Federated Investors Inc. (FII, Financial) has had a rough go of things lately. The general market consensus is hold or sell. The stock price has dropped and doesn’t look to change direction anytime soon. The story is more likely to get worse than better. We advise our readers to avoid Federated Investors or sell any existing holdings.
In a generally high-performing market, why take a chance on (or hold onto) a stock with a ton of risk and not much upside potential? This is a thesis we have been trying to drive home of late. There are so many exciting plays, why waste time on a dud?
The story of Federated Investors is a bright one turned sour. The company performed quite solidly from 2010 to 2016, coming out of the financial downturn strongly and capitalizing on a weakened asset management market, offering products and services at reasonable rates. But growing concerns about growth, management and competition have sharply changed the narrative.
A story of inconsistent financial performance
If there was one word to describe the story of Federated Investors, it would have to be inconsistency.
While the company grew steadily, though certainly not dramatically, from about 2010 to midway through 2016, it has since seen growth level off and even decline slightly. For us to see Federated as an attractive or contrarian play, it would need to be doing at least 10% to 15% annual growth, not close to nothing or even a decline, backtracking on previous gains.
Revenue for 2017 dropped by 4% from $1.14 billion to $1.10 billion from the previous year, breaking what had been an impressive upward trajectory. Just a year previous, from 2015 to 2016, revenue increased by 23%.
The beginning of the growth stagnation can be pinpointed at the final quarter of 2017 and the first quarter of this year. Revenue for fourth-quarter 2017 was completely flat, dropping by a mere $3,000 from the third quarter. The real drop came the next quarter, with a fall in revenue of more than $14 million.
While costs are not out of control relative to revenue, if revenue growth cannot be recharged, the company will continue to face middling growth and not serve as an attractive stock to serious investors hunting for real value. Its value maximum very well may have been reached.
The one glimmer of hope is in net income as it has continued to increase fairly consistently. Federated Investors' net income increased by 23% and 39% in 2016 and 2017 respectively. Overall, however, net income has still not seen the growth numbers one would have hoped for given its previous track record.
Taking a read of earnings per share performance likewise supports the inconsistency claim. While earnings per share have not been robust, they have not been terrible either. However, they have grown only tepidly over the last year or so. Evaluating earnings per share performance versus expectations, we see earnings has fluctuated between 53 cents and 60 cents, beating expectations only by 6% at best, and missing expectations by 8% at worst. Earnings for the first quarter were particularly troublesome, showing a decline of more than two cents from the previous quarter.
Slowed growth and increased competition is a recipe for trouble
Slowed growth is a problem in and of itself, but when coupled with increased competition, that can spell trouble. The company has net income that is acceptable, a balance sheet that is comfortable and a frequent dividend that is attractive. But these are not enough to signal a buy recommendation.
Federated Investors began its particular recent success in the aftermath of the financial crisis in 2010. While other similarly-sized investment groups went under, were purchased or remained distressed, Federated was able to come out stronger than ever.
This head start on competition was helpful, but could not last forever. Now the company faces constant pricing pressure from larger, more able-bodied competitors and margins are shrinking. In our increasingly digital world, free trading platforms have emerged to cut from Federated’s clientele, and competition has increased from folks like Charles Schwab (SCHW, Financial), index funds (which people gravitate toward in a healthy economy) and so on in the face of increasing interest rates.
Verdict
Despite all the disappointing news, it would not yet be wise to sound the death knell of Federated Investors. Certainly it is not dead, despite all the negativity and troubling economics.
The company may yet regain its ability to grow, but we do not believe the stock serves as a value investment any longer. The dividend is certainly not unattractive, but in an economy in which there are quite a few hidden gems that are far better suited to a strategy of identifying undervalued, event-driven, mid-cap businesses, we do not see this as much of a buying opportunity right now.
There are plenty of other places where investors’ money has a greater chance of paying dividends.
You might get a few dollars back every year, but no one is going to be getting rich off of Federated Investors. We, at least, are steering clear.
Disclosure: I/We own no stocks discussed in this article.
(This article was co-authored by Clyde William Engle Jr., an investment analyst with Almington Capital – Merchant Bankers.)
