Asset management firm Schroders (SDRC) throws up a bit of a mixed bag. On the plus side, it has a very good underlying business model. Operations are inherently capital light, which usually means plenty of cash for things like dividends. On the down side, competition from ‘passive’ providers has left active managers like Schroders struggling to justify their fees. That has put pressure on margins as well as growth prospects. That said, and with the non-voting shares trading at a price-earnings ratio (“PE”) of 11.5, the investment proposition looks quite reasonable right now.
The Business
Many readers will know the name, possibly on account of its extensive mutual fund range, one of which has featured on this site already. Anyway, the firm is one of the largest asset managers in the UK, with assets under management (“AUM”) of circa £535b at last count. This encompasses traditional services to institutions and retail investors, such as the mutual funds you see on investment platforms, as well as wealth management services, multi-asset solutions and more illiquid private and alternative assets.
Schroders generates most of its revenue from management fees levied as a proportion of AUM. It has other revenue lines – performance fees and so on – but management charges make up the vast majority. Of the £2.54b it booked in FY19 revenue, £2.38b came from management fees. There is a lot to like about that from an investment perspective. For one, it is highly recurring revenue. Two, it lends itself to plenty of cash generation as profit margins tend to be high and capital investment low. Its fee margin – that is, the slice of AUM it earns – stands at around 40 basis points on a company-wide basis.
Secular Decline
Like most asset managers, Schroders faces stiff competition from providers of passive products. Whereas a simple index tracker might cost a small number of basis points, an active counterpart could charge ten or more times that amount. It is not easy to justify, and the traditional services outlined in the last section have come under pressure as a result. Net asset flows have not been in positive territory very often in recent years.
The company plans to combat this negative secular trend in a few ways. First, its AUM mix now sports an increasing exposure to more illiquid assets like real estate and private equity. These are much harder to index and so the ‘passive’ option is less of an issue there. Fee margins also look to be higher in that segment. Second, Schroders is beefing up other aspects of its business that have seen stronger net asset flows. Wealth management is seen as a long-term growth avenue, as are multi-asset solutions. Those three lines now represent circa 55% of AUM following the strategic partnership with Lloyds Banking Group. That deal ultimately saw Schroders take on around £75b in Scottish Widows, insurance and wealth-related assets. It is also responsible for a big chunk of AUM growth here in recent years.
Non-Voting Stock
Schroders has two classes of shares – voting and non-voting – to protect the Schroder family’s control over the business. On-the-ball readers will note that I tagged the piece with the non-voting shares (SDRC). Now, the non-voting stock currently trades for circa 2,265p; the voting stock trades for around 3,433p. The gulf between them is vast, and largely undeserved. Yes, there is utility in being able to attend and vote at AGMs and so on. Fair enough, a modest discount to the non-voting stock is justified and should be the norm. But the level it is at now looks too large given the shares are the same in all other respects. They carry the same dividend and entitle holders to the same economic benefits.
Valuation
FY20 was clearly a volatile year for the markets. Schroders entered the year with AUM of circa £500b, which had actually increased to £535b by the end of Q3. Given COVID, I am not sure anybody would have been brave enough to predict that in the early part of the year. Still, the share price remains down circa 12% on pre-COVID levels. Analysts expect the firm to report profit per share (“EPS”) of around 185p for FY20, rising to circa 200p this year. Quick maths puts the stock at a PE of around 11.5. The dividend yield is 5% based on an annualised payout of 114p per share.
That leaves us to ponder the long-term growth outlook here. Annual AUM growth in the low single-digit region seems like a reasonable scenario. Rising assets prices can lead to that even with muted asset flows. Stable fee margins would see that translate to similar top line growth, although that requires bucking the trend of recent years. If margin compression were to continue, we might knock fee growth down to the 1-2% per annum region. Stable costs would then translate into similar levels of profit growth.
It all looks pretty modest, but the valuation doesn’t exactly require heroic growth. A well-covered 5% dividend, plus low single-digit EPS growth outlined above, might just be enough to generate acceptable shareholder returns overall.
Note
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