Magellan Financial Reflects Lofty Expectations

This story features MAGELLAN FINANCIAL GROUP LIMITED. For more info SHARE ANALYSIS: MFG

Magellan Financial has outlined a plan to increasingly use a partnership model to engage directly with retail investors.

-Brokers generally consider the stock too expensive
-Closed-end fund improves the quality of earnings
-Magnitude and potential success of opportunities remain unclear
 

By Eva Brocklehurst

Magellan Financial ((MFG)) has called attention to its future growth initiatives with the launch of a closed-end fund and an equity raising. The company intends to increasingly use and leverage its partnership model with direct investors, raising capital to invest in listed products with loyalty bonuses funded by the manager in order to maintain an increasingly sticky retail base.

The partnership offer will capitalise on the gap in the retail wealth segment created by the exit of the banks, and Morgan Stanley also suggests this provides an alternative to the growing strength of industry super funds.

Nevertheless, more capacity is required to deliver on its growth aspirations. To this end Magellan Financial has announced a $275m institutional share placement with proceeds to be directed towards a high conviction trust as well as to seed new investment strategies. Is?

This includes $50m to support a new retirement income product. Details are limited and the company has reiterated that the retirement product will not be capital intensive nor an annuity so Citi adopts a wait-and-see approach.

While the deployment of capital to fund investor discounts for such funds makes strategic sense, the increasing capital intensity of flows is also an indication to UBS that Magellan Financial is entering a more mature growth phase. With partnership costs becoming a more recurring feature and the stock trading at 28x FY20 price/earnings (PE) estimates the broker envisages downside risks to valuation.

Morgan Stanley suspects the capital raising could dilute earnings per share and, given a PE ratio around such levels, considers the stock too expensive. A closed-end fund may improve the quality of earnings but the broker points out the retirement income product is light on capital and will not require an APRA licence, while also being 6-12 months away.

Growth Driver?

A competitive response is also expected should the product be successful. Ord Minnett supports the strategy but believes the manager-funded priority offer will be no more than an incremental driver of growth, taking into account the company's $90bn funds under management base.

Still, the company maintains an ability to deliver solid inflows over FY20/21 on the back of sustainable US strategies and US$6bn of remaining capacity in the infrastructure fund, Morgans suggests, while acknowledging the stock is susceptible to any meaningful pullback in the market. Morgans retains a Hold rating given the quality of earnings and the growth options.

Credit Suisse upgrades earnings estimates following the announcement of the opportunity inherent in the launch of the trust and retirement product. The broker acknowledges, with the share price up over 150% to date in 2019, a substantial increase in its target price, to $49.30 from $42.90, may be simply chasing the trend.

Growth opportunities appear compelling and Credit Suisse believes there are a number of initiatives that have the ability to significantly increase funds under management. Nevertheless, the stock is trading at a 60% premium to the market and the magnitude and potential success of the opportunities remains unclear.

Citi and Ord Minnett have downgraded to Sell ratings. Ord Minnett's target rises to $49.60 from $40.33 on marking to market amid strong flows and the potential of the new fund. Yet this implies a negative total shareholder return of -13.5% and the broker assesses there is a slim margin of safety, while the market is paying up for success.

Citi agrees expectations are lofty, although acknowledges the high conviction trust is an innovative approach that brings an element of recurring acquisition costs to the business, albeit with newly raised funds effectively locked in and future earnings potentially capitalised at over 20x PE.

High Conviction Trust

The partnership model will be expanded with the launch of the Magellan High Conviction Trust which includes a 7.5% loyalty bonus to eligible share and unit holders, around 70,000 in total, a 2.5% IPO bonus for new investors and nil brokerage.

Net profit in FY19 was $377m and ahead of broker estimates. UBS assesses this purely reflected one-off unrealised asset gains. The broker expects funds management margins, ex performance fees, should remain resilient at around 50 basis points of average assets under management in FY20, before slowly contracting.

FNArena's database shows one Hold (Morgans) and five Sell ratings. The consensus target is $49.03, suggesting -14.1% downside to the last share price. This compares with $44.69 ahead of the results. Targets range from $38.50 (Morgan Stanley) to $57.80 (Morgans).

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