Legg Mason Outshines Estimate - Analyst Blog

Legg Mason Inc.'s (LM) third-quarter 2011 earnings of 73 cents per share significantly outpaced the Zacks Consensus Estimate of 43 cents. Reported quarter results included 10 cents per share in transition-related costs and 4 cents per share of costs related to a closed-end fund launch.

Earnings outpaced the prior-year quarter by 16 cents. Results improved due to higher revenue, offset by higher operating expenses coupled with a decline in total assets under management (AUM).

Adjusted net income came in at $110.3 million compared with $115.0 million in the second quarter of 2011 and $93.2 million in the year-ago quarter. Including one-time expenses, net income was $61.6 million.

Quarter in Detail

During the reported quarter, Legg Mason's total revenue was $721.9 million, up 5.0% year over year due to an increase in performance fees and augmented advisory fee yields attributed to favorable asset mix.

On a sequential basis, revenues were up 7.0% due to increase in average AUM, improved advisory fee yield, which resulted from favorable asset mix and elevated performance fees. Revenues also surpassed the Zacks Consensus Estimate of $699.0 million.

Investment Advisory fees increased 5.7% on a year over year basis and 7.6% sequentially to $625.1 million. Distribution and Service fees decreased 2.5% year over year, but increased 3.5% sequentially to $95.5 million. Other revenues were up 1.6% sequentially, but declined 7.0% to $1.3 million on a year-over-year basis.

GAAP operating margin of Legg Mason improved to 13.4% from 13.0% in the prior quarter and 11.5% year over year. The decline was attributed to higher operating expenses that augmented 6.0% sequentially and 2.0% on a year-over-year basis. Expenses included $10.2 million of costs related to the launch of the closed-end fund in the quarter coupled with $24.0 million of transition-related costs related to the reformation initiative.

As of December 31, 2010, Legg Mason's AUM was $671.8 billion, down 0.3% sequentially from $673.5 billion due to net outflows of $16.7 billion, significantly offset by market appreciation of $14.8 billion. On a year-over-year basis, AUM was down 1.0% from $681.6 billion. Fixed income represented 53% of consolidated AUM as of December 31, 2010, liquidity represented 20% and equity comprised 27%. 

During the quarter, fixed income outflows were approximately $12.9 billion, liquidity outflows were $0.5 billion and equity outflows were $3.3 billion. Total client outflows increased to $16.7 billion from $12.7 billion in the second quarter of 2011. Besides, average AUM was $672.4 billion, up 2.1% from $658.6 billion in the prior quarter, but declined 3.0% from $693.3 billion in the year-ago quarter.

As of December 31, 2010, Legg Mason had approximately $1.3 billion in cash, in line with the prior quarter, while total debt was $1.4 billion, flat sequentially. Shareholders' equity was $5.8 billion. The ratio of total debt to total capital (total equity plus total debt excluding consolidated investment vehicles) was also 20%, in line with the second quarter of 2011.

Share Repurchase and Dividend Update

As of December 31, 2010, the company had repurchased and retired 12.6 million shares of common stock over the previous three quarters. In the third quarter of 2011, Legg Mason completed additional open market purchases of 1.2 million shares.

Legg Mason's board declared a quarterly cash dividend of 6 cents per share on its common stock. The dividend is payable on April 11, 2011 to shareholders of record as of March 10, 2011.

Performance by Competitors

In Legg Mason's peer group, Charles Schwab Corporation's (SCHW) earnings as of December 31, 2010 came in at 18 cents per share, substantially ahead of the Zacks Consensus Estimate of 10 cents. The results benefited from improved revenue and increase in interest-earnings assets. However, rise in non-interest expenses and decline in trading revenue were the downside.

Our Take

Though near-term challenges remain with slow economic recovery, we believe Legg Mason has the potential to outperform its peers in the long run, given its diversified product mix and leverage to the changing demographics in the market. Additionally, with the restructuring initiatives and the cost-cutting measures, we expect operating leverage to improve while share buybacks to inspire investors' confidence on the stock.

The company claims to have been able to pave a recovery path for fiscal 2011, given the early signs of economic recovery and improvement in business sentiments. A sound cash position against a risk-free balance sheet will also provide ample leverage coupled with its restructuring initiatives.

Legg Mason currently retains its Zacks #3 Rank, which translates to a short-term Hold rating. Considering the fundamentals, we are maintaining a Neutral recommendation on the stock.

 
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