2023-10-09 09:00:25 ET
Summary
- The article explores the question of whether and how BlackRock, Inc. could be affected by the increasingly evident political backlash against ESG.
- In addition to public reporting, I detail BlackRock's AUM, net flows, and fund allocations.
- The likelihood of an earnings beat on Friday, when BlackRock will release its third quarter earnings report, is analyzed.
- I also share whether I think BLK stock is a buy, sell or hold, going into earnings, considering it is down 20% from its 52-week high.
Introduction
In my last article on BlackRock, Inc. (BLK), I explored the question of whether active asset manager T. Rowe Price Group, Inc. (TROW) could figuratively resemble the carriage at the end of the 19th century. Given the expected tailwinds from increased use of artificial intelligence ((AI)) and as the largest issuer of exchange-traded funds ((ETFs)) in the U.S., it doesn't seem far-fetched to call BlackRock a winner of this "industrial revolution" already.
However, upon closer examination, I found that TROW has outperformed BLK on several key performance indicators, at least since the Great Recession. And while I acknowledge that past performance is not necessarily a good indicator of future performance (think of the increasingly retiring baby boomers, for example), I still found that both BLK and TROW stocks are worthwhile components in a diversified portfolio.
In this update, I explore whether the growing backlash against ESG (environmental, social, governance)-oriented investing in general, and BlackRock's strong position in particular, could actually hurt the company and ultimately lead to poor shareholder returns. Given that the company will release its third-quarter results pre-market on Friday, Oct. 13, and will hold a conference call at 7:30 a.m. EDT, I also discuss the likelihood of an earnings beat and BlackRock's past performance. I'll close with a brief summary and share whether I think BLK is a good stock to buy now amid an arguably jittery environment.
As an aside, I want to emphasize that this is not a political piece and should not be taken as either a pro or con position on ESG (forgive me for using it as a catch-all term) - I am simply exploring how BlackRock may be (or is already) affected by what appears to be a growing political backlash against ESG.
Why BlackRock Could Suffer From An ESG Backlash
BlackRock's focus on ESG is well-known and widely discussed. In the company's own words, BlackRock has
[…] a platform of dedicated sustainable investment solutions that seek to align capital with positive social and environmental outcomes.
BlackRock manages an enormous amount of money on behalf of mostly passive investors ($9.4 trillion at the end of the second quarter of 2023) and has significant voting power in most, if not all, publicly traded companies. In addition, the company increasingly manages alternative investments where it likely has even more influence than the mid-single-digit voting rights it typically holds (e.g., 8.0% of PepsiCo, Inc., (PEP)). However, this segment is still insignificantly small, accounting for just 2.2% of BlackRock's total assets under management (AUM, excluding alternative investments in commodities and currencies).
ESG-conscious investing (e.g., through factor-based ETF strategies or direct investment in individual stocks) became particularly popular in 2020 - not only due to increasing product offerings, but also due to new regulatory requirements. For example, the EU Taxonomy Regulation came into force in July 2020 , in an effort to " helps direct investments to the economic activities most needed for the transition, in line with the European Green Deal objectives " ( European Commission ), and the Glasgow Financial Alliance for Net Zero ((GFANZ)) was launched in April 2021 . In recent years, major insurance companies stopped or started to severely limit their investments in and underwritings of new oil and gas projects (e.g. AXA, Allianz).
But reservations are growing about an industry that seems to be marching in lockstep. According to this article by Reuters , there are 44 new bills or laws in 17 U.S. states aimed at punishing Wall Street firms for taking a stand on various hotly debated issues, such as climate change. A Texas law finalized in 2021 mandates that " state agencies must divest must divest from financial companies identified by [state Comptroller] Hegar as boycotting energy stocks, or explain why they are continuing those relationships."
