We are maintaining our Neutral recommendation on Legg Mason Inc. (LM) based on its strong fiscal first-quarter 2013 earnings, which topped the Zacks Consensus Estimate. However, asset outflows remain a concern with aggregate net client outflows of $2.6 billion and dispositions of $4.6 billion at the end of the quarter.
In July, Legg Mason reported fiscal first quarter 2013 adjusted earnings of 64 cents per share, significantly outpacing the Zacks Consensus Estimate of 2 cents. However, results were well below the prior-quarter earnings of 88 cents per share.
The decline in operating expenses and reduction in outstanding debt were the positives for the quarter. Yet, a dropp in total revenues and client outflows were the headwinds.
Legg Mason has been working on improving its operating efficiencies through its key initiatives, which include cost cutting, innovative product solutions, tapping sound investment capacities and expanding distribution relationships. In the fourth quarter fiscal 2012, Legg Mason completed the streamlining initiative announced in May 2010 in order to drive increased profitability and growth.
The initiative resulted in annual cost savings of over $140 million, which will be fully realized on an annual basis during fiscal 2013. These initiatives are expected to create value for clients and shareholders.
Moreover, Legg Mason remains committed to increasing shareholder’s wealth. The company is effectively deploying capital through share repurchases and dividend payments. Additionally, during the fiscal first quarter, Legg Mason announced a new capital plan, which enhanced financial flexibility and poised the company well for sustained growth. Based on these efforts, outstanding debt was reduced by $350 million.
On the flip side, challenging and volatile conditions lingered throughout the first quarter of fiscal 2013. Economic uncertainties related to the European debt crisis slowed the global economy and contributed to a sharp descent in the equity markets. Moreover, during the reported quarter, the Federal Reserve Board continued to hold the federal funds rate at 0.25%, the lowest in history. Economic challenges are expected to persist and the impact it can have on the company’s results remains ambiguous.
Therefore, the current volatility in the financial markets along with governmental regulations heightens the chance of interest rate fluctuations in the funds business of the company.
However, we believe that Legg Mason has the potential to outperform its peers in the long run, given its diversified product mix and leverage to the changing market demography. Asset outflows remain a significant headwind in the near term, though efforts to reduce outflows in the volatile markets are underway.
Yet, considering the restructuring initiatives and cost-cutting measures, we expect operating leverage to improve. Share buybacks and dividend increases will continue to inspire investor confidence in the stock.
Furthermore, we believe that the risk-reward profile of Legg Mason is currently balanced and, hence, we have reiterated our Neutral recommendation on its shares. Legg Mason currently retains its Zacks #3 Rank, which translates into a short-term Hold rating. Among the company’s peers – BlackRock Inc. (BLK) also retains a Zacks #3 Rank.
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