T. Rowe Price Holds Steady

Hey, Fools! Seeing that it's earnings season again, you may have noticed that we've reshuffled the writer schedule this week in Makerland. Today, I'll be covering the earnings releases of T. Rowe Price (Nasdaq: TROW) and Schering-Plough (NYSE: SGP) by walking through as many of our Rule Maker Criteria as possible.

Let's hit T. Rowe first. Although this is going to sound like a broken record, our company yet again turned in another excellent quarter as the company continues to ride the strong market and accumulate more assets under management. In addition, the company announced that it will be acquiring the 50% of international joint venture Rowe-Price Fleming that it didn't own. This came about as a consequence of Chase Manhattan's (NYSE: CMB) acquisition of Robert Fleming Holdings, the U.K. company that owned the other half of the venture. More on the acquisition in a moment.

Revenues for Baltimore-based T. Rowe Price increased to $316.3 million, a 28.7% increase over the previous year. While that is very impressive growth, it is not quite as good as it sounds, since $21.3 million of those revenues came as investment income, which is a 272% increase over the income from investments in the first quarter of 1999. The company's growth in investment advisory fees, which represents T. Rowe's bread and butter, were $234 million in the quarter, up 22.7% from the previous year. While that's not quite as impressive as the total revenue growth rate, if this company can grow revenues at 20%, then EPS gains in the 30-40% range are the usual outcome due to the scaling capabilities inherent in the mutual fund business.

T. Rowe's expenses increased 23.2% in the quarter, primarily due to a heavy increase in marketing. The company noted in the press release that marketing for the mutual fund industry is quite seasonal, and that it peaks in the fourth and first quarters, as the company attempts to gain name recognition for the retirement account business that typically comes in those quarters.

Net income jumped 40.5% to just over $75 million, and net margin jumped by 200 basis points to 23.7%, versus the 21.7% the company posted in Q1 '99. T. Rowe reduced the diluted share count by just over 1% during the past 12 months, which helped juice diluted earnings per share to $0.58, a 41.5% jump from last year. These solid earnings encouraged management to raise the dividend 30% to $0.13 per share for the quarter.

Finally, assets under management (AUM), which is our key leading indicator, increased to $185.2 billion from $179.9 billion the previous quarter -- a 2.9% sequential increase. That's equivalent to an 11.6% annual increase, though our experience with T. Rowe suggests that this number will never show smooth increases from quarter to quarter, but will jump around a lot depending on market conditions and inflow/outflow activity in the funds.

Unfortunately, most of that $5.2 billion increase in AUM comes from asset appreciation rather than net inflows. Only $173 million came into the company in the form of net new sales, a tiny fraction of the total. This is becoming a concern, because absent new money coming into the funds, T. Rowe will have to continue to rely upon market appreciation to grow assets. Even so, as long as overall AUM continues to inch upward over time at an average of 10% or so per year, the company should be able to put up consistently good EPS growth of 15% or better.

Turning back to the acquisition of the other 50% stake in Rowe-Price Fleming, I consider this a major move, but one that the company pretty much had no choice but to do as a result of Chase's buyout of Robert Fleming. Chase Manhattan represents a competitor to T. Rowe, and the company couldn't simply wave good-bye to the $21.4 billion in assets under management that the 50% ownership represents, especially since they would have been giving those assets to a direct competitor.

T. Rowe paid $780 million in cash for the remaining stake in Rowe-Price Fleming. That amount represents a premium compared to the market price of the assets T. Rowe Price currently has under management. By my calculations, T. Rowe is receiving about $27.40 in AUM for each acquisition dollar. This compares to the $37 or so in AUM that you and I get for each dollar that we invest in the company at current prices (assuming that we pay the current market cap of $4.9 billion for the $185.1 billion that T. Rowe Price currently has under management).

This acquisition is expected to be dilutive to GAAP (Generally Accepted Accounting Principles) earnings in the near-term, but will in fact likely be accretive to cash flow due to the amortization of the non-cash goodwill charges that will result. The other significant impact of the acquisition is that T. Rowe will take on some debt in order to finance the $780 million purchase price, and of course one would also expect to see the $438 million in cash currently on the balance sheet to be reduced substantially. Therefore, T. Rowe's cash-to-debt ratio will be a point of interest for us next quarter.

While initially rising on the earnings news, T. Rowe gave up some of those gains after Prudential Securities downgraded the stock. While I haven't read the report, I can kind of understand the concern given the following factors: 1) the acquisition will reduce EPS in the short-term; 2) the nasty downside volatility in the Nasdaq this quarter will likely impact assets under management due to a likely increase in redemptions and the lack of enthusiasm for the stock market in general compared to previous periods; and 3) the trickle of new fund inflows.

Fortunately, we in the Rule Maker portfolio don't have to worry about whether T. Rowe will outperform in the next six months. The biggest concern, as it has been since we originally purchased our shares in T. Rowe, is the company's ability to grow assets under management going forward given the tiny net inflows in recent quarters. Although the acquisition introduces some dynamics that will bear watching, overall T. Rowe's quarter was steady as she goes.

Meanwhile, the good folks over at Schering-Plough turned in a nice quarter, with sales rising to $2.4 billion in the quarter, just meeting our 10% target for sales growth. Sales were driven by old faithful Claritin, which rose 18% to $665 million, and Intron-A, which grew 23% to $336 million. Due to a slight increase of pharmaceuticals in the sales mix and good cost control, gross margins for Schering increased to 81% from 80.3% last year.

Despite the 15% increase of research and development expenses to $290 million in the quarter, net income grew to $628 million, a 17% increase over last year, and net margin improved to 26.1% from 24.7% in the first quarter. Diluted EPS was also up 17% to $0.42 a share.

In addition, the company raised the dividend during the quarter by 12% to $0.14 per share. While dividend income is somewhat of an afterthought to us, dividends do matter over a 20-year time horizon, and I personally like to see dividends going up every year. The most recent dividend increase was the 17th time the company has raised a quarterly dividend since 1986. Unfortunately, Schering-Plough didn't provide any balance sheet information or cash flow data in the press release, so we'll have to wait for the 10-Q in about a month from now before we see how well the company did on a cash flow basis, which is of interest to us considering the relatively flat three-year trend I discussed when I last looked at the company.

That's about it for today. I'll be back two Fridays from now to continue our look (finally!) at Adobe and move on in our software industry study. Tomorrow, Bill will be stepping in to go over Nokia's (NYSE: NOK) earnings, which were reported today. (Here's the earnings release.) Until then, y'all stay Foolish!

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