In isolation, the 4Q outflow of -$5.1bn is not a complete surprise (mandate losses totalled $2bn, including $1bn in J O Hambro). All divisions suffered from net outflows, including the typically consistent Corporate Trust business.
We are though concerned that PPT’s second attempt to quantify cost guidance in conjunction with what we view as an overstretched balance sheet means that the re-rating of the PPT share price is now further away than we had originally hoped.
There is a scenario in that cost synergies that PPT originally flagged ($60m then upgraded to $80m in May) are neutralised by higher ongoing costs that just prove difficult to remove.
Management track record. PPT CEO Rob Adams does not have a strong track record of being able to extract M&A synergies. Barrow Hanley and Trillium acquisitions at 1H23 results failed to deliver earnings accretion despite >$500m being deployed. Between FY18 and FY23E EPS is expected to fall by ~30%.
Our early read on Perpetual/Pendal integration is that the potential for further fund outflows, combined with uncertainty on the costs base, could lead investors to bring into question the balance sheet with ~$800m of debt expected at the end of 30 June 2023 (1H $769m), which would equate to ND/EBITDA of >2.0x. This is too high for asset managers.
We downgrade PPT to Sell. Despite the relative value appeal of PPT at ~10x PER FY24E and above market dividend yield, we are concerned that the market is too optimistic around FUM, and the associated level of earnings that can be generated, coupled with emerging balance sheet risks.
Key Issues
We remained concerned that PPT net outflows have picked up again. Whilst large mandate losses explain ~$2bn of the $5bn in net outflows in 4Q23, the balance of net outflows comes despite almost 80% of PPT investment strategies being in positive performance territory on a 3-year-view.
Whilst PPT is guiding to ~$1.5bn of new client mandate inflows in 1Q24, it's difficult to see a change in the recent multi-year trend of FUM losses (from 2019) from PPT.
In our experience, it’s very difficult for Asset Managers to outperform the broader market when they are experiencing fund outflows. The key problem areas for fund outflow continue to be Barrow, J O Hambro, and TSW global equities along with Australian fixed income and equities.
Lower FUM will put pressure on management fees, whilst performance fees are likely to materially lower in FY23E.
These factors along with what is looking like a stickier cost base of the combined businesses threaten to take balance sheet gearing closer to 2x ND/EBITDA – which we consider to be too high for an asset manager. This raises the prospects for a strategic reset of the business if poor operating trends continue.
We downgrade our rating from Hold to Sell.
Figure 1: PPT FUM is up >4x since the 2019 strategy pivot to growth
Figure 2: PPT EPS expected to be 30% lower in FY23e vs FY18. ppt has spent ~$650m in acquisitions since 2019 (excluding the Pendal merger). Shares on issue have doubled from ~50m to 100m.
Figure 3: PPT has suffered from net outflows since it adopted the growth strategy in 2019.
Figure 4: PPT’s leverage ratio has jumped from net cash (FY19) to ~1.6x. We see risks that the leverage may increase to >2x in FY24E given poor cash generation and earnings generation at present.
Figure 5: PPT vs Peer Comps. PPT EPS growh primarly driven by Pendal acquistion.
Investment View
Share prices of asset managers need to see a period of positive fund inflows and risk-on-market sentiment to outperform the market. There remains a risk post-merger that net fund-out flows accelerate given fund overlap, something we have witnessed globally in mergers of asset managers in the past.
We remain sceptical that the merger can create inherent long-term value for PPT shareholders. The two most prospective higher growth businesses within PPT – Corporate Trust and Wealth Business have been effectively diluted under the merger.
PPT's track record of M&A over the last 5-years is patchy at best. Despite the growth of FUM and positive market tailwinds, PPT’s EPS has deteriorated by double-digit percentages along with a material increase in net debt.
Erosion of earnings from here would increase balance sheet risk given higher financial leverage. We rate PPT a Sell.
Risks to Investment View
The key risks for PPT include regulatory and compliance issues, key person retention (across key fund brands) and integration risks around the various acquisitions including the recently completed Pendal acquisition, especially around integration challenges, and overestimation of possible synergies including how long they will take.
A strong reversal of recent fund outflows would threaten our negative stance on PPT.
There are also risks around the various fund performance, particularly if it leads to FUM outflows.
