2023-06-21 14:55:16 ET
Summary
- BlackRock, Inc. stock is overlooked, as most market participants have yet to recognize the firm's recent inflection points.
- The firm's base rates improved in Q1, which we think will continue into late 2023 and early 2024.
- Although we believe BlackRock's private equity incentives will remain depleted for the rest of 2023, opportunities exist within the Private Equity arena, and BlackRock has the cash to spend.
- A potential entry into cryptocurrencies might enhance BlackRock's reach. Moreover, cross-sales of other iShares products are a possibility.
- Risks such as poor ESG product management and absolute valuation concerns are present. However, we still back BlackRock's stock to succeed.
BlackRock, Inc. (NYSE: BLK ) stock has shed approximately 7% of its market value since our latest coverage , which is quite a surprise given the year-to-date recovery in the broader financial markets.
However, a closer observation suggests that BlackRock's key drivers are lagging behind the broader market, providing us with a basis for a contrarian opinion in today's article. Moreover, noteworthy developments have occurred since our latest coverage, providing us with the necessary latitude to update our thesis.
Pearl Gray's Previous Coverage (Seeking Alpha)
Without further delay, let's delve into a more detailed discussion about our latest findings.
Higher Entry Fees and Incentives Inbound?
BlackRock's quarterly revenue receded in its previous quarter, driven by the continued depletion of performance and advisory fees. Moreover, the firm claims a stronger U.S. dollar had an adverse effect on its equity offerings, depleting its revenue capacity.
Let's dissect a few aspects to determine what's ahead.
General Liquid Assets
Although base fees continued to weaken year-over-year, a quarterly uptick was experienced amid a near broad-based financial market recovery. Based on our outlook on the S&P 500 ( discussed here ), we expect both base fees and incentives from liquid assets to improve in BlackRock's prospective quarters.
Firm-Wide Base Fees (BlackRock)
If the stock and bond markets both strengthen as anticipated, we believe BlackRock's iShares products will blossom, as the company has a robust position in the ETF arena.
The rise of ETFs is probably set to continue as it caters to a diverse set of needs ranging from retail investor participation to institutional portfolio management efficiency. Additionally, BlackRock's market position allows it to charge lucrative margins, leading to significant profits.
Another factor worth considering is BlackRock's Bitcoin ( BTC-USD ) ETF filing , which is a preliminary procedure to establish a spot Bitcoin ETF, allowing investors to invest in the cryptocurrency at a lower price.
According to BlackRock's managerial team: "The Shares have been designed to remove the obstacles represented by the complexities and operational burdens involved in a direct investment in bitcoin, while at the same time having an intrinsic value that reflects, at any given time, the investment exposure to the bitcoin owned by the Trust at such time, less the Trust's expenses and liabilities,"
Although we are neutral on the prospects of Bitcoin and related cryptocurrencies, the move toward cryptocurrencies as an asset class provides BlackRock with exposure to a new group of investors, allowing it to target emerging investors. Keep in mind that cross-product sales will also come into play if a new investor base is reached.
Crypto Ownership in the U.S by Age (Statista)
Alternative Investments
I would like to emphasize BlackRock's private equity endeavors for most of today's alternative investment discussions, as various inflection points exist.
Private market activity and performance tend to lag behind public market endeavors as assets are slower to reprice, and deal completions are more prolonged. In addition, underlying asset impairments are often a significant problem (a headwind for most private equity firms in 2022/early 2023).
In our view, private equity deal activity will only tick up in the latter stages of 2024 as capital scarcity diminishes from receding benchmark interest rates (assuming interest rates pivot). Moreover, we could also see higher asset valuations in the private markets during late 2024, as lower interest rates and an enhanced corporate earnings outlook might come into play.
BlackRock's alternatives division currently has $33 billion in committed capital to draw down. Although the firm's credit and infrastructure segments were of key focus during Q1 (collectively achieving 16% year-over-year growth in base fees), we anticipate a shift toward private equity due to a pending shift in the interest rate cycle.
