Federated Inv. [NYSE:FII] May 20, 2009: $22.19
52-week range: $15.80 (Dec. 29, 2008) - $36.63 (Sep. 19, 2008)
Dividend = $0.24 quarterly = 4.32% current yield
• Federated provides investment-management services to institutions and individuals. The company offers 158 funds as well as management of separate accounts. Of the company's managed funds, 50 are money market funds, 51 are fixed-income funds, and 57 are equity funds. Its money market funds represent more than 80% of its managed assets. Its largest equity fund, the Federated Kaufmann Fund, represented 13% of its annual revenue in 2008.
• Company profile from Morningstar.
Federated’s focus on fixed-income and money market funds has paid off during the trying market conditions of the past year. 2008 saw all-time high earnings per share of $2.20 and was the eighth year of the past ten with higher year-over-year results. Dividends grew in each of the past 10 years climbing from an annual rate of $0.11 to the current $0.96 /share.
First quarter earnings were down this year due to waived fees on Treasury funds (related to ultra-low tsy yields) and a non-recurring write-down of thirteen cents a share on the value of intangible assets from prior acquisitions.
Including that impairment charge Zacks sees 2009 and 2010 earnings of $1.84 and $1.98 respectively. That puts Federated’s multiple at just 12x this year’s and 11.2x next year’s expectations. Compare that with their historical P/Es from past years…
Year ….. Sales …... C/F …... EPS …... Div ….... B/V ….. Avg. P/E
1999 ….. 4.90 ….. 1.07 …. 0.96 ….. 0.11 ….. 0.97 …… 12.5x
2000 ….. 5.81 ….. 1.40 …. 1.27 ….. 0.14 ….. 1.26 …… 17.1x
2001 ….. 6.20 ….. 1.72 …. 1.44 ….. 0.18 ….. 2.06 …… 20.3x
2002 ….. 6.32 ….. 1.98 …. 1.74 ….. 0.22 ….. 3.03 …… 17.3x
2003 ….. 7.58 ….. 2.07 …. 1.83 ….. 0.30 ….. 3.64 …… 15.0x
2004 ….. 7.92 ….. 2.03 …. 1.77 ….. 0.41 ….. 4.28 …… 17.0x
2005 ….. 8.49 ….. 2.08 …. 1.84 ….. 0.58 ….. 5.05 …… 17.0x
2006 ….. 9.42 ….. 2.07 …. 1.80 ….. 0.69 ….. 5.10 …… 19.3x
2007 …..11.08 …. 2.39 …. 2.12 …...0.81 ….. 5.64 …… 17.8x
2008 …..11.97 …. 2.41 …. 2.20 …...0.93 ….. 4.14 …… 14.8x
Statistics are as reported by Value Line.
It is noteworthy that the only other times these shares approached 12x earnings was in 1999 and during the recent panic sell-off. Buyers at the low in 2003 saw their (split-adjusted) shares climb from $10 to $31.70 in under two years. Investors who picked up FII shares in late December, 2008 have already seen a 40% gain.
Federated runs a tight ship. They have shown operating margins averaging over 37% over the past decade. Unlike most asset management firms they actually posted a 21% increase in assets under management [AUM] year-over-year in the March 2009 quarter.
As the equity markets recover and the interest rate environment turns more normal, I expect to see both their AUM and profit margins increase quite dramatically.
The generous and well covered dividend yield is 4.32% right now. That’s better than what you can earn presently on 10-year Treasuries and bank CDs. Federated’s balance sheet looks good and capital spending needs are minimal.
Value Line rates FII ‘above average’ for safety and gives them an ‘A’ for financial strength. They garnered 70th and 100th percentile rankings for ‘stock price stability’ and ‘earnings predictability’ (with 100th being best).
Morningstar echoes those sentiments with a 4-Star (out of 5) overall rating and a present day ‘fair value’ estimate of $30 /share.
If Federated merely returns to a lower than normalized, fourteen multiple by next January, my target price becomes 14 x $1.84 = $25.76 /share.
Here’s a nice way to play these shares for that eight month period:
Buy 1000 FII @$22.19 ……...$22,190
Sell 10 Jan. $25 calls @$1.90 ………..…$1,900
Sell 10 Jan. $25 puts @$5.20 …….…….$5,200
Net Cash Out-of-Pocket …….$15,090
On Jan. 16, 2010 if Federated shares are $25 or higher
(up 12.7% from today’s quote):
The $25 calls will be exercised.
You will sell your shares for $25,000.
