Income investors who depend on dividends are facing an unpleasant reality. As a result of business activities coming to a standstill thanks to the global lockdown, many high-dividend-paying companies in the energy and real estate sectors have decided to reduce quarterly payments or altogether suspend shareholder distributions until further notice. Amid this challenging environment, chasing for yield, or the act of aggressively investing in companies with high dividend yields, could lead to unwelcome results in the future. The best course of action is to invest in the shares of solid businesses that are in a strong financial position to continue dividends. BlackRock Inc. (BLK, Financial), the largest asset manager in the world, is one such company that is bucking the trend by generating solid revenue and earnings growth. The dividend yield was 3% at the closing market price of $484.16 on May 1.
BlackRock is defying the odds
The fortunes of an investment management company are closely tied to global economic growth. Therefore, it’s natural to assume that a recession will lead to a massive loss of revenue for this industry, which eventually results in a significant decline in the market value of publicly listed companies representing this sector. Empirical evidence backs up this claim as well. The chart below illustrates the stock performance of major asset management companies during the global financial crisis.
The disappointing performance during the last recession was expected this time around as well. However, BlackRock defied the odds and reported earnings per share of $6.60 for the first quarter, beating the consensus estimate of $6.51. BlackRock shares have weathered the turmoil in equity markets better than its peers as well.
| Company | Share price performance in 2020 |
| BlackRock | (-4%) |
| AllianceBernstein Holdings LP (AB, Financial) | (-28%) |
| State Street Corp. (STT, Financial) | (-25%) |
| T. Rowe Price Group Inc. (TROW, Financial) | (-9%) |
Source: GuruFocus
This outperformance was a result of BlackRock’s attractive financial performance in the first quarter, and a deeper dive into the numbers reveals the reasons behind this.
The success should be attributed to BlackRock’s scale and moat
The asset manager’s well-known strength is its iShares suite of products that have risen to the top of the passive investment management space. In the first quarter of the year, this product line once again came to the rescue. BlackRock reported net inflows of $35 billion for the quarter, supported by $53 billion inflows to cash and liquid funds, which more than offset the outflows from equity and bond funds. The company has products to cater to all investment requirements of clients, which has been one of its core strengths. Amid the chaos in global capital markets, investors who were seeking the shelter of dollar-denominated liquid asset classes pumped money into BlackRock’s suite of passive investment vehicles.
One of the lesser-known strengths of the company is Aladdin, the portfolio management software arm of BlackRock. In the first-quarter earnings conference call on April 16, CEO Larry Fink remarked that Aladdin processed a record-high trade volume in the first three months of the year, fueled by the increased usage of the platform by institutional clients who were confined indoors due to coronavirus-related lockdowns.
The increase in base fees was the primary driver of quarterly revenue in comparison to the first quarter of 2019. However, as illustrated below, technology services revenue supported this growth as well, which comes as a result of the management’s long-term plan to diversify the revenue sources of the company to survive difficult times better in comparison to its peers.
Source: Earnings presentation.
In the asset management industry, intangible assets such as brand value and the quality of fund managers employed by the company play a major role in developing competitive advantages, or moats. According to Morningstar analyst Greggory Warren, BlackRock has one of the strongest moats in the industry, resulting from the unparalleled scale of its products offering. Another factor playing in the company's favor is the stickiness of its customers. For a client served by BlackRock, there are very few reasons to switch service providers. The company employs some of the best brains in the industry, has built a reputation as the leader of the asset management space and has products to cater to any requirement of clients. This stickiness has helped the company build on its moat as well.
The strong financial position helps BlackRock reward investors
While many companies have decided to suspend or abandon quarterly dividends, BlackRock has done the opposite. In January, the board of directors approved a 10% increase in the quarterly dividend to $3.63 per share from $3.30. The company has consistently hiked dividends per share for 16 years, which is a testament to the commitment by the management to distribute wealth to shareholders. More importantly, BlackRock has covered its distributions with free cash flow. This is proof of the safety of the dividend.
BlackRock has $5 billion in long-term liabilities, but the debt-to-equity ratio has improved in the last five years, as illustrated below.
The manageable debt load is another indication of the company’s ability to honor shareholder payments on time. As many investors should be aware, the majority of dividend cuts in the last couple of months were the result of liquidity issues faced by companies. BlackRock, however, will most likely not be in such a precarious situation anytime soon.
If active investing gains traction again, BlackRock’s performance will be even better
Since the fallout of the financial crisis, low-cost passive funds have dominated the inflows to the asset management industry. However, as pointed out in an article published in February, the performance of active and passive strategies are cyclical. The turmoil in global capital markets today might prove to be the catalyst for active funds to gain traction once again, which would be a blessing for investment management companies.
BlackRock’s operating margins have declined in the last five years, but a resurgence in popularity of actively managed funds will help the company expand its margins as much higher fees are attached to these products. Unlike its peers, the company is well positioned to grow even if this phenomenon does not take place, but the growth will be much higher than analysts are factoring in if this happens.
Takeaway: BlackRock is a top pick for dividend investors
Income investors were hit hard by the reduction in dividends of many S&P 500 companies. BlackRock, with its 3% yield and strong financial position, stands out as one of the top picks for investors to generate income while patiently waiting for markets to recover. Shares are, however, trading at a premium to other asset managers. For instance, BlackRock is trading at a price-earnings multiple of 19.7, which is higher than all the companies in its peer group. But it’s reasonable to conclude this premium is warranted given the company’s ability to generate better returns than its competitors. The scale is one of the most important factors for an investment manager, and BlackRock has plenty of that.
Disclosure: I do not own any stocks mentioned in this article.
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