2023-05-02 17:27:12 ET
Summary
- T. Rowe Price has compounded its share price by more than 14% since it went public in 1986.
- The company’s business drivers are supported by rising incomes and market appreciation.
- The business has generated significant free cash flow, supporting its return of capital to shareholders.
- The company appears attractive compared to its peers and the market.
T. Rowe Price Group, Inc. ( TROW ) has been a stock market star since it went public in 1986. However, the firm has suffered in recent years thanks to the success of growth stocks and passive investment vehicles. With the release of its 1Q23 earnings report , this is a good time to take a look at the firm. Our analysis will show that, despite headwinds hurting the company's profitability over the last year or so, the fundamentals of the business remain strong, the business model attractive, and the valuation appealing.
A Stock Market Laggard
Since its initial public offering ((IPO)) in 1986, T. Rowe Price share price has compounded by over 14% a year. compared to a 10% total shareholder return (TSR) for the S&P 500 ( SPX ). In the last five years, the company has not lived up to its pedigree. The share price has grown by around 2%, but given the company's dividend issuance, the company's TSR was just over 15%. Meanwhile, the S&P 500 earned a TSR of around 57%. The company's peers earned a TSR of over 30%.
T. Rowe Price's peer group, according to its 2023 Proxy Statement, comprises Affiliated Managers Group, Inc. ( AMG ), AllianceBernstein Holding L.P. ( AB ), Ameriprise Financial, Inc. ( AMP ), BlackRock, Inc. ( BLK ), The Charles Schwab Corporation ( SCHW ), Franklin Resources, Inc. ( BEN ), Invesco Ltd. ( IVZ ), and Northern Trust Corporation ( NTRS ).
Secular Growth
Although all countries undergo periods of recession, in the long run, the real gross domestic product ((GDP)) is in an era of secular appreciation, and, according to data from FRED , has risen from $26,851 in 1973 to $59,995 in 2023, compounding at nearly 1.6% a year. Although you might not think it, given a narrative of secular decline, FRED's data on disposable personal income (DSPI) in America shows us that DSPI has also risen, going from $1,008.4 in 1973 to $18,608.30 in 2023, compounding at 6% a year. Although these are aggregate figures and do not represent the behavior of wealth for the typical American, nevertheless, it does tell us that the supply of funds available for investing is in a long-term trend of growth.
Not only is the amount of what we can call "investable income" rising, the stock market itself tends toward long-term growth, which means that a key driver of T. Rowe Price's business model, assets under management ((AUM)), will, in the long run, appreciate.
Since 2008, the company AUM has grown from $276 billion to $1.34 trillion in 1Q23, compounding at more than 11% a year. The combination of market price appreciation as well as net inflows, driven by the factors we have highlighted, support the view that the firm's long-term AUM trend is upward.
In 1Q23, the firm's AUM rose from $1.27 trillion at the end of 4Q22, despite a $16.1 billion net outflow, compared to a $5.3 billion net outflow in 1Q22 and a $17.1 billion net outflow in 1Q22. Rob Sharps, the chief executive officer and president, explained this saying in the 1Q22 earnings report, "Market posted gains, our investment performance showed signs of improvement, and we had strong net inflows of $7.5 billion to our target date products."
In 1Q23, equity was the most important asset class in terms of AUM, making up nearly 52% of AUM, compared to 12.7% for fixed income (inc. money market), more than 32% for multi-asset and over 3% for alternatives.
Fee Compression
The second driver of T. Rowe Price's business model is the fee rate for the company's products. Alongside the increase in supply in investable funds, there has been an explosion in the number of asset managers across the world. The Wikipedia entry for asset managers across the world shows a huge number of firms. There are no meaningful barriers to entry in the industry, and more and more asset managers are likely to emerge. The consequence of this is that the typical asset manager does not have any pricing power, and competition has driven down fee rates. Not only are there asset managers, but there are also passive investment instruments, against which the typical asset manager will, logically, fail to beat. This puts additional pressure on fee rates. T. Rowe Price's investment advisory fees, which, in 2022, represented nearly 92% of firm revenues, have faced downward pressure over the last five years. In 2022, U.S mutual funds were responsible for 58% of investment advisory fees, while 42% of investment advisory fees came from other investment portfolios. The average annualized fee rate earned by the company on its AUM has declined from 46.8 basis points (bps) in 2018 to 42.7bps in 1Q23. Although there was a modest improvement in the effective fee rate, from 42.3bps in 1Q22 to 42.7bps in 1Q23, this should be viewed as merely noise, with no reason to believe that the effective fee rate is likely to undergo meaningful, secular appreciation.
