BlackRock's shares (NYSE:BLK) have gained over 13% since my initiation report in early November 2018, supported by the strong operating performance and the positive broad market performance during this period.
Share price movement of BLK in the last six months
(Source - Morningstar)
Even on the back of the recent gains, I continue to believe that BLK is trading at an attractive price level for dividend growth investors, primarily driven by the outlook for global market performance in 2019 and the competitive advantages of BlackRock over its peers.
Q1 2019 was another strong quarter for BlackRock
Assets under management (AUM) increased 3.1% on a year-over-year basis to $6.515 trillion, which was understandably supported by the positive global market performance in the first quarter of the year. However, revenue declined both on a sequential basis and a year-over-year basis, and the technology services sector was the only business segment that reported an improvement from the revenues reported in Q4 2018 and Q1 2018.
(Source - Investor presentation)
Technology services segment represents an insignificant portion of BlackRock's revenues, and the positive performance in this segment failed to lift revenues meaningfully.
Q1 revenues by business segment
(Source - Investor presentation)
Net inflows for the quarter were reported at $59 billion, which was supported by the inflows to the iShares offering to the tune of $30.7 billion. A notable improvement was the inflows to actively managed funds. This comes as a result of improving macroeconomic and geopolitical outlook, especially the possibility of a trade deal.
(Source - Company filings)
Despite underwhelming market performance in 2018, BlackRock continued to see organic asset growth throughout the year, and there was no exception in Q1 2019 as well. Organic asset growth was over 4%, which is a sign of the market leading position of BlackRock and the attractiveness of its product offering.
The industry-leading iShares fund offering is continuing to provide BlackRock an edge over its peers, and investors have little reason to shift from BlackRock to another provider, which leads to economic moats for the firm.
Active funds represent around 26% of the total AUM, but still accounts for 47% of base fees earned by BlackRock. As the popularity of ETFs and passive investment strategies grow, BlackRock's profit margins might come under pressure as the fees charged by BLK on its passive investment products are considerably lower than the fees charged on actively managed funds offered.
Growth opportunities are still present for BlackRock outside the U.S. as emerging markets are expected to resume their positive performance in 2019. On the other hand, emerging markets are yet to be penetrated properly by BlackRock and other asset managers, which leaves sufficient room for growth.
AUM breakdown and fees earned by client type, style, product type, and region
(Source - Investor presentation)
BlackRock still earns 35% of its revenues from outside the U.S., and I expect this to change in the future as emerging markets will see unprecedented growth for a longer period than the U.S., and such growth will help the uprise of a middle-class in many of these regions, which should incentivize BlackRock to penetrate these markets aggressively.
Diluted earnings per share declined from $6.70 in Q1 2018 to $6.61 in Q1 2019, which was driven by the lower revenues earned by BlackRock in the quarter. However, the marginal decline in the EPS does not provide a reason for concern at the moment as the future outlook is stable for the company. On the other hand, Q1 2019 marked the beginning of the recovery from the downturn in the latter part of last year, and the yield curve inversion resulted in outflows as well.
(Source - Investor presentation)
Macroeconomic outlook is promising, but margins might come under pressure
Global markets continued to gain momentum in Q1 2019, primarily driven by the expectations of a trade deal between the U.S. and China. The tit-for-tat trade tariffs imposed by the U.S. and China in 2018 set the platform for global market under-performance in 2018, and the improving outlook in this front should help markets gain traction in 2019.
The rising rates environment remained a threat for equity products offered by BlackRock for the last three years, as it is generally assumed that equity outflows will take place when rates rise.
Fed Funds Rate
(Source - Trading Economics)
The Fed Chair, Jerome Powell, confirmed the patient stance regarding interest rate hikes in 2019, which should support equity market performance in 2019. This will result in inflows to equity products offered by BlackRock. The company earns nearly 50% of its base fees on equity products, and the positive outlook for equity markets will help BlackRock earn higher fees through higher AUM for equity products.
Passive investments are continuing to gain popularity as actively managed funds are failing to provide expected alpha. BlackRock is well positioned to benefit from this secular trend as its iShares offering is the global leader of ETFs. Even though BlackRock would be able to grow its AUM with the success of its iShares offering, profit margins might come under pressure as passive investment products are priced low in comparison to actively managed funds. Operating margins have remained stable for the last couple of years, and I expect margins to remain under pressure for the next few years as well.
