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- By Robert Abbott
Would the arrival of commission-free trading wreak havoc on companies with brokerage operations? That was the question in the autumn of 2019 as several major brokerages eliminated commissions in a bid to garner market share.
Apparently, Raymond James Financial Inc. (NYSE:RJF) was ready. On Oct. 19, 2019, it announced it would provide commission-free trades to its advisors, who in turn could pass the savings along to their retail clients.
In its 10-K for 2020, filed on Nov. 24, though, it reported that it still faced pricing pressures:
"We continue to experience pricing pressures on trading margins and commissions in fixed income and equity trading. In the fixed income market, regulatory requirements have resulted in greater price transparency, leading to price competition and decreased trading margins. In the equity market, we experience pricing pressure from institutional clients to reduce commissions, partially due to the industry trend toward the separate payment for research and execution services."
Will Raymond James survive these pressures? The answer is quite likely yes; to begin, it may be losing trading commissions on the retail side, but zero-commissions have also brought in new clients (as described below) who sign up for other paying services. And it has "good bones."
The firm has a place on the Undervalued Predictable list at GuruFocus, meaning it has consistently delivered revenue and earnings growth, as well as selling at a discount to its intrinsic value.
It is an intermediary between investors and the markets. The St. Petersburg, Florida-based company calls itself "a leading diversified financial services company providing private client group, capital markets, asset management, banking and other services to individuals, corporations and municipalities." In other words, it is more than just a brokerage.
This chart shows where its revenues originate, by segment:
The Private Client Group, which provides more than two-thirds of the company's revenue, offers financial planning, investment advice and securities transaction through its branch network. Where do the advisors and clients come from? That's spelled out in the 10-K:
"We recruit experienced financial advisors from a wide variety of competitors. As a part of their agreement to join us, we may make loans to financial advisors and certain key revenue producers primarily for recruiting, transitional cost assistance, and retention purposes."
Like much of the financial industry, shares of Raymond James plunged when Covid-19 first began threatening not only our health but our financial well-being. However, it quickly recovered most of its lost ground:
Investors may have been responding to good quarterly news. In its third fiscal quarter (ended June 30) it had both good and bad news. While its net revenue and net income were down, it also reported record net revenues and pre-tax income in the Capital Markets segment; Private Capital Group assets were up 11% over the previous third quarter, and it had a record number of financial advisors, 8,155 serving Private Capital clients.
The fourth fiscal quarter and year, ending on Sept. 30, also produced good news:
Quarterly net revenue set a record, up 3% over the previous year.
Annual net revenue also set a record at $7.99 billion.
It also set a record for client assets under administration, $930.10 billion and financial assets under administration of $153.10 billion.
Those quarterly results helped Raymond James deliver an annualized adjusted return on tangible common equity of 15.3%. Chairman and CEO Paul Reilly wrote:
"We are well positioned entering fiscal 2021, with strong capital ratios and quarter-end records for client assets and the number of Private Client Group financial advisors. Moreover, financial advisor recruiting activity remains robust across all of our affiliation options and our investment banking pipelines are strong."
The company attributed much of its revenue growth to "higher asset management and related administrative fees, investment banking revenues, and brokerage revenues, which were partially offset by the negative impact of lower short-term interest rates."
However, it ended the year with lower earnings per share without non-recurring items:
That will be one of the reasons Raymond James' fundamentals are only middling:
The company does carry some debt, but not much in relation to its cash position:
Note at the bottom of the financial strength table that there is no reference to return on invested capital; that's because this metric is not reported by financial firms.
Turning to the profitability table, Raymond James has a net margin of 10.36%, which is below the capital markets industry's 10-year median of 13.21%. The 10.36% is slightly above the company's 10-year median of 9.99%.
The three-year averages for revenue growth and earnings per share growth are both adequate, but not exciting. The dividend yield clocks in at 1.57% and if directors continue to raise the payment at the same rate as they have over the past five years, the yield would be only 3.4% (five-year yield-on-cost). More shares are being bought back than are being issued, by a modest margin; the three-year average share buyback ratio is 1.8.
Competitors are numerous and competition is intense. In the 10-K, management reported:
"The financial services industry is intensely competitive. We compete with many other financial services firms, including a number of larger securities firms, most of which are affiliated with major financial services companies, insurance companies, banking institutions and other organizations. We also compete with companies that offer web-based financial services and discount brokerage services to individual clients, usually with lower levels of service, and, more recently, financial technology ("fintech") firms."
Raymond James' three biggest competitors, by revenue, are Stifel Financial Corp. (NYSE:SF), Virtu Financial Inc. (NASDAQ:VIRT) and Lazard Ltd. (NYSE:LAZ). All three bring in less revenue.
Its predictability of revenue and earnings growth ranks highly, a full five out of five stars. This indicates not only an ability to consistently generate top and bottom-line growth, but also indicates the company is likely to post higher-than-average earnings and a lower risk of loss over the next 10 years.
According to the valuation metrics available to us, Raymond James is either fairly valued or slightly undervalued. The former comes to us from the GuruFocus Value chart:
It has a price-earnings ratio of 16.27, which is slightly below both the industry's 10-year median of 17.05 and its own 10-year median of 16.45. That, too, indicates fair value.
However, the discounted cash flow analysis, based on a full five-star predictability rating, shows a modest undervaluation:
The gurus were enthusiastic buyers of Raymond James stock earlier this year, but have since cooled off:
Seven of the gurus had positions and six of the seven reduced their share counts in the third quarter. The one who did not (and did not buy, either) was Jeremy Grantham (Trades, Portfolio) of GMO LLC; he held just 10,875 shares at the end of the quarter.
The three biggest were:
PRIMECAP Management (Trades, Portfolio) with 4,183,875 shares, representing 3.06% of Raymond James' capitalization and 0.25% of Primecap's assets under management. The fund reduced its holding by 5.41% during the quarter.
Glenn Greenberg (Trades, Portfolio) of Brave Warriors Advisors, who held 2,098,460 shares, a reduction of 4.58%.
T Rowe Price Equity Income Fund (Trades, Portfolio) held 1,200,000 shares at the close of trading on Sept. 30, a reduction of 4.76%.
It appears Raymond James Financial has at least held its own in response to the zero-commissions threat. That, plus the company's high predictability score, suggests the company is well managed and should be able to get past current pricing issues and operate profitably for the next five to 10 years.
The valuation metrics suggest the company is slightly undervalued to fairly valued, which makes it of interest to some investors.
Value investors will likely look for a deeper discount to get a solid margin of safety, and that may become possible on future pullbacks. Growth investors who like the Raymond James story may see this as a potential entry point. Income investors will want to look elsewhere since there are much better dividend yields to be had.
Disclosure: I do not own shares in any of the companies named in this article and do expect to buy any in the next 72 hours.
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This article first appeared on GuruFocus.