Even Better Times for Franklin Resources

 | Sep 24, 2013 | 2:00 PM EDT
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Much of the asset management group has been on a tear in the past year as the stock market has rallied, with many of the leading stocks, such as Blackrock (BLK) and Eaton Vance (EVG), reaching record highs. One that has also done well, but has modestly lagged the group, and should have more upside from here is Franklin Resources (BEN).

BEN has become one of the leading asset managers, emerging from the 2008/09 Great Recession as a stronger player than before. Current assets under management are a record $834 billion versus an approximate $650 billion under management at its prior peak in 2007. Net profit margins have also held steady and are back to 42%. Earnings are a remarkable 45% higher than the previous 2007 peak.

BEN has thrived in the downturn and recovery, thanks to strong inflows into its successful cash, fixed income and hybrid income product lines. Today, the company manages over $500 billion in these income-oriented products compared with $260 billion prior to the crisis. Income-oriented assets now account for 60% of company assets (versus 40% prior).  

As a result of this increased concentration of income-oriented products, investors have been hesitant to bid up BEN's shares. BEN currently trades at 14.9x earnings, vs. 17 to 18x earnings for its leading peers, and 15 to 17x earnings for the overall group. 

BEN was a significant beneficiary of the Fed's recent announcement not to begin tapering its quantitative easing stimulus program. Bonds rallied in the wake of the announcement and BEN followed suit. The longer that the Fed delays ending its easing, the greater the tailwind is for BEN. 

Notwithstanding this recent bond-related rise, management perceives its heavy fixed income concentration to be a source of vulnerability. Aware of its fixed income concentration risks, management has undertaken several steps to enhance, to strengthen and to protect the franchise.

First, Management is steering the organization back towards a higher equity focus by opening new funds and expanding global distribution. BEN is also open to select equity acquisitions in order to accelerate this process.

Second, Management is accelerating the return of cash to shareholders by means of dividends and share repurchases. The board's objective is to return 75% of earnings to shareholders each year.

There also is a strong likelihood that the board will double-down both on share buybacks and dividends, since the firm's balance sheet has close to $8 billion in net cash and investments. This large cash position amounts to more than 20% of the firm's market capitalization, more than $12 net per share.

Given management's commitment to generating steady earnings growth during the coming transition to a more equity oriented firm, and the substantial undervaluation of BEN to its group (especially to its fellow industry leaders), we think investors should consider stepping in now.

BEN offers investors very attractive returns from the current share price.

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