Guest post: Franklin Resources – Valuation and Dividend Safety Analysis.
Today a guest post by Dividend Power on Franklin Resources (BEN).
Franklin Resources Overview
In this article I present a valuation and dividend safety analysis of Franklin Resources (BEN). The company is an asset manager that focuses on active mutual funds. It traces its roots back to 1947. The main interest for some investors is the high forward yield of ~4.4%. The company also qualifies as a dividend growth stock. In fact, it is a Dividend Champion having raised the dividend for 40 consecutive years. The company is also a Dividend Aristocrat since it is in the S&P 500. The stock is trading at a depressed valuation due to its difficulties in growing assets under management or ‘AUM’ and declining fees. But still, some investors may want to research this stock further for income.
Before I present the valuation and dividend safety analysis, let’s first discuss Franklin Resource’s business. The firm provides its services globally to individuals, institutions, pension plans, trusts, and partnerships. Franklin Resource’s funds are marketed under the Franklin, Templeton, Mutual Shares, Bissett, Fiduciary, and Darby brands.
At the end of January 2020, the form had AUM of approximately $688B. Of this about 40% is in equity funds, 20% in multi-asset or balanced funds, 39% in fixed income funds, and the remainder in cash. Roughly 42% of AUM is in global or international funds with the rest in US funds. Most asset managers in the US tend to have a much larger proportion of US funds. Notably, the company is still run by its founding family with Greg Johnson in the Chairman and CEO role and his sister Jennifer Johnson as the President and COO. Their father held the Chairman and CEO role earlier. Their uncle is the Vice-Chairman and another brother is a director. The Johnson family controls roughly 40% of the voting shares.
Franklin Resources Is Having Trouble Growing Revenue
Franklin Resources has struggled with top line and bottom-line growth since 2014. In fact, companywide revenue, operating income, and net income have declined since then. Gross margins, operating margins, and profit margins have also trended down since 2015 as cost cuts have not kept up with the decline in revenue. Active asset managers, such as Franklin Resources, are facing significant industrywide headwinds resulting from the rise of passive investing. Increasingly, retail and institutional investors are migrating to index funds due to their very low costs and ubiquity.
Fund costs are a penalty on investor returns. From this perspective, index funds have an advantage. They track the benchmark index, so costs are minimal. In addition, there is seemingly an index fund for almost any basket of stocks. So, investors can get exposure to large areas of the market with little expense. There are some asset managers that have bucked this trend, but Franklin Resource is not one.
The company’s AUM has declined or at best remained flat year-to-year. Good years have been from market appreciation as opposed to net inflows, which have been negative. But the industry is also facing industrywide fee compression, particularly for equity funds. This has also contributed to lower revenue.
The problem has been compounded by relatively poor fund performance. Franklin Resources’ funds tend to be in the bottom half of their peer groups over the trailing 1-year, 3-year, and 5-year time periods. The funds do better over the trailing 10-years, but recent fund performance is arguably negatively impacting AUM. Ultimately, good fund performance will drive gains in AUM.
The market has punished Franklin Resource’s stock price, which is down over (50%) from the all-time high set in 2014 and is now trading at ~$24.36 (as of this writing). Additionally, the stock is trading near its 52-week low and is well-below its 52-week high. For most asset managers the stock price is tied to AUM and market performance. However, there is probably no easy way to turn around revenue declines in the face of industry changes and fee compression. But with that said, Franklin Resources remains profitable and still pays a good dividend.
Abercrombie & Fitch Dividend Safety
Let’s now examine the dividend safety of Franklin Resources. From the perspective of earnings, the dividend is well covered. Consensus FY 2020 EPS is $2.58, and the annual dividend is $1.08 per share giving a payout ratio of ~41.9%. This is a good value and well below my criteria of 65%. The trend though is for the payout ratio to increase for Franklin Resources. Note that the payout ratio was below 20% for years and only been above that the past few years. If earnings continue to decline and the dividend keeps inching up, then the payout ratio will approach my threshold value in a couple of years.
The dividend is not covered by free cash flow in the past two years. In FY2019, operating cash flow was $201.6M and capital expenditures were $233.7M giving free cash flow of ($32.1). The dividend required $518.6M, which means that the company needed to use debt or cash on hand to pay the dividend.
Share buy back
Franklin Resources is also repurchasing shares at a fairly rapid clip. In 2019, this totaled $754.5M so this means again that the company is using cash on hand or debt to finance the buybacks. Note that FCF barely covered the dividend in FY2018. Operating cash flow was $2,229.7M and capital expenditures were $106.5M giving FCF of $2123.2M. But the dividend required $496.8M giving a dividend-to-FCF ratio of ~23.3%. This seems good and it is better than my threshold of 70%. However, stock buybacks were $1,424.8M and a special dividend of $1,620.1M needs to be included in this calculation, which leads to poor coverage by free cash flow.
Debt is a bright spot right now since the company has a net cash position. The company has long-term debt of only $696.6M at end of FY 2019. This is offset by $5,847.6M in cash and cash equivalents on hand. But this is trending down since 2017. Interest coverage is excellent at about 60X. Debt doesn’t currently place the dividend at risk.
Franklin Resources’ Valuation
Franklins Resource’s is trading at a depressed valuation of 9.5X forward earnings. This much lower than the S&P 500’s average of ~25X at the moment. The current valuation is also lower than the trailing average in the past decade. But of course, there is a reason for this as revenue and margin declines have been persistent for several years. It is tough to say that the stock is a bargain despite trading at a low multiple. There is seemingly no easy way to turn around the revenue and margin declines in the face of industry headwinds for active asset managers.
Final Thoughts on Franklin Resources
Franklin Resource’s yield is attractive. At approximately 4.4% it far exceeds that of the broader market. It is also higher than that of many conventional income stocks. But Franklin Resources is facing industrywide headwinds that is negatively affecting AUM and thus revenue and margins. This has led to declining earnings. The company has little control over this and seemingly has not found a way to reverse the trend. The dividend is a mixed story of being well covered by earnings but not free cash flow. If the revenue and margin trends continue, then the dividend may not be safe over the long-term.
TAGS: Dividend Stocks, Dividend Growth, Dividend Champion, Dividend Aristocrat, BEN
BIO: Dividend Power is a blogger on dividend growth stocks and personal finance. Dividend Power publishes analyses on Seeking Alpha. He is currently is in the top 10% out of over 7,100 financial bloggers as tracked by TipRanks (an independent analyst tracking site). Some of his writings can be found on ValueWalk. He also works as a part-time freelance equity analyst with a leading newsletter on dividend stocks.