2023-08-23 10:03:53 ET
Summary
- Recent underperformance presents a potential buying opportunity.
- Despite lackluster Q2 results, BlackRock demonstrates resilience and steady navigation.
- In-depth DCF analysis underscores significant upside potential for BlackRock's stock.
Introduction
BlackRock's ( BLK ) earnings release has been rather disappointing, coupled with its significant underperformance compared to the broader market in recent months. One might argue that this investment management company is far from a buy. I initially held a similar view. However, as I delved deeper into the company's fundamentals, I realized that BlackRock appears to be fairly undervalued instead.
My view is based on its robust business model, leading market position, and the strong cash flow levels it has demonstrated in the past and is likely to continue. In the following sections, we will explore why this industry giant is a strong candidate for your portfolio if you're seeking stability, attractive dividends, and, most importantly for me, substantial room for upside potential based on its current share price based on the fair or intrinsic value that I will try to assess throughout this article.
Black Rock currently offers a dividend yield of 2.87%, equivalent to a $20 payout, backed by 13 consecutive years of dividend growth driven by robust cash flows.
Recent Results
Even in the face of poor investment results, the inherent stickiness of investor money can be advantageous. As many of Black Rock's peers faced headwinds over the past, reflecting shrinking revenues, profits, and margins, Black Rock's business model, which offers a broad suite of products attracting every type of investor that is out there, proved once more valuable, as the company is still holding up decently.
The cause of the dismal performance, which has been ongoing due to severe market disruptions in 2022, is evident. Emerging concerns about inflation, an economic downturn, and worries about a looming more significant one, along with geopolitical tensions that started to emerge within the last year, led to a deterioration in the asset management industry's fundamentals.
BlackRock's Q2 financial results for the second quarter ended June 30, 2023, therefore appear rather lackluster. The company's revenue declined by 9.7% year over year to $4.2 billion in the first quarter. This decline corresponded with a 7.9% decrease in average assets under management, totaling $8.9 trillion for the quarter.
BlackRock's EPS significantly declined by 16.7% year over year to $7.93 for the quarter. Despite years of financial success, expense reductions were only able to offset the reduced topline within a short timeframe. As a result, BlackRock's profit margin contracted to 28.3%, a decrease of 280 basis points in the quarter.
However, there's some light as a counterbalance to the bad news. As already mentioned, BlackRock's ability to produce compelling products resulted in net inflows of $382 billion from Q2 2022 to Q1 2023. This further helped mitigate the impact of the market downturn.
BLK - Financial Results Q2 (Black Rock Inc.)
And with financial markets regaining stability again, combined with the FED being likely to only announce one more 25-bps rate hike for this year before probably announcing rate cuts sometime next year, BlackRock's AUM, revenue, and profits are likely to follow accordingly.
Valuation
Nevertheless, the crux of my article, as well as the basis for my perspective on investing in BlackRock stock, lies in its fundamentals. I conducted a Discounted Cash Flow ((DCF)) analysis to assess its intrinsic value. Despite potential revenue concerns for the full year of 2023, as indicated by BlackRock's Q2 numbers, the company is still anticipated to maintain its robust cash flow margin.
To provide a comprehensive view, I presented three cases for BlackRock's Cash Flow growth in the future, considering a range of scenarios from optimistic to cautious due to the prevailing uncertainty. For the timeline from FY23 to FY25, I incorporated growth assumptions from analysts at Market Screener for the optimistic scenario.
Beyond that period, I basically assumed a steady growth rate, which might not reflect reality, but as a wise man said, financial models are always merely a magnifying glass with a certain degree of sharpness you look through in order to gain a perspective on reality. It's never accurate, but it might give you a trend or an indication.
The results across all scenarios are noteworthy. While I consider the worst-case scenario pessimistic, it still implies only a 12% decrease based on BlackRock's current Share Price. On the other hand, significant upside potential is evident in the "street" and bull case scenarios. Additionally, it's important to note that BlackRock maintains a healthy cash position of approximately $6.8 billion, coupled with manageable debt levels below $8 billion.
Risks to my Thesis
While my optimism remains high, exercising caution as a prudent investor is essential. Uncertain growth outlooks, persistent inflation, rising interest rates, recession risks, and elevated geopolitical tensions are potential challenges. Despite the advantages of being a market giant, BlackRock's size could also hinder agility in navigating the current volatile environment, further exacerbated by ongoing challenges.
One immediate risk BlackRock faces is the uncertainty of whether the market has reached its bottom. If, against my expectation, a severe recession emerges in the coming months, financial markets could experience further declines, affecting BlackRock's results.
Such external events may render the assumptions in my fundamental analysis and DCF model obsolete. Factors such as the company's long-term revenues, profits, and growth rates may be impacted by these events.
Final Notes
Currently, the asset management industry is weathering somewhat of a storm. Despite lingering risks and uncertainties, my fundamental analysis of BlackRock, coupled with my inclination toward stable dividend prospects, reinforces my recommendation for a buy rating on this company.
Furthermore, I believe the Federal Reserve has managed to mitigate inflation significantly. Although inflation remains above 2%, there's no strong argument that their final adjustments will necessarily lead to a sharp and drastic decline in the overall economy. On the contrary, prevailing indications suggest a different outcome. As interest rates near their peak and the Fed is likely to ease financial conditions, the trajectory of rising stock prices is supposed to hugely benefit asset managers like BlackRock and solidify my case for the company.
For further details see:
BlackRock: Strong Cash Flows And Upside Potential Signal Buying Opportunity