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Legg Mason Outshines, Revenues Up

Zacks Equity Research

Legg Mason Inc.’s (LM) fiscal fourth-quarter 2012 earnings of 88 cents per share significantly outpaced the Zacks Consensus Estimate of 48 cents. Moreover, earnings were well above the prior quarter’s earnings of 55 cents per share.

The upbeat performance was attributed to higher revenues aided by rising investment advisory, distribution and services fees, partially offset by increased operating expenses. Improved assets under management (:AUM) were also a positive factor for the quarter.

Adjusted net income came in at $123.6 million, compared with $76.8 million in the prior quarter. Including one-time expenses, net income came in at $76.1 million or 54 cents per share.

Performance in Detail

During the reported quarter, Legg Mason’s total revenue was $648.6 million, up 3.4% sequentially, spurred by increased average AUM, including a more favorable average asset mix and higher performance fees. Moreover, revenues were also above the Zacks Consensus Estimate of $644.0 million.

In fiscal 2012, total revenue was $2.7 billion, down 3.6% year over year. The decline in revenues reflected fall in average AUM along with reduced performance fees. Further, revenues were in line with the Zacks Consensus Estimate.

Investment Advisory fees increased 3.6% sequentially to $564.7 million in the quarter. Distribution and Service fees surged 2.1% sequentially to $82.4 million. Other revenues were up 50.0% sequentially to $1.5 million.

Operating expenses increased 1.5% sequentially to $576.4 million, attributed to rise in compensation and benefits, partly offset by other non-operating income. Adjusted operating margin of Legg Mason declined to 21.2% in the quarter from 21.7% in the prior quarter.

As of March 31, 2012, Legg Mason’s AUM was $643.3 billion, up 2.6% sequentially from $627.0 billion, driven by market appreciation of $24.4 billion, partially offset by net client outflows of $4.9 billion and dispositions of $3.2 billion. Fixed income represented 55% of consolidated AUM as of March 31, 2012, liquidity represented 19% and equity comprised 26%.

During the quarter, fixed income outflows were approximately $2.8 billion and equity outflows were $4.9 billion. However, liquidity inflows were $2.8 billion. Average AUM was $634.9 billion, up 2.1% from $622.0 billion in the prior quarter.

As of March 31, 2012, Legg Mason had approximately $1.4 billion in cash compared with $1.2 billion in the prior quarter, while total debt was stable at $1.4 billion, in line with the prior quarter. Shareholders’ equity was $5.7 billion, up from $5.6 billion in the previous quarter. The ratio of total debt to total capital (total equity plus total debt excluding consolidated investment vehicles) was 20%, stable compared with the previous quarter.

Capital Deployment Update

Legg Mason ended its streamlining plan in fiscal 2012. The plan generated more than $140 million in annual cost savings, and deployed over $440 million to shareholders through share repurchases and dividends.

Moreover, Legg Mason’s board declared an increased quarterly cash dividend of 11 cents per share from 8 cents on its common stock. The hike reflects 37.5% increase in the rate of dividend. The dividend will be paid on July 9, 2012 to shareholders of record as of June 12, 2012.

Peer Performance

In Legg Mason’s peer group, T. Rowe Price Group Inc.’s (TROW) first-quarter 2012 net income of 75 cents per share were marginally below the Zacks Consensus Estimate of 77 cents. However, this compares favorably with the prior-year quarter’s earnings of 72 cents.

Better-than-expected top-line growth was more-than-offset by higher non-interest expenses. However, increased assets under management (:AUM) were positive for the quarter.

Our Take

We believe 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. In the near term, though, assets outflows will remain a significant headwind. Yet with the restructuring initiatives and the cost-cutting measures, we expect operating efficiencies to improve, and dividend payments to continue to inspire investors’ confidence in the stock.

Legg Mason currently retains its Zacks #3 Rank, which translates to a short-term Hold rating. Considering the fundamentals, we also maintain a Neutral recommendation on the stock.

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