One could argue that these steps are simply a case of mean-reversion. However, if one considers, for example, the European energy crisis (largely self-inflicted, e.g., Germany's move away from coal and nuclear energy , and exacerbated by the Ukraine war), more and more people are realizing that there is no "quick and easy" transition and that a balanced approach is absolutely necessary. Reliable and secure access to fossil fuels and their availability is absolutely critical to the transition to more sustainable energy sources. The transition - especially in terms of developing competitive and efficient solutions - requires not only capital (access to which is becoming increasingly difficult for O&G companies), but also time. A comparison of energy returned on energy invested (EROEI or EROI) of energy sources and power plants shows how early we are on this path. An EROEI of 3:1 (33% of energy is needed to maintain supply) is the bare minimum for an energy source to be considered viable. Biofuels have an EROEI of about 3:1, while diesel has an EROEI of 30:1, and today's best offshore wind farms (including buffering) have an EROEI of 5-10:1 (p. 11 ff. in this article ).
With the European energy crisis and growing reservations in the U.S. as well, and with both institutional and retail investors becoming more aware of the need for a smooth and well-designed transition, asset managers with a more-or-less hard-line stance like BlackRock could come under pressure. The company generates most of its revenue from management fees (which are charged as a small fraction of the value of AUM). Investors who disagree with the company's policies could negatively impact BlackRock's growth potential by withdrawing their money - even if it is not directly invested in BlackRock's sustainable funds - due to the company's known voting priorities .
Is BlackRock Stock Set To Underperform Amid The Growing ESG Backlash?
BlackRock has experienced healthy AUM growth since at least 2011 (Figure 1). The average annual AUM growth rate of 7.7% is largely due to the roaring bull market that began after the Great Recession and ended in 2021 (excluding the crash due to the pandemic in 2020). In 2022, BlackRock AUM fell by 4%, but started to recover in the second quarter of 2023.
Figure 1: BlackRock, Inc. (BLK): Quarter- or year-end assets under management (own work, based on company filings)
Of course, the decline in 2022 can be attributed to the bear market, but the fact that BlackRock's AUM declined far less than the market (as measured by the S&P 500, SPY ) suggests that there was no negative impact due to investors pulling their money out of BlackRock because of ESG concerns. However, a closer look at the relative change in AUM shows that BlackRock's AUM growth lagged that of the S&P 500 not only in the first and second quarters of 2023, but also in most of the preceding years (Figure 2). However, I do acknowledge that the S&P 500 is far from an ideal comparison due to BlackRock's broad offering and global footprint, so we need to dig a little deeper.
Figure 2: BlackRock, Inc. (BLK): Relative change in quarter- or year-end assets under management compared with the performance of S&P 500 - SPY (own work, based on company filings and SPY price data)
A look at BlackRock's net flows is likely the best indicator of potential negative impact. The fact that the firm has had net inflows from clients in 11 of the 12 years since 2011 is very reassuring, as is its performance in the midst of the bear market in 2022 and a choppy market so far in 2023 (Figure 3). I don't think it is reasonable to infer an "anti-ESG" impact from these data. In my view, BlackRock's ability to continue to attract significant new funds - averaging 3.0% of year-end AUM over the period - is evidence of the firm's strong economic moat.
Figure 3: BlackRock, Inc. (BLK): Absolute and relative net flows during the year, quarter or annualized quarter (own work, based on company filings and SPY price data)
But what if we are only in the early stages of a significant movement? Consider that several states, such as Florida , Louisiana and Missouri , have either already pulled money from BlackRock and/or expect to do so. Florida's Treasury plans to pull $2 billion from BlackRock, while Louisiana has already pulled nearly $600 million and expects to reallocate another $800 million. Missouri's State Employees' Retirement System has already withdrawn $500 million from BlackRock. That sounds like a lot of money, and the total including other investors is probably much higher than the roughly $4 billion, but of course should be considered in the context of BlackRock's AUM. Withdrawals representing only 0.047% of year-end 2022 AUM are definitely not moving the needle. Assuming the $4 billion was withdrawn in 2022, this would represent about 1.3% of BlackRock's total net inflows in 2022, or 1.7% of the $230 billion in inflows attributable to U.S. clients.