T. Rowe Price's investment advisory fees have grown from $4.85 billion in 2018 to $5.97 billion in 2022, compounding at 4.24% a year. In 1Q23, investment advisory fees were $1.39 billion compared to $1.66 billion in 1Q22 and $1.37 billion in 4Q22. The firm also receives capital allocation-based income, which is -$54.3 million in 2022, and $16.9 million in 1Q23. The final source of revenue are administrative, distribution, and servicing fees, which have grown from $522 million in 2018 to $573.6 million in 2022, compounding at 1.9% a year. Net revenues have grown from $5.37 billion in 2018 to $6.49 billion in 2022, compounding at 3.86% a year. According to Credit Suisse's "The Base Rate Book" , 28.8% of firms between 1950 and 2015 earned a 5-year sales compound annual growth rate ((CAGR)) of between 0% and 5%. The mean and median 5-year sales CAGR for the reference period was 6.9% and 5.2% respectively. In 1Q23, net revenues were $1.54 billion, compared to $1.86 billion in 4Q22 and $1.5 billion in 1Q22.
T. Rowe Price's actively managed mutual funds earn far higher fee rates compared to target date retirement products, and fixed income products. Although fee compression is an important driver going forward, it has reached a level where, so close to zero, it is unlikely to decline dramatically in the near term.
Declining Profitability
T. Rowe Price is enormously profitable. Its gross profitability has declined from 0.43 in 2018 to 0.33 in the TTM period. Its gross profitability is at the threshold that Robert Novy-Marx' research shows determines a stock's attractiveness. The firm's peer group has an average gross profitability of 0.09. T. Rowe Price's operating income has risen from $2.36 billion in 2018 to $2.37 billion in 2022. In 1Q23, operating income was $484.2 million, compared to $877.4 million in 1Q22 and $253.1 million in 1Q23. In that period, operating margin rose from 43.95% to 36.58%.The peer group average operating margin is 36.55%. In 1Q23, operating margins were 31.49%, compared to 47% in 1Q22 and 16.6% in 4Q23. Declining margins and operating income are a function of both anemic revenue growth and fairly stable compensation and related costs.
T. Rowe Price's earnings declined from $1.77 billion in 2018 to $1.45 billion in 2022, compounding at -3.9% a year. In our reference period, 34.1% of firms had a 5-year earnings CAGR of between 0% and -10%. In that time, the mean and median 5-year earnings CAGR was 7.3% and 5.9% respectively.
An Asset Light, Scalable Business
The nature of an investment firm is such that it does not have any meaningful capital expenditure requirements, resulting in a very asset light business model. The firm's assets are largely liquid, with property and equipment making up just 6.5% of the firm's assets.
The biggest expense that the firm faces is compensation and related costs, which have risen from $1.81 billion in 2018 to $2.32 billion in 2022, compounding at over 5% a year. In 1Q23, compensation and related costs were $653.5 million. This not only results in a capital light model, but in a very scalable business. Rather than considering large capex investments, growth is a matter of hiring more people, and in an age of remote work, may require an even lower expenditure on office space.
The consequence of that asset light business is that its returns on invested capital ((ROIC)) are very high, at a 5-year average ROIC of 42.7%. In the trailing twelve months, the firm has a ROIC of 30.7%, compared to a peer average of 4.78%.
Source: T. Rowe Price Group, Inc. Filings and Author Calculations
Switching Costs
An investor's relationship with their asset manager is fairly sticky. Institutions are loath to chop and change their asset managers because of the switching costs they will have to do in terms of due diligence, the energetic bill of moving from inertia to activity, and the possibility of making an additional error by going to a worse asset manager. The tendency is toward inertia. The thing that turns inertia to activity is poor results. In that respect, T. Rowe Price do not necessarily have to have sensational results, they need an acceptable enough level of results to keep their investors onside. The company itself describes the performance of its products in the last 3, 5 and 10 year periods as "solid". Over a 10-year period, 76% of the company's U.S. mutual funds have outperformed the Morningstar median, 64% of its U.S. mutual funds have outperformed the passive peer median, and 71% of composites have outperformed benchmarks.
