 2015. If this scenario materializes, the company could potentially generate over $12 billion in Operating Income by the end of 2032.
If my expectations don't convince you, the 3rd party data may. Statista is actually forecasting substantial growth in the wealth management industry , with a projected compound annual growth rate CAGR of 6.14% between 2023 and 2027. This growth is underpinned by several factors, including the increasing number of high-net-worth individuals worldwide, a rising trend among Millennials and Gen Z to invest, particularly in ESG-related causes, and the accelerating availability of digital investment offerings, which make investing more accessible to the public.
Nevertheless, it's essential to consider that historically, BlackRock's performance has closely correlated with positive market returns, particularly during the period from 2010 to 2023. Therefore, if you anticipate overall market underperformance in the next decade, including in fixed income, it may be prudent to reconsider this investment option.
Return to Shareholders
Here's something worth considering if you're thinking about adding BlackRock to your portfolio or increasing your current position: the company offers a rather appealing 2.86% dividend yield. This yield outpaces the Vanguard Financials ETF ( VFH ), which currently offers a 2.35% yield. What's reassuring is that BlackRock maintains a payout ratio of 55%, indicating that the dividend is adequately covered, despite the company's recent financial performance not being all that stellar.
Perhaps the dividend yield is tempting, but what truly sets BlackRock apart as an exceptional choice for dividend growth investors, including myself, is the company's remarkable track record of dividend growth, dating all the way back to 2003 when they initiated dividend payments. It's worth noting that even during the challenging Financial Crisis of 2008-2009, BlackRock didn't cut but neither grew its dividend, showcasing resilience in the face of financial turmoil, despite being in the financial sector.
Since that inaugural dividend payment in 2003, BlackRock has achieved an impressive CAGR of 16.2%, recently reaching a dividend of $5.00 per share. And don't be misled; even in the past five years, the growth has only marginally slowed to a CAGR of 11.6%. This suggests that the company is well-positioned to continue raising dividends, especially as short-term difficulties subside, heading into 2024.
Another noteworthy aspect is BlackRock's active engagement in share buybacks. Starting back in 2014, the company has effectively repurchased about 12.66% of its diluted shares. What's even interesting is that BlackRock has recently given itself the green light for further buybacks , allowing the company to repurchase an additional 7.9 million shares. This amounts to approximately 5.18% of the total outstanding shares and will be executed at a later date.
Valuation
Now, turning to valuation, let's start with the Forward PE Ratio. While each Asset and Wealth Manager has its unique offerings and characteristics, I've chosen to benchmark BlackRock against five companies in the same industry to gauge its valuation. Currently, BlackRock sits in the middle of the pack, with a Forward PE Ratio of 19.51x. This is roughly in line with its 5-year historical average of 19.15x. Here's how some other notable companies compare: Berkshire Hathaway ( BRK.A ) ( BRK.B ) perhaps the biggest outlier from the list in terms of its business model, trading at 22.16x, Blackstone ( BX ) at 26.60, Charles Schwab ( SCHW ) at 18.31, State Street ( STT ) at 9.75, and Northern Trust ( NTRS ) at 12.12.
If we're solely considering the Forward PE ratio, in my view, BlackRock appears to be reasonably valued at the moment. However, it's important to note that this metric doesn't take into account its superior expected growth rate beyond the next fiscal year. With that in mind, let's shift our focus to the DCF model for a more comprehensive evaluation.
To project BlackRock's Fair Value, I'm leaning on the revenue projections previously discussed. The anticipation is that by the conclusion of 2032, the company will reach a Revenue figure of approximately $30.18 billion and an Operating Income of around $12.07 billion. I base this on what I consider a conservative assumption, expecting the company to experience a CAGR of 5.15% over the next decade. Furthermore, as BlackRock matures and its Revenue growth outpaces its Expense growth, I foresee an increase in the Operating Margin, growing from its current 36.2% to 40% by the close of 2032.
Additional assumptions for the DCF analysis are:
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A tax rate of 23.74%.
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D&A and CAPEX amounting to 5.8% and 4.1% of EBIT, respectively.
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WACC of 10.3%.
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EV/EBITDA multiple of 14.28.
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A Terminal Growth Rate set at 2.5%.
After discounting these values over the next 10 years, the PV of FCF amounts to approximately $48 billion, while the PV of TV reaches $64.3 billion. Consequently, the total Enterprise Value is estimated at $112.5 billion. Following adjustments for Cash, Marketable Securities, Short & Long-term debt, the resulting Equity Value is assessed at $111 billion.
According to my calculations, the estimated Fair Value for the company today is $744, suggesting an undervaluation of approximately 6.5% compared to today's price of $696.
Conclusion
In a world grappling with elevated inflation and rising interest rates on a global scale, the business models of asset and wealth management firms, including BlackRock, have faced challenges. Many individuals have been withdrawing their investments, resulting in a decline in AUM for companies like BlackRock. However, there's a positive shift in this trend, with BlackRock reporting higher AUM in Q2 2023 compared to 2022. This suggests that the company is regaining its footing.
Historically, BlackRock's total returns have been closely tied to positive equity market performance. With most countries around the world steering clear of anticipated recessions and stock markets delivering positive returns, BlackRock is on a promising path to recovery, building momentum as we approach 2024.
When you factor in BlackRock's diversified business model, its strong fundamentals spanning across developed countries, and the current slight undervaluation of approximately 6.5%, along with the projection of robust single-digit annual growth over the next decade, I recommend the company as a STRONG BUY. I anticipate that it has the potential to outperform the market and deliver impressive returns during the next decade.
For further details see:
BlackRock: A Dividend Growth Compounder You Do Not Want To Miss