(Source - Investor presentation)
BlackRock is investing to expand its technological capabilities as well, which will result in higher operating expenditures in the short-term, but would help margins expand in the future by allowing the company to achieve a high level of efficiency in the future. On the other hand, the growth of the technological services segment will help margins expand in the future as well, but I do not see this happening within the next couple of years. I expect margins to compress initially, then to gain momentum as investments related to improving technological capabilities provide cost benefits to the firm.
Dividends and share repurchases
BlackRock has provided a steady stream of income to its investors over the last couple of decades, and dividend distributions have grown in line with the growth of profitability.
Dividend growth history
(Source - Seeking Alpha)
Dividend distributions will grow in the future as well, and the management remains optimistic on obtaining the authorization to implement share repurchase programs in the future as well. BlackRock repurchased $1.6 billion worth of common shares in Q1 2019, which marked the completion of the targeted level of share buybacks for 2019.
"Our capital management strategy has always been to first invest in our business and then return excess cash to shareholders through a combination of dividends and share repurchases. As previously announced, we increased our quarterly cash dividend by 5% to $3.30 per share of common stock and repurchased $1.6 billion worth of common shares in the first quarter including $1.3 billion repurchased in a private transaction at approximately $413 per share. We have now completed our targeted level of share repurchases for 2019, but we will remain opportunistic should relative valuation opportunities arise." - Gary Shedlin, CFO
Share repurchases will not only add an additional stream of income to investors, but will also improve per-share earnings figures in the future, which should support BLK to trade at higher multiples.
Valuation
The median analyst target price for BLK is $515, which represents an upside of 10% from the current market price. The dividend yield of 2.8% at the current market price provides an additional income source for investors.
(Source - CNN Money)
BlackRock is the world's largest asset manager, and has a variety of products to cater to different types and styles of investors. The scale of BlackRock provides competitive advantages over its peers, and the company has been able to organically grow its AUM even when other asset managers failed to do so in 2018, which is proof of strong competitive advantages arising from the wide variety of products available, large scale, and switching costs.
I expect these competitive advantages to remain the same for an extended period of time, and the favorable macroeconomic and geopolitical outlook should help BLK converge with its median target price in 2019.
At a forward P/E of 16, BLK is still an attractive play for dividend growth investors.
(Source - Morningstar)
Risks
There are multiple risks of investing in BLK:
- A global market meltdown will affect BlackRock adversely, and a significant outflow of invested funds will result in lower fees.
- Even though the interest rate environment is looking stable at present, this could change within the span of a few months if GDP growth remains at elevated levels and the Fed decides to hike rates to cool down the economy.
- Fees earned on passive investment products are considerably low than fees earned on actively managed products, and the increasing shift to passive investment products on a global basis will compress margins of BlackRock in the future.
These risks are the most visible at present, but I believe BlackRock will be able to retain its profitability in 2019, which should support the share price.
Conclusion
BLK has gained 13% over the last six months, but shares are still trading at an attractive level considering the outlook for global capital markets in 2019 and BlackRock's market leading position. Shares are a buy at the current market price.
This article was written by
Dilantha De Silva
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Hello, my name is Dilantha De Silva, and I am an investment analyst with 8 years of experience in financial markets. I specialize in U.S. equities and incorporate a top-down approach to identify developing macro-level trends and the companies that would benefit from such trends. As the founder of Leads From Gurus, a Marketplace service on Seeking Alpha, I aim to uncover alpha-generating opportunities and provide timely updates on new articles. I also work with leading financial publications including Refinitiv, ValueWalk, and GuruFocus. My portfolio is designed to benefit disproportionately from the rise of under-covered small-cap stocks, which I identify through a rigorous due diligence and research process. I believe that the best investment opportunities can often be found in hidden gems that are overlooked by many investors and analysts. My investment approach is focused on long-term macro trends and themes, and I use my top-down analysis to identify individual opportunities within these themes. I take a disciplined and consistent approach to investing, and I am a strong believer that patience and conviction are key to long-term success in the stock market. I build and maintain valuation models for all stocks in my portfolios to estimate the intrinsic value of these companies in a fair, conservative way to avoid value traps in this volatile market. I am a CFA level 3 candidate and an Associate Member of the Chartered Institute for Securities and Investment (CISI, UK). During my free time, I enjoy reading and staying up-to-date with the latest financial news and trends. Please click the "Follow" button to stay updated on my latest articles and insights.
Disclosure: I am/we are long BLK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
