Justified or not, in recent years few industries have managed to scare away investors like financial firms have.
The financial industry was home to some of the worst performers of 2008 – no surprise given the massive asset write-downs, forced deleveraging, and bankruptcies that plagued the industry that year. But it doesn’t end there – while the financial crisis helped mandate a minimum level of financial health for major banks, the level of stability in the financial sector has been largely outpaced by investor sentiment. At present, scores of financial companies are still in precarious financial situations, threatened by the risks of another bout of major losses if the economy slinks back toward recessionary currents.
It should come as no surprise then that financial stocks got punished once again earlier this spring, as volatility and concerns over European debt sent stocks into red for 2010. But while investors continue to treat financial stocks with equal reluctance in the sell-off, some financial firms are better on better footing than others.
One example is the asset managers. Asset management firms, the companies that professionally manage mutual funds, private accounts, and the like, took their knocks in the latest financial crisis for obvious reasons – their assets under management (AUM), the biggest contributor to revenue for most, tumbled across the board as scared investors grabbed their cash and ran.
But that selloff is proving to be premature. After all, while investors eschewed stocks in 2008, they were pulling their money out to invest in less accessible instruments like fixed income and money market investments – two areas where asset managers dominate. Sure enough, AUM has crept back up for most firms… And so have profits.
In fact, the only things that haven’t made their way back up to pre-2008 levels are share prices.
That’s why our newest Rhino Stock play is an asset manager – one with a uniquely lucrative business stucture…
If you’ve been keeping up on weekly Market Recaps, you’ve already heard me mention the name AllianceBernstein (NYSE:AB). The New York-based firm is an institutional investment manager with $482 billion in assets under management. Unlike many of the firm’s other competitors, AllianceBernstein benefits from a storied name, well-aligned product offerings, and strong growth in 2010.
With roots going back to 1967, the company’s predecessors – Alliance Capital and Sanford C. Bernstein – merged in 2000 to create AllianceBernstein in its current incarnation.
Today, that merger has meant that AllianceBernstein has one of the more diverse customer bases in the business – around 59% of customers are institutional, 15% are private wealth clients, and 26% are retail investors. That diversification helped the company retain clients in the mass exodus from equities in 2008 (institutional clients are less prone to flee positions under selling pressure), while still maintaining the higher profit margins of a big retail investment base.
That diversification extends to AllianceBernstein’s offerings as well – with more than 36% of its clients domiciled outside the U.S., the firm was one of the first to move toward allocating large amounts of capital in overseas investments. But while diversification is one thing, growth is quite another. Earlier in August, the firm announced that it had managed to grow its AUM by approximately 5% for the month, a stellar increase. As investors continue to seek out research-driven investment expertise, AllianceBernstein should be able to maintain strong AUM growth.
Even though this stock is making substantial fundamental strides toward recovery, shares of AllianceBernstein haven’t rallied in kind. In fact, despite some rumblings of a recovery in 2009, shares are still down 71% over the past few years despite the fact that AUM (and thus revenues) only fell around 38% over that same time. As the company asset base continues to grow, that valuation is becoming even more skewed.
That brings us to AllianceBernstein’s business structure.
AllianceBernstein is set up as a limited partnership, which means that barring few exceptions most of the firm’s earnings are required to pass through to investors in the form of dividend distributions. It also changes the way we value shares of AllianceBernstein’s stock – more on that in a minute.
Attractive Financial Fundamentals
One of the biggest benefits of an asset management firm like AllianceBernstein is low overhead – and thus very high margins. 70% of the firm’s revenues come from management fees levied on the AUM that AllianceBernstein manages for its clients, and most of that money passes through to the firm’s bottom line. While a contraction in AUM should have squeezed the firm’s margins in recent years, cost efficiency has kept net margins above 80% through the financial crisis.
Of that income, AllianceBernstein’s structure as an LP has kept the firm’s payout ratio (the percentage of income paid to shareholders) at 83% — that’s 259% higher than the industry average. AllianceBernstein’s product offerings are research-driven and scalable, which means that capital investments are minimal for the company to grow. Because of that, it makes sense for the firm to pay such a generous distribution.
Another result of the company’s LP structure is a relatively sparse balance sheet. While AllianceBernstein’s books don’t give investors a very accurate picture of the company’s size, they do show that the firm has plenty of balance sheet liquidity considering its hefty cash reserves and limited debt load.
From a value standpoint, AllianceBernstein looks attractive right now…
The firm currently only trades for a 43% premium over book value – a low number considering that this financial stock doesn’t own any capital assets other than marketable securities and office equipment. The real value generator for AllianceBernstein is its dividend payouts.
But even dividends don’t tell a very good story for investors used to traditional discretionary payments from their income stocks. Because AllianceBernstein is an LP, the firm is required to pay investors the vast majority of its income for any given quarter – that means that unlike a traditional corporation, where dividends are often predetermined and fixed, this firm’s distributions vary each quarter, and the dividend yield isn’t a very telling number.
That said, financial models can give us a glimpse at what this stock is worth right now. Based on our analysis (which allows for a fairly conservative growth projection and a generous margin of error) I believe that this stock should be priced at around $46 – an 84% upside from capital gains, not to mention the hefty distributions.
Riding the Technicals
That upside potential has been increased by waiting on buying shares for the last few weeks. When I first wrote to you about AllianceBernstein in early August, I told you that while I liked the stock’s fundamental potential, I thought there was more downside ahead for shares.
Sure enough, the stock has fallen around 6% in the weeks since…
Frankly, that’s a great thing for us. It means that we’re able to lock in an even lower price for a stock whose valuation hasn’t changed at all. But that discount could soon be coming to an end as shares of AllianceBernstein close in on support.
Right now, this company is turning back toward a bullish bent, so I’m adding shares to the Rhino Stock Report’s portfolio today…
Action to Take: Buy Shares of AllianceBernstein (NYSE:AB) at current levels…