In my view, BlackRock's continued strong performance - despite the growing backlash against ESG - is due in large part to the strong value proposition of the company's offerings. They are highly competitively priced ( iShares franchise ), and the company operates with tremendous economies of scale. This is primarily enabled by BlackRock's Aladdin platform , which is certain to benefit significantly from the increasing adoption of AI.
Leaving aside the risk of investors pulling their money away from BlackRock in the face of increasing rejection of ESG, I think it is worth taking a look at BlackRock's direct exposure to "sustainable" investments.
As I indicated earlier, the relevant technologies (in particular power buffering) are still at a fairly early stage. As a result, there is still a lot of research and development that needs to be done to develop these technologies and make them more profitable, or profitable at all. Keeping in mind the concept of EROEI, it is clear that an energy source or power plant with a poor EROEI will consequently have a low return on investment ((ROI)). Companies that make significant direct investments in such technologies are setting themselves up for poor shareholder returns - at least in the short term. But just because BlackRock has a strong position on sustainable investments doesn't mean the company is directly invested in them. After all, an asset manager buys assets on behalf of its clients. Instead of direct exposure to potentially low-return assets, I think the risk for BlackRock is that customers who have invested in the company's sustainable funds could withdraw their money if they find that their funds are performing poorly due to underwhelming ROIs. However, considering that BlackRock's sustainable funds represented less than 3% of AUM at year-end 2022, I don't think this risk is material either - even if this segment continues to grow strongly (three- and six-year CAGRs of 20%).
In any case, despite the continued strong net inflows and the insignificant share of funds classified as sustainable, investors should keep an eye on these metrics.
Similarly, BlackRock's own ESG rating should be monitored, as a potential downgrade could lead to negative stock performance: Despite its efforts and positioning, BlackRock was only rated S-4 (out of 5) by Moody's in its Social Issuer Profile Score. To be fair, however, the company's overall rating is CIS-2 (out of 5), as it scored well in the areas of Environment (E-2) and Governance (G-2).
Did BlackRock Beat Earnings Before And What To Expect From Q3 Earnings?
In principle, predicting asset manager revenues and earnings seems like a futile task. An analyst with a good track record of predicting long-term asset manager earnings is probably better off applying his wisdom to investing, since asset managers are essentially a leveraged bet on the stock market. This is well illustrated by FAST Graphs' analyst scorecard (Figure 4), which shows a -15% difference between one-year-forward consensus estimate and actual results for 2022. While it wasn't too hard to see that the market was running hot in 2021 and inflation was likely to accelerate, who could have predicted the Ukraine conflict and the rapid pace at which the Federal Reserve raised interest rates?
Figure 4: BlackRock, Inc. (BLK): One-year forward analyst scorecard (FAST Graphs)
But, of course, we must remember that analysts regularly adjust their estimates according to management's comments and based on external factors as the earnings date approaches.
For the recently completed quarter, analysts expect BlackRock to report earnings per share ((EPS)) of $8.47 (-11.3% year-over-year) and revenue of $4.56 billion (+5.76% year-over-year). Quarterly EPS and revenue revisions (EPS revisions in Figure 5) suggest that analysts have become a bit more cautious over the months, but they still expect fairly solid revenue and profit growth for the third and fourth quarters (+6% and +9% year-over-year, respectively). However, I would not overinterpret these growth rates, considering the easy comps due to the bear market of 2022, which had its low point in the second half of the year.
Figure 5: BlackRock, Inc. (BLK): Quarterly consensus earnings per share revision trend (Seeking Alpha)
I think BlackRock has a good chance of meeting or beating quarterly estimates for revenue and EPS on Friday. BlackRock has generally beaten earnings estimates in recent quarters (Figure 6). And while long-term forecasts are indeed based on guesswork rather than hard facts (which don't exist), estimating the numbers for a recently completed quarter with reasonable accuracy should be comparatively easy. After all, the performance of various stock and bond market indexes is no secret.
Figure 6: BlackRock, Inc. (BLK): Earnings per share surprises on a quarterly basis (Seeking Alpha)
For next years, expectations remain solid too (10% and 12% year-over-year revenue and EPS growth, respectively), but I don't think it makes much sense to discuss the longer-term outlook for BlackRock, as it is simply impossible to predict the unknown.