The $25 puts will expire worthless- a good thing for you as a seller).
You will have collected $480 in dividends.
You will have no further option obligations.
You will hold no shares and $25,480 cash for your original net
outlay of $15,090.
That’s a best-case scenario net profit of $10,390 / $15,090 = 68.8%.
This would be achieved as long as FII had gone up by at least 12.7% from the trade inception price of $22.19/share.
What’s the risk?
On Jan. 16, 2010 if Federated shares are below $25:
The $25 calls will expire worthless.
The $25 puts will be exercised.
You will be forced to buy another 1000 shares and to lay
out an additional $25,000 cash.
You will have collected $480 in dividends.
You will have no further option obligations.
You will own 2000 shares of FII and hold $480 cash.
What’s the break-even point on the whole trade?
On the first 1000 shares it’s the $22.19 cost less
The $1.90 /share call premium = $20.29 /share.
On the ‘put’ shares it’s the $25 strike price less
The $5.20 /share put premium = $19.80 /share.
Your average cost would be…
$20.29 + $19.80 / 2 = $20.05 minus $0.48 /sh. in dividends = $19.57 /sh.
Federated shares could drop by as much as $2.62 /sh. Or (-11.8%) without
causing a loss on this trade.
At $19.57 you’d own the 2000 shares at < 10.7x what we expect will be trailing earnings of $1.84. You’d also have a projected dividend yield of 4.9% or higher.
FII shares did not trade below $23.30 ever from January 1, 2001 right through
August of 2008. Highs in each of those eight years ranged from $31.90 to $45.
If you had to own extra shares at $19.57 it’s a good bet you’ll get a chance to
sell later for a very nice gain.
Since you’d be writing in-the-money puts in this example you should be sure to have the extra $25,000 in reserve should you actually be ‘put’ the additional shares between now and January 16th.
Summary:
Federated Investors is a high-quality, good yielding stock near the bottom of its historical valuation range. If our best-case plays out, you can make a cash-on-cash return of over 68% in eight months. If FII shares fail to reach $25 you’re still protected from loss on anything less than an 11.8% decline.
Disclosure: Author is long FII shares and short FII options.
NOTE: With the futures down pre-market you can now buy FII even cheaper than the indicated $22.19 close from May 20th.
FII shares and the call prices will be lower and put prices will be higher than in the write-up.
52-week range: $15.80 (Dec. 29, 2008) - $36.63 (Sep. 19, 2008)
Dividend = $0.24 quarterly = 4.32% current yield
• Federated provides investment-management services to institutions and individuals. The company offers 158 funds as well as management of separate accounts. Of the company's managed funds, 50 are money market funds, 51 are fixed-income funds, and 57 are equity funds. Its money market funds represent more than 80% of its managed assets. Its largest equity fund, the Federated Kaufmann Fund, represented 13% of its annual revenue in 2008.
• Company profile from Morningstar.
Federated’s focus on fixed-income and money market funds has paid off during the trying market conditions of the past year. 2008 saw all-time high earnings per share of $2.20 and was the eighth year of the past ten with higher year-over-year results. Dividends grew in each of the past 10 years climbing from an annual rate of $0.11 to the current $0.96 /share.
First quarter earnings were down this year due to waived fees on Treasury funds (related to ultra-low tsy yields) and a non-recurring write-down of thirteen cents a share on the value of intangible assets from prior acquisitions.
Including that impairment charge Zacks sees 2009 and 2010 earnings of $1.84 and $1.98 respectively. That puts Federated’s multiple at just 12x this year’s and 11.2x next year’s expectations. Compare that with their historical P/Es from past years…
Year ….. Sales …... C/F …... EPS …... Div ….... B/V ….. Avg. P/E
1999 ….. 4.90 ….. 1.07 …. 0.96 ….. 0.11 ….. 0.97 …… 12.5x
2000 ….. 5.81 ….. 1.40 …. 1.27 ….. 0.14 ….. 1.26 …… 17.1x
2001 ….. 6.20 ….. 1.72 …. 1.44 ….. 0.18 ….. 2.06 …… 20.3x
2002 ….. 6.32 ….. 1.98 …. 1.74 ….. 0.22 ….. 3.03 …… 17.3x
2003 ….. 7.58 ….. 2.07 …. 1.83 ….. 0.30 ….. 3.64 …… 15.0x
2004 ….. 7.92 ….. 2.03 …. 1.77 ….. 0.41 ….. 4.28 …… 17.0x
2005 ….. 8.49 ….. 2.08 …. 1.84 ….. 0.58 ….. 5.05 …… 17.0x
2006 ….. 9.42 ….. 2.07 …. 1.80 ….. 0.69 ….. 5.10 …… 19.3x
2007 …..11.08 …. 2.39 …. 2.12 …...0.81 ….. 5.64 …… 17.8x
2008 …..11.97 …. 2.41 …. 2.20 …...0.93 ….. 4.14 …… 14.8x
Statistics are as reported by Value Line.
