2023-09-06 08:20:35 ET
Summary
- Even when considering no growth until 2030, T. Rowe Price Group appears to be attractively valued.
- Based on the Bear- and Bull-Case Discounted Cash Flow Analysis, the company could be undervalued between 18% and 45%.
- Rating Upgrade to 'Strong Buy'
In my latest article I rated T. Rowe Price Group ( TROW ) stock as a 'Buy' with a price target of $140. In this article we are going to revisit the company and revamp the valuation of the company.
TROW's AUM (Assets Under Management) are up around $50 million from Q1 of 2023. This is a trend in the right direction, but the AUM have still a long way to go to bet at 2020 or 2021 levels.
Valuation
If we take a look at TROW's P/E ratio, we can see that it is currently trading above its 10 year average P/E ratio of ~16. When we however factor in the company's forward PE of 15.5 , the company looks reasonably valued.
According to FinanceCharts , TROW's average 10 year dividend yield is at ~3.4%. The current yield of 4.3% is therefore also suggesting that the company might be undervalued right now.
Seeking Alpha's Quant Rating has another opinion on TROW's valuation, as SA is currently giving T. Rowe the Valuation Grade "D+". However keep in mind that TROW is here compared to the "whole" financials market and the comparison to banks for example doesn't make any sense for me. For instance the Price/Book ratio of banks will always be below TROW's.
SA Valuation Grade for TROW (seekingalpha.com)
Peer-Group-Analysis
Here I'm changing things quite a bit compared to my last article. The last time we compared TROW to Ameriprise Financial, Inc. ( AMP ) Ares Management Corporation ( ARES ) and Blue Owl Capital Inc. ( OWL ), but I believe that BlackRock ( BLK ) and Franklin Resources ( BEN ) seem like a more suitable comparison.
According to the EV/EBIT of the previous 12 months, TROW appears to be favorably valued in comparison to BLK, while the business appears to look pricey in comparison to BEN.
EV / EBIT TROW, BLK, BEN (seekingalpha.com)
When we look at the EV/Sales over the previous 12 months, we see a similar scenario.
EV / Sales TROW, BLK, BEN (seekingalpha.com)
Interesting is the look at the P/E GAAP for the last trailing 12 months. Here TROW and BEN are trading almost at the same ratio:
P/E GAAP (TTM) TROW, BLK, BEN (seekingalpha.com)
To put these metrics more into perspective we now take a look at the growth and profitability metrics of the three companies:
Growth Metrics (seekingalpha.com) Profitability Metrics (seekingalpha.com)
While BEN and BLK seem to be growing at a higher rate than TROW, T. Rowe manages to achieve (mostly) higher margins than its two counter parts. These however factor in the past and therefore the decreased AUM's for all three companies and could therefore be subject to rapid changes. Up or down.
The stock market, however, often looks ahead, as we all know, consequently I'm going to update the two Discounted Cash Flow Analysis, that we did last time and take some new/improved assumptions.
Discounted Cash Flow Analysis
One assumes that T. Rowe will be able to return to its 10-year average growth rate, and another expects that TROW's AUM and thus their revenue will remain unchanged until 2030. The key projections I took are in the blue cells. The key ideas and presumptions are also outlined here:
Bear-Case
Revenue: Like mentioned above, for our Bear-Case we assume that the AUM and therefore the revenue of TROW don't grow at all over the next few years and will stay flat at ~$6.5 billion
EBIT Margin: In order to determine the company's EBIT, I averaged the previous three years' EBIT margins and utilized 44% for the next seven years.
Financial Result And Taxes: I used the three-year average and therefore a -23% 'discount rate' to get the Net Profit for the years 2023 through 2030.
Tax Rate: I used 23% as the tax rate - the average of the previous three years.
Free Cash Flow: After that, I used the provided tax rate to determine the EBIAT before attempting to apply an appropriate EBIAT to FCF ratio. Here, the three-year average, or 2%, appeared appropriate.
WACC: TROW's WACC improved to 10% since my last article.
Perpetuity Growth Rate: I assumed 2.5% for the perpetuity growth rate, this is pretty conservative.
Discounted Cash Flow Analysis for T. Rope Price Group - Bear Case (seekingalphga.com; own assumptions)
Based on these assumptions we are at a target price of ~$137, suggesting that the company is currently undervalued by around 18% even when factoring no growth at all for the next 8 years.
Bull-Case
As previously noted, our second DCF will now assume that TROW's AUM and hence their revenue remain unchanged until 2030. Other stats remain constant.
Discounted Cash Flow Analysis for T. Rope Price Group - Bull Case (seekingalpha.com; own assumptions)
With our Bull-Case we arrive at a price target of ~$205, this indicates that the company is possibly undervalued by 45% right now, considering that the company manages to achieve its 10 years average revenue growth rate.
Risks To Consider
T. Rowe's whole business is reliant on one metric: Their Assets Under Management ((AUM)). The principal source of revenue for the company, management fees, are calculated based on the AUM. In general, more AUM results in more significant fees and, as a result, better profitability. This reliance on AUM has a number of consequences. First of all, it implies that the company must constantly bring in fresh funds to manage, either by attracting new clients or convincing current ones to increase their investments. Second, it implies that the company has a stake in the success of the assets it manages because out-performance is a selling point for getting new assets and in itself increases the assets managed.
The danger of being vulnerable to market downturns, however, is high given this strong reliance on the managed assets. Asset values may decline during a weak market or recession, causing AUM to be negatively impacted. Additionally customers may withdraw money to cut losses or reallocate assets to less risky endeavors, which further reduces the value of current assets and in turn TROW's revenue and profitability. This could lead to a cascading effect, as if the AUM decreases in one way or another performance might also suffer which in turn could lead to further outflow of capital.
AUM of TROW Q2 23 (troweprice.gcs-web.com)
Above you can clearly see the tight correlation between AUM, revenue and margin. With our Bear-Case however assuming no top line growth until 2030, and consequently no Assets Under Management growth, I believe that we factored in this risk in our analysis.
A prolonged recession and/or a prolonged under-performance by TROW's products could nevertheless lead to lower AUM than what we assumed for the Bear-Case, leading to a reduction in fundamentals and in our price target.
Conclusion
Considering that the company seems reasonably valued when looking at historical PE-Ratios, attractively valued when compared to historical dividend yields, once again reasonably valued between its peer BLK and BEN and especially attractively valued through our two discounted cash flow analyses, the company appears to be an attractive investment right now. Our DCFs suggest that the company could be undervalued by 18% to 45%. As always the truth will probably be somewhere in between.
Based on this I upgrade my rating on T. Rowe Price to a 'Strong Buy' with a price target of $160.
For further details see:
T. Rowe Price Group: Still The Time To Buy (Rating Upgrade)