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T. Rowe Price Downgraded to Neutral

Zacks Equity Research

We are downgrading our recommendation to Neutral from Outperform on T. Rowe Price Group Inc. (TROW), based on weaker-than-expected first-quarter 2012 earnings and incompetent expense management. The company’s first-quarter 2012 earnings lagged the Zacks Consensus Estimate, which is attributable to higher operating expenses.

However, earnings compared favorably with the prior-year quarter.  Better-than-expected top-line growth and increased assets under management (:AUM) were positives for the quarter.

Marked by the economic recovery, U.S. equity markets ended first-quarter 2012 with double-digit growth, driven by enhanced investor optimism. Moreover, Federal Reserve is resolving short-term issues to ensure continued U.S. economic recovery. Therefore, with the significant revival of the economy, T. Rowe Price is expected to post strong results in the coming quarters.

T. Rowe Price remains debt free with substantial liquidity including cash and mutual fund investment holdings. This has helped in strengthening the company’s capital leverage and generating return on earnings that is substantially higher than the industry average. These growth drivers have paved the way for an industry-leading dividend yield, thereby creating ample investor confidence and scope for investment and growth opportunities in the future.

In February 2012, T. Rowe Price’s Board of Directors approved a 10.0% hike in the company’s quarterly common stock dividend. The revised quarterly dividend now stands at 34 cents per share. This marks T. Rowe’s 26th consecutive year of dividend increase, reflecting the company’s commitment toward returning value to shareholders with its strong cash generation capabilities.

With the recovery of the economic environment, AUM increased $65.3 billion sequentially and ended the first-quarter at $554.8 billion. Net cash inflows from investors were $12.4 billion, with market appreciation and income of $52.9 billion. Moreover, among the company’s peers, BlackRock Inc. (BLK) also reported a rise in AUM of $3.68 trillion as of March 31, 2012, up 5% sequentially and 1% year over year. The sequential increase was due to strong inflows of $25.7 billion in long-term products.

On the flip side, operating margins are expected to be impacted by the revenue environment with more risk to the downside in the upcoming quarters, reflecting volatile AUM and continuing reinvestment spending. Therefore, T. Rowe Price continues to focus more on growing its products, expanding its third-party distribution, and augmenting its non-U.S. investor base. Though management is cautious regarding the control of other discretionary expenses, elevated operating expenses would limit margin expansion.

T. Rowe Price has the potential to take advantage of the economic recovery and benefit from the growth opportunities in the domestic and global AUM. Yet, competitive pressures amid economic headwinds remain as the major concerns.

T. Rowe Price currently retains a Zacks # 3 Rank, which translates into a short-term ‘Hold’ rating.

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