Waddell & Reed Financial (WDR, Financial), the $1.63 billion asset manager, reported an 18.1% drop in its total operating revenues to $946 million in the third quarter and a 31.1% loss in profits to $125.8 million during its nine months fiscal 2016 operations.
The asset manager was able to reduce its total expenses by 10% overall but still delivered a much-reduced profit compared to a year earlier. As a result, shares fell by 5.6% compared to the -0.37% return provided by the Standard & Poor's 500 index that day.
“Our industry is undergoing a period of transformational change and we understand that in order to remain competitive our business needs to evolve. While we have made progress in addressing the areas of our business that require attention, we realize a lot of work still remains to be done.” – Philip J. Sanders, CEO of Waddell & Reed Financial Inc.
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(Google Finance)
In hindsight, it would have been so wonderful to rather ignore those declining figures and just buy some shares for speculation.
Valuations
Despite the recent 21.34% rally in its share price, Waddell & Reed Financial had a trailing 12-month price-earnings (P/E) ratio of just 8.6 times (industry median: 15), price-book (P/B) ratio of 1.92 times (industry median: 0.97), price-sales (P/S) ratio of 1.25 times (industry median: 6.85; 1).
The asset manager also has a very juicy 8.9% trailing dividend yield and an 81% payout ratio.
Market performance
Year to date, Waddell & Reed Financial underperformed the broader index greatly with -21% return vs. 13.51% (2). Five-year total returns demonstrated that it had provided 2.4% while S&P 500 returned 15.59%.
Waddell & Reed Financial
Waddell & Reed Financial was founded in 1937 and represents one of the oldest mutual fund complexes in the U.S. The asset manager introduced its Waddell & Reed Advisors group, the Advisor Funds, of mutual funds in 1940 (3).
Later on, Waddell & Reed Financial also added its list of fund families: Ivy Funds, Ivy Funds Variable Insurance Portfolios, InvestEd Portfolios, 529 college savings plan ("InvestEd"); and the Ivy Global Investors Fund SICAV and its Ivy Global Investors sub-funds.
(Five Largest Mutual Funds by Waddell & Reed Financial, 10-K)
In 2015, Waddell & Reed Financial’s Ivy Asset Strategy had the most assets under management (AUM) with $15.3 billion, compared to $27.4 billion in 2014. All of the five mutual funds listed above experienced a decline in AUM except for Ivy International Core Equity, which grew 65.9% to $4.5 billion in 2015.
As of Dec. 31, 2015, Waddell & Reed Financial had $104.4 billion in AUM. As of Sept. 30 the asset manager had an 18.5% decline in its AUM, consisting of $85.1 billion.
Waddell & Reed Financial derives its revenues from providing investment management, investment advisory, investment product underwriting and distribution and shareholder services administration to its mutual funds and institutional and separately managed accounts.
(10-K and 10-Q filings)
Investment management fees
In its filings, investment management fees are based on the amount of average assets under management and are affected by sales levels, financial market conditions, redemptions and the composition of assets.
In 2015, investment management fees contributed 46.8%, or $709.6 million, in total Waddell & Reed Financial fiscal 2015 sales. Investment fees lost 7.6% that period.
Nine months into fiscal 2016, investment management fees suffered a 21.9% loss, compared to its year-on-year figure, to $424.4 million.
Underwriting and distribution fees
Underwriting and distribution revenues consist of Rule 12b-1 asset-based service and distribution fees, fees earned on fee-based asset allocation products and related advisory services, commissions derived from sales of investment and insurance products and distribution fees on certain variable products.
In 2015, underwriting and distribution fees contributed 43.8%, or $664 million, of total company sales. The underwriting and distribution fees grew -2.2% in that year.
Shareholder service fees
Shareholder service fee revenue includes transfer agency fees, custodian fees from retirement plan accounts and portfolio accounting and administration fees and is earned based on assets under management or number of client accounts.
In 2015, shareholder service fees contributed 9.4% to overall sales while growing -5.2%. Nine months into fiscal 2016, shareholder fees were $93 million, compared to $108.7 million in the same time period last year.
Overall, Waddell & Reed Financial had a five-year sales and profit growth average of 7.7% and 9.36% (2). The asset manager also had a five-year operating margin average of 27.4%.
Cash, debt and book value
As of Sept. 30 Waddell & Reed Financial had $530 million in unrestricted cash and $189.6 million in long-term debt having a debt-equity ratio of 0.22. The company had 10.9% of its $1.4 billion assets in goodwill and intangibles and had a book value of $856 million compared to $846 million in December 2015.
Cash flow
(10-Q)
Nine months into fiscal 2016, Waddell & Reed Financial suffered 71% loss in its cash flow from operations to $66 million. Other than the company’s suffering profit performance, the asset manager’s cash flow in its investment gains, trading securities purchases and sales and trading securities held by consolidated sponsored funds for the period performed poorly.
Waddell & Reed Financial had a $57 million cash flow reduction in its trading securities held by consolidated sponsored funds, compared to $0 cash flow year on year.
Waddell & Reed Financial defined sponsored funds as either equity method investments (when the company owns between 20% and 50% of the fund) or as available for sale investments (when the company owns less than 20% of the fund).
Capital expenditures were $13.9 million, and free cash flow was $52 million, compared to $209.9 million year on year. The company also took in $148.4 million in proceeds from sales of available for sale and equity method securities, compared to $30.4 million last year.
(10-K and 10-Q filings)
The asset manager allocated 312%, or $162.7 million, of its free cash flow for dividends and share repurchases for the period. On average, Waddell & Reed Financial allocated 84% of its free cash flow in shareholder payouts.
Conclusion
Could the decline in both top and bottom lines be a minor bump that started in 2015? Waddell & Reed Financial recognizes that its industry is undergoing a transformational change, and it acknowleded that a lot of work still has to be done.
As one would recognize, the asset manager does not require much capital in usual expenses and rather has kept a good and healthy balance sheet over the years.
Nonetheless, its cash flow payouts seem a bit more plenty than its free cash flow in recent years. It remains a question whether its shareholders have seen the bottom in recent months – pertaining to fund outflows – whereas earlier it was observed that the company has suffered much of it this year.
Given the uncertainty surrounding its industry and bountiful cash flows still being provided to its shareholders, staying on the sidelines and not participating in the recent share price appreciation may still be a prudent action.
In summary, Waddell & Reed Financial is a pass.
Notes
(1) GuruFocus data.
(2) Morningstar data.
(3) Data and objective information herein mostly came from 10-Ks and 10-Qs.
Disclosure: I do not have shares in Waddell & Reed Financial.
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