We maintain our Neutral recommendation on Franklin Resources Inc. (BEN) based on strong fiscal third-quarter 2011 results. The results outpaced the Zacks Consensus Estimate and were ahead of the prior-year quarter as well as prior quarter’s earnings.
In August, Franklin reported fiscal third-quarter 2011 earnings of $2.26 per share, surpassing the Zacks Consensus Estimate of $2.16. Earnings beat the prior-year quarter figure of $1.58 per share and prior-quarter earnings of $2.25. Quarterly results at Franklin reflect strong revenue growth and higher AUM, partially offset by increased operating expenses.
Earlier in September, Franklin reported preliminary assets under management (AUM) of $$716.4 billion by its subsidiaries for the end of August 2011. Results were down 4.1% from $747.2 billion as of July 31, 2011, but were up 19.3% from $600.4 billion as of August 31, 2010.
Franklin’s closest competitor, Invesco Ltd. (IVZ), reported preliminary AUM of $629.4 billion for August 2011, slipping 3.6% from $652.8 billion in July 2011. The decrease in AUM was mainly attributable to the effects of negative market returns. Besides, the foreign exchange lowered the AUM by $1.5 billion during the month under review.
During the nine-month period ended June 30, 2011, market returns improved as the global economy continued to proceed toward recovery. During the fiscal third quarter, recovery slowed down and volatility increased amid concerns about economic growth and the sovereign debt crisis in Europe.
However, the overall improvement in the markets appreciably benefited Franklin’s AUM, fee revenues and operating income. We expect the company to continue to gain from the economic recovery.
Franklinis growing strategically and strengthening its foothold. During the course of the calendar year 2011, the company entered into a new strategic relationship with (Telegis) Capital Management, acquiring a 20% equity stake. This company’s experience in commodities, managed futures, and hedge fund replication ideally balances the existing alternative offerings of Franklin.
Furthermore, Franklin completed the acquisition of Rensburg Fund Management, a UK equity specialist with about $1.5 billion in AUM in January 2011. The Rensburg acquisition allows the company to diversify product offerings in key markets.
Moreover, Franklin’s acquisition of Balanced Equity Management in July 2011 aims to mark its presence in the Australian market by providing best investment options to satisfy local investors' needs. Therefore, we expect Franklin to benefit from the growth potential of these transactions.
Franklinstands healthy from a balance sheet perspective. The company has been able to generate positive cash flow even in an increasingly difficult operating environment. The company remains in compliance with the requirements for regulatory ratios. For the past six years, it has been constantly increasing its dividend.
The company also enhanced shareholders’ value by returning over $5.5 billion to shareholders through dividends and repurchases in the past four and half years, including over $0.8 billion in the last nine months ended June 2011.
On the flip side, Franklin’s increasing focus on international markets for investment products has led to increased exchange rate and other risks in connection with earnings and income generated overseas. Moreover, Franklin’s investment management and related services are subject to wide and intricate, overlapping and frequently changing rules, regulations and legal interpretations in the countries in which it operates.
Although the financial markets continued to improve during the nine month ended June 2011, the business and regulatory environments remained uncertain and subject to change.
However, consolidation in the financial services industry has created stronger competitors for the company, who possess better-quality financial resources and broader distribution channels. New product offerings from prime competitors could decrease sales of products, potentially resulting in market share decline, revenue and net income.
Therefore, Franklin invests in advertising and promotion due to changing business conditions for developing products and potential new growth opportunities. As a result of potential changes in strategic marketing campaigns, the level of advertising and promotion expenditures may increase more rapidly than revenue.
Overall, Franklin's global footprint is an exceptionally favorable strategic attribute, since its AUM is well diversified. Moreover, a strong balance sheet and recently completed acquisitions are expected to boost the financial results of the company. However, the regulatory restrictions and turbulence in global markets, along with the sluggish economic recovery, could mar the AUM growth while increasing its costs.
Franklin currently retains its Zacks #3 Rank, which translates into a short-term Hold rating.
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