We maintain our Neutral recommendation on Legg Mason Inc. (LM), based on its strong cash position and the successful completion of its streamlining efforts. However, asset outflows remain a concern with aggregate net client outflows of $27.5 billion and dispositions of $23.9 billion in the year ended fiscal 2012.
In May, Legg Mason reported fiscal fourth-quarter 2012 earnings of 88 cents per share, significantly outpacing the Zacks Consensus Estimate of 48 cents per share. Including one-time expenses, net income came in at $76.1 million or 54 cents per share.
Quarterly earnings were well above the prior quarter’s earnings of 55 cents per share. The upbeat performance was attributed to higher revenues aided by rise in investment advisory, distribution and services fees, partially offset by increased operating expenses. Improved AUM was also a positive for the quarter.
Legg Mason has been working on improving its operating efficiencies through its key initiatives that include cost cutting, innovative product solutions to client base, tapping sound investment capacities and expanding distribution relationships. In fourth-quarter fiscal 2012, Legg Mason completed the business model streamlining initiative announced in May 2010 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, beginning 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 repurchase and dividend payment. The company utilized its cash by announcing a 37.5% hike in dividend in April 2012.
On the flip side, although the financial environment, both globally and in the U.S., continued to rebound during fiscal 2012, challenging and volatile conditions lingered throughout a portion of fiscal year 2013. During fiscal 2012, the Federal Reserve Board held the federal funds rate at 0.25%, the lowest in history. While the economic outlook has been substantially positive than in recent years, the financial environment continues to be challenging in fiscal 2013.
Therefore, the current volatility in the financial markets along with governmental regulations heightens the chances 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 inspiring investors’ confidence in the stock.
Further, 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. The company’s closest competitor – BlackRock Inc. (BLK) also retains a Zacks #3 Rank.
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