In my view, it is enough to know that asset valuations know only one direction over the long term, and BlackRock is very well positioned to earn a significant share of that growing pie, despite the recent and apparently growing backlash against the company's emphasis on ESG. Of course, there is no guarantee that the next bull market is just around the corner, so investors' patience may be tried. However, given the inevitable return to a period of monetary expansion at some point, BlackRock - as a financial company - is favorably positioned in the context of the Cantillon effect .
Conclusion - Is BLK Stock A Good Buy Now Before Earnings?
The article discussed possible reasons for the recent increase in (political) backlash against asset managers who have ESG issues firmly on their agenda, and explained the possible implications for BlackRock - a leader in this area.
The asset manager's past performance does not indicate a material negative impact on assets under management, the main source of revenue and income. On the contrary, BlackRock continues to perform very well even in a choppy market environment. The company continues to see strong inflows from clients, dwarfing outflows due to ESG concerns reported in the media.
However, even if the company is only marginally affected by these pressures, it is worth remembering that its major competitor Vanguard moved to a less stringent ESG policy not long ago and even withdrew from the Net Zero Asset Managers ((NZAM)) initiative in late 2022. BlackRock is still one of the more than 315 signatories and has not changed its stance on ESG issues, although CEO Larry Fink no longer uses the "weaponized term ESG," but the above developments at Vanguard may indeed indicate a possible moderation in the BlackRock's stance on ESG. This could improve BlackRock's standing with certain institutional investors who began pulling money from the asset manager. At the same time, I would not underestimate the impact of the increasingly mandated direction of capital toward "sustainable" activities (e.g., the EU Taxonomy Regulation) as a tailwind for BlackRock. I also discussed this aspect in another article in which I explored the question of whether an "anti-ESG premium" is already evident when comparing sector-specific corporate bond yields.
Despite the continued solid performance and strong long-term outlook attributable to BlackRock's scalable and highly efficient solutions, investors should keep an eye on the company's net flows, the AUM share of sustainable funds (against a backdrop of potentially poor returns and consequently disappointed investors) and, of course, the asset manager's own sustainability ratings.
BlackRock is set to report its third-quarter earnings on Friday, Oct. 13, but despite the high probability of an earnings beat and the solid long-term outlook, I'm not looking to add to my existing position at this time.
Granted, the stock is down 20% from its all-time high and the return outlook is solid, according to FAST Graphs (Figure 7), but with a blended price-to-earnings ratio of nearly 19, I still think BLK stock valuation is a bit too expensive. Also, BlackRock's dividend of $5.0 per quarter (last increase of 2.5% ), which translates to a dividend yield of 3.1%, is not overly compelling compared to the long-term risk-free rate, which is currently above 5% . Granted, BlackRock's dividend yield is 20% above its five-year average - but I would take that with a grain of salt given the previous bull market and the strong performance of asset managers post-pandemic.
It is impossible to predict the long-term market development - and thus also that of asset managers. Therefore, I take the expected annualized return with a grain of salt and require a margin of safety. I would add to my position if BlackRock's stock price falls to between $530 to $600, which would equate to a P/E ratio of 15 or 17, assuming earnings remain intact. Of course, in the event of another bear market, BlackRock's P/E ratio could rise if earnings fall disproportionately relative to the stock price. Therefore, I prefer to stick to an absolute buy price when planning my short-term purchases and not necessarily a multiples-based valuation. Of course, the situation must be reassessed over time.
Figure 7: BlackRock, Inc. (BLK): FAST Graphs chart, based on adjusted operating earnings per share (FAST Graphs)
Thank you for taking the time to read my latest article. Whether you agree or disagree with my conclusions, I always welcome your opinion and feedback in the comments below. And if there's anything I should improve or expand on in future articles, drop me a line as well. As always, please consider this article only as a first step in your own due diligence.
For further details see:
BlackRock Q3 Earnings Preview: Poised To Underperform Amid ESG Backlash?