It is noteworthy that the only other times these shares approached 12x earnings was in 1999 and during the recent panic sell-off. Buyers at the low in 2003 saw their (split-adjusted) shares climb from $10 to $31.70 in under two years. Investors who picked up FII shares in late December, 2008 have already seen a 40% gain.
Federated runs a tight ship. They have shown operating margins averaging over 37% over the past decade. Unlike most asset management firms they actually posted a 21% increase in assets under management [AUM] year-over-year in the March 2009 quarter.
As the equity markets recover and the interest rate environment turns more normal, I expect to see both their AUM and profit margins increase quite dramatically.
The generous and well covered dividend yield is 4.32% right now. That’s better than what you can earn presently on 10-year Treasuries and bank CDs. Federated’s balance sheet looks good and capital spending needs are minimal.
Value Line rates FII ‘above average’ for safety and gives them an ‘A’ for financial strength. They garnered 70th and 100th percentile rankings for ‘stock price stability’ and ‘earnings predictability’ (with 100th being best).
Morningstar echoes those sentiments with a 4-Star (out of 5) overall rating and a present day ‘fair value’ estimate of $30 /share.
If Federated merely returns to a lower than normalized, fourteen multiple by next January, my target price becomes 14 x $1.84 = $25.76 /share.
Here’s a nice way to play these shares for that eight month period:
Buy 1000 FII @$22.19 ……...$22,190
Sell 10 Jan. $25 calls @$1.90 ………..…$1,900
Sell 10 Jan. $25 puts @$5.20 …….…….$5,200
Net Cash Out-of-Pocket …….$15,090
On Jan. 16, 2010 if Federated shares are $25 or higher
(up 12.7% from today’s quote):
The $25 calls will be exercised.
You will sell your shares for $25,000.
The $25 puts will expire worthless- a good thing for you as a seller).
You will have collected $480 in dividends.
You will have no further option obligations.
You will hold no shares and $25,480 cash for your original net
outlay of $15,090.
That’s a best-case scenario net profit of $10,390 / $15,090 = 68.8%.
This would be achieved as long as FII had gone up by at least 12.7% from the trade inception price of $22.19/share.
What’s the risk?
On Jan. 16, 2010 if Federated shares are below $25:
The $25 calls will expire worthless.
The $25 puts will be exercised.
You will be forced to buy another 1000 shares and to lay
out an additional $25,000 cash.
You will have collected $480 in dividends.
You will have no further option obligations.
You will own 2000 shares of FII and hold $480 cash.
What’s the break-even point on the whole trade?
On the first 1000 shares it’s the $22.19 cost less
The $1.90 /share call premium = $20.29 /share.
On the ‘put’ shares it’s the $25 strike price less
The $5.20 /share put premium = $19.80 /share.
Your average cost would be…
$20.29 + $19.80 / 2 = $20.05 minus $0.48 /sh. in dividends = $19.57 /sh.
Federated shares could drop by as much as $2.62 /sh. Or (-11.8%) without
causing a loss on this trade.
At $19.57 you’d own the 2000 shares at < 10.7x what we expect will be trailing earnings of $1.84. You’d also have a projected dividend yield of 4.9% or higher.
FII shares did not trade below $23.30 ever from January 1, 2001 right through
August of 2008. Highs in each of those eight years ranged from $31.90 to $45.
If you had to own extra shares at $19.57 it’s a good bet you’ll get a chance to
sell later for a very nice gain.
Since you’d be writing in-the-money puts in this example you should be sure to have the extra $25,000 in reserve should you actually be ‘put’ the additional shares between now and January 16th.
Summary:
Federated Investors is a high-quality, good yielding stock near the bottom of its historical valuation range. If our best-case plays out, you can make a cash-on-cash return of over 68% in eight months. If FII shares fail to reach $25 you’re still protected from loss on anything less than an 11.8% decline.
Disclosure: Author is long FII shares and short FII options.
NOTE: With the futures down pre-market you can now buy FII even cheaper than the indicated $22.19 close from May 20th.
FII shares and the call prices will be lower and put prices will be higher than in the write-up.
