Investment manager Federated Investments, Inc. (NYSE:FHI) reported second-quarter earnings, and for the most part, the results were pretty good. The highlights:
- Earnings per share of $0.40, up 14%, and ahead of Wall Street estimates.
- Equity assets up 10% to a record $55 billion.
- Total managed assets fell slightly, due to a decline in fixed-income and money market assets.
Federated has long counted on money markets for a major portion of its business, but during the past several years, the company has taken major steps to diversify into more equity and fixed-income investment offerings. This was due to the extremely low interest rate environment.
The company now counts on equity and fixed income for more than two-thirds of revenue. Until the rate environment fully shifts, that's a necessary step, and it's a good thing Federated started taking it a few years back.
Let's take a closer look at the details from the quarter. There are some key metrics that will give you a better understanding of Federated's results and prospects.
money market business continues to shrink, but that's not really a bad thing
Historically speaking, Federated is known for its money market offerings, but declining interest rates and serious legislative challenges turned the tide against money markets a few years back. Luckily, the company began expanding alternatives like equity and fixed income a few years back in response. Since 2010, the company has shifted from collecting half of its revenues from money markets to 31% last quarter. Equity assets, on the other hand, generated nearly half of revenue -- 48% -- last quarter.
During the past several years, Federated has had to regularly issue money market fund fee waivers in order to keep funds at a neutral or positive yield, versus historically -- in a more normal historical interest rate environment -- being able to count on money market funds to generate higher profits. Unfortunately, that's still not the situation; but it's improving.
Money market fee waivers decreased in the quarter, and are lower so far this year than last. This is partly because of a drop in assets, and to a lesser degree, an improving interest rate environment. The falling money market assets are also helping increase revenue. The company said that the 6% increase in sales so far this year is primarily due to the decrease in fee waivers.
Here's a comparison between this year and last year's fee-waiver impact:
As you can see, the company issued what netted out to $59.3 million in fee waivers the first half of 2014 versus $49.2 million so far this year. That's roughly $10.1 million in additional revenue gained this year via reduced fee waivers of 41% of this year's revenue growth.
Equity assets are likely to remain a major revenue and profit driver until interest rates return to more historical levels.
Financial position, dividend, and stock buybacks
Cash and debt remained essentially unchanged in the quarter, with $300 million in cash, and $204 million in long-term debt. The company also announced that it repurchased 317.747 shares during the quarter, for a total of $10.5 million. That's good for about $33.05 per share, a slight discount to recent prices. That works out to about a 0.3% reduction in shares outstanding, a similar amount to what it did in the first quarter.
The company's stock incentive program has been the major source of dilution during the past decade, costing $62.4 million during the past three years, and having added 27.1 million new shares outstanding since inception. The current buyback rate is about double the cost of dilution during the past three years.
Federated also announced a $0.25 per-share dividend, the same as has been historically paid every quarter for a number of years. The company does occasionally pay a special dividend, last paying one in 2012. But it's unclear when that will happen again.
Looking ahead: Rising rates good for business?
With the Fed expected to begin rising interest rates late this year, there's a solid chance that the money market business could finally begin improving. And as much as Federated has grown its equity business, money markets are still incredibly important to the company. After all, even after all the growth in equity assets under management, the $55 billion in assets are still dwarfed by the $242 billion in money market assets.
In short, the eventual swing should be a major boon for Federated, but it's still unclear when that will finally happen. For now, the growth in equity assets will continue to drive profits.