We have maintained our Underperform recommendation on Federated Investors Inc. (FII) based on second-quarter 2011 earnings results. The results were in line with the Zacks Consensus Estimate and were below the prior-year quarter and prior quarter earnings.
In July, Federated’s second-quarter 2011 earnings came in at 41 cents per share, in line with the Zacks Consensus Estimate, and below the year-ago quarter’s earnings of 46 cents. Moreover, this compares unfavorably with the earnings of 43 cents recorded in the prior quarter. As of June 30, 2011, total assets under management (AUM) were $349.4 billion, up 4% from $336.8 billion as of June 30, 2011.
Results reflected decrease in top-line growth, increase in voluntary fee waivers, and augmented operating expenses on a year-over-year basis. This was partly offset by a rise in fixed income and equity assets, higher AUM and a decline in the amortization of deferred sales commissions.
During the latter half of 2008 and early 2009, disruptions in the financial markets severely dislocated the functioning of the credit markets and damaged the availability of liquidity in the short-term debt markets. In certain money market funds, the gross yield was not sufficient to cover all of the funds’ normal operating expenses due to historically low short-term interest rates. Since the fourth quarter of 2008, Federated has voluntarily waived fees in order for certain funds to maintain positive or zero net yields. During second-quarter 2011, interest rates for money market investments declined, which led to an increase in these fee waivers. We expect fee waivers and related reduction in distribution expenses to continue into 2012 and will likely be significant.
Federated’s pressurized AUM has resulted in a negative organic growth in the core business as investors are transferring cash from money market funds to higher yielding bank deposits or investments across the fixed income universe and equities.
As of June 30, 2011, approximately 47% of Federated’s total revenue was attributable to money market managed assets compared with 50% in the prior-year quarter. A significant reduction in money market managed assets due to changes in financial markets, including increases in interest rates over a short period of time, considerable deterioration in investor confidence, prolonged periods of historically low short-term interest rates and resulting fee waivers, could have a material adverse effect on Federated’s results of operations.
On the flip side, Federated continues to look for more opportunities to crack profitable deals. It intends to further advance its businesses, including money market business, outside the U.S. as part of its strategy to expand globally. During the second quarter of 2011, Federated added $2 billion in new business from a large offshore client besides working on 2 new money market entry opportunities in the U.K. The company has received approval in Ireland for sterling-denominated money fund that will be launched in third-quarter 2011. The company also completed 2 deals, one with the EquiTrust Funds and the other with the Tributary International Equity Fund. Both agreements added approximately $600 million in new assets in a variety of strategies.
After the evaluation of Federated’s existing liquid assets, expected continuing cash flow from operations, and its ability to obtain additional financing arrangements and issue debt or stock, we also believe that the company will have sufficient liquidity to meet its present as well as reasonably foreseeable cash needs. For Federated, cash and marketable securities totaled $294 million as of June 30, 2011.
Moreover, the company has the potential for substantial growth in the long run, given its fairly healthy balance sheet, a diversified asset as well as product mix. However, volatile equity markets and sluggish global economic growth are expected to keep AUM, flows and margins under pressure. Moreover, stringent regulations are expected to significantly affect the company’s financial results.
Federated currently retains a Zacks #5 Rank, which translates into a short-term ‘Strong Sell’ rating. However, the company’s peer – Franklin Resources Inc. (BEN) retains a Zacks #3 Rank (a short-term ‘Hold’ rating).
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FEDERATED INVST (FII): Free Stock Analysis Report
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