How would such a move net out? In our view, valuations in PE (private equity) are low , and exploitation of such valuations could result in profitability. Infrastructure is seen as a long-term solution, and private credit is a tactical play in a high-interest-rate environment; therefore, an anticipated drawdown in short-term interest rates will likely result in better all-around diversification.
Alternative Assets (BlackRock)
Lastly, we expect BlackRock's cash solutions business to resume its strength. We base this on investors' return to the money market amid the cooling of bank/credit crisis talks that dominated headlines earlier this year. Moreover, interest rates remain elevated, adding much allure to the risk-return profile of cash solutions.
Dividend Prospects and Share Buybacks
BlackRock's stock presents investors with a solid dividend opportunity. The stock's forward dividend yield of 2.89% is accompanied by 13 consecutive years of dividend growth, conveying the stock's suitability to income-seeking investors.
Furthermore, BlackRock repurchased $375 million worth of ordinary shares in its first quarter and anticipates repurchasing an additional 375 million shares in 2023 via open-market transactions.
Buybacks often provide tailwinds to stocks, as investors generally view them as accretive. In addition, a blended shareholder compensation package of buybacks and dividends provides BlackRock with flexibility, as open market buyback plans are relatively laissez-faire.
Risks
ESG Restructuring
BlackRock's ESG solutions have been scrutinized in the past year. For instance, the firm was recently accused of " greenwashing " and otherwise criticized for favoring ESG investments at the expense of maximizing their pension fund clients' profitability .
Regardless of the ground truth, BlackRock and its peers' ESG funds have yet to deliver their anticipated results, with ESG fund closures occurring in recent times.
At Pearl Gray, we firmly believe the issue is not within ESG as a concept but instead the structuring of ESG funds. ESG ratings are sparse and disorganized, making for loose investment mandates that investors misinterpret. Moreover, we think ESG factors are not built to coalesce, but instead, our view is that a mandate focused on individual factors will be easier to manage and explain.
In essence, the ESG experiment is not going as planned, presenting a structural concern to BlackRock's corporate strategy.
Absolute Valuation Concerns
Model Outputs
Although BlackRock's stock provides a solid dividend profile and prospects of value-additivity via share buybacks, its absolute valuation remains of concern.
For today's analysis, I decided to emphasize our findings on the stock's justified price multiples, as BlackRock presents consistent growth rates that can be easily substituted into parsimonious asset pricing models.
Based on our work, BlackRock's stock is trading at a premium to many of its justified multiples, with its trailing price-to-book ratio sitting at a 2.9x premium . Additionally, the stock's trailing price-to-earnings ratio of 20.46 is well beyond its justified price-to-earnings multiple, which is merely 7.11.
Although justified price multiples do not dictate a stock's prospective returns, they certainly provide a credible indication. As such, we deem BlackRock's absolute valuation a significant risk.
Justified Price Multiples (Author's Work with data from YCharts and Seeking Alpha)
Final Word
Although absolute valuation concerns are present, we think BlackRock's prospects are set to realign as support from the financial markets provides it with the latitude to recognize better base rates and enhance its incentives. Moreover, an entry into the cryptocurrency arena might draw a new investor base and coalesce with BlackRock's iShares offerings to produce internal growth.
Furthermore, BlackRock possesses dry powder within its alternative investments segment. In our view, depressed private equity valuations present big buyers such as BlackRock with lucrative opportunities. Additionally, a potential interest rate pivot might enhance asset valuations.
As already mentioned in this closing argument, the stock's absolute valuation is of concern. However, an argument exists that the firm's core valuation will improve in future quarters. Besides, BlackRock's stock provides collateral to its investors via an alluring dividend profile.
Strong Buy Rating Assigned.
For further details see:
BlackRock: Higher Entry Fees And Incentives Inbound (Rating Upgrade)