Free Cash Flow Supports Returning Capital to Shareholders
In the last five years, T. Rowe Price has grown from $2 billion in 2018 to $2.2 billion in 2022, for a cumulative $11.58 billion, or 46.54% of its market capitalization. In that time, the firm has grown dividends issued from $694.3 million in 2018 to $1.11 billion in 2022, compounding at 9.79% a year. In that time, the firm paid out $5 billion in dividends. This shows us that the firm's FCF generation supports the dividend policy, with ample room for growth of dividends. In addition to supporting dividend issuance, the firm has used its FCF for share buybacks. In doing so, it has reduced the weighted average shares outstanding from 260.9 million in 2015 to 224.4 million in 2022. The firm has made $4.98 billion in share repurchases over the last five years. All this represents $10 billion in capital returned to shareholders over the last five years. This leaves ample room for dividend issuance and share repurchases to continue and grow. In 1Q23, the company increased quarterly dividends for the 37th consecutive year, paying out $284 million in dividends.
Source: T. Rowe Price Group, Inc. Filings and Author Calculations
Risks
As our discussion has shown, the company's revenue growth has been anemic and its profitability is in decline. These are the biggest issues facing the company, and are the reason why it has suffered net outflows for so long. The primary source of drag has been the performance of its equity funds, which have fared poorly in an era in which technology stocks have done so well. In the last year, the majority of its U.S. mutual funds have underperformed their Morningstar median, Morningstar passive peer median, and 69% of composites have underperformed their benchmarks. Given that fees are a function of performance, this has hurt revenue growth and profitability.
Nevertheless, in the long run, this will not continue, and investors must simply accept this period of underperformance as a kind of de-risking: as the demand for the underlying equities declines, the supply of future returns increases. If you want to be a net buyer of stocks, then buying when the valuations are declining makes sense, not just for T. Rowe Price, but for investors in the company itself.
Valuation
T. Rowe Price Group, Inc. has a P/E multiple of 16.64 compared to its peer group weighted-average P/E of 15.9. However, the S&P 500 has a P/E multiple of 24.03 . The company's gross profitability is 0.33, just the precise threshold for attractiveness. In comparison, its peers have a weighted-average gross profitability of 0.09. The company's FCF yield, 8.53%, is higher than the weighted-average FCF yield of its peers, which is 5.47%, and of the 2000 largest firms in the United States, which New Constructs calculates at 2.7% . Overall, then, the company appears more attractive than its peers, and the general market.
Company | Ticker | Gross Profitability | P/E Multiple | FCF Yield |
T. Rowe Price Group, Inc. | TROW | 0.33 | 16.54 | 8.53% |
T. Rowe Price is an attractive investment that investors should consider for the long-term. Affiliated Managers Group, Inc. | AMG | 0.26 | 5.59 | 20.54% |
AllianceBernstein Holding L.P. | AB | 0.15 | 14.43 | 7.89% |
Ameriprise Financial, Inc. | AMP | 0.08 | 13.43 | 13.27% |
BlackRock, Inc. | BLK | 0.12 | 19.51 | 4.45% |
The Charles Schwab Corporation | SCHW | 0.04 | 14.78 | 1.19% |
Franklin Resources, Inc. | BEN | 0.29 | 13.58 | 10.76% |
Invesco Ltd. | IVZ | 0.20 | 11.56 | 6.46% |
Northern Trust Corp. | NTRS | 0.04 | 12.55 | 10.40% |
Peer Group Average | 0.09 | 15.90 | 5.47% |
Source: Company Filings and Author Calculations
Conclusion
T. Rowe Price is riding on clear secular trends supporting its business drivers. So, while the firm may suffer short-term hits to the business, we believe investors should have faith that in the long run, the firm will be a market winner. This has been true since 1986 when it went public, and we expect it will be true in the years ahead. In addition, the firm has used the substantial FCF it has generated to return capital to shareholders, helping to narrow the gap with the market. T. Rowe Price is an attractive investment that investors should consider for the long-term.
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Trust T. Rowe Price For The Long Haul