Ashmore: 66% Margins And £547m Net Cash

11 March 2015
By Maynard Paton

Today I’m continuing my hunt for Watch List shares with a look at Ashmore (ASHM).

Here are the initial attractions that prompted this research:

Majestic financials: Accounts showcase 66% average margins and £547m net cash and investments
Hefty insider ownership: Founder/chief exec enjoys £808m shareholding
Interesting valuation: The shares offer a trailing dividend yield of 5.9%

As usual, I’m applying a question-and-answer template to help me pinpoint companies that match the criteria set out in How I Invest. I’m looking for as many Yes answers as possible.

Activity: Fund manager specialising in emerging-market debt
Website: www.ashmoregroup.com
Share price: 280p
Shares in issue: 707,372,473
Market capitalisation: £1,981m

Does the business boast a respectable track record?

Yes.

ASHM was established in 1992 as part of the Australia and New Zealand Banking Group. Senior management completed a buy-out in 1999 and the firm joined the stock market during 2006.

Between 2003 and 2014, ASHM’s funds under management (FUM) ballooned from $3bn to $75bn, which in turn took annual revenue from £21m to £263m and operating profits from £11m to £165m.

ASHM has suffered two setbacks as a quoted company. The banking crash caused reported earnings to drop 19% during 2009, while a combination of adverse currency movements, lower FUM and minimal performance fees prompted earnings to drop 33% during 2014. Half-year results for 2015 (see later) revealed FUM dropping further.

Overall, the last five financial years have witnessed somewhat mixed financial progress:

Year to 30 June20102011201220132014
Management fees (£m)192.1250.9302.6316.0283.1
Performance fees (£m)82.985.425.433.43.1
Other revenue (£m)6.46.56.26.27.9
Total revenue (£m)281.4342.8334.2355.6294.1
Distribution costs (£m)(2.2)(1.6)(3.7)(4.8)(4.6)
Foreign-exchange movements (£m)7.0(7.4)2.84.7(26.6)
Net revenue (£m)286.2333.8333.3355.5262.9
Operating profit (£m)209.3239.4225.9228.3165.0
Other items (£m)--(0.8)3.62.8
Finance income (£m)7.96.518.125.72.5
Pre-tax profit (£m)217.2245.9243.2257.6170.3
Earnings per share (p)23.8728.0826.8229.9819.29
Dividend per share (p)13.0014.5015.0016.1016.45

Two factors have curtailed ASHM’s progress of late.

First, performance-related fees have dropped considerably.

Second, management fees as a proportion of FUM have been falling consistently:

Year to 30 June20102011201220132014
Management fees (£m)192.1250.9302.6316.0283.1
Management fees ($m)298.1398.1475.3487.9454.6
Average FUM ($bn)31.346.063.972.275.2
Management fee rate (basis points)9586746860

Both of these factors lead me to believe clients may have become a bit disgruntled with their ASHM-run portfolios.

So this next table is interesting — it shows exactly how ASHM has grown its FUM from $24.9bn to $75.0bn between 2010 and 2014:

Year to 30 June20102011201220132014TOTAL
Start FUM ($bn)24.935.365.863.777.4
Performance ($bn)2.85.1(3.4)0.35.19.9
Net client subscriptions ($bn)7.625.4*1.313.4(7.5)40.2
End FUM ($bn)35.365.863.777.475.0

(*includes $9.7bn acquired)

My sums indicate an average FUM base of $45bn over the five years has produced an aggregate investment performance gain of $9.9bn — equivalent to an average annual return of just 4%. I am not sure what returns ASHM’s clients expect from emerging-market debt, but that 4% figure does not look great to me.

At least the dividend has never been cut since the flotation. There have been no exceptional items, too.

Has the business grown mostly without acquisition?

Yes.

ASHM has acquired just one business since the flotation. During 2011, the group acquired an emerging-market equity fund manager with $9.7bn FUM for about £75m.

Has the business mostly self-funded its growth?

Yes.

The latest balance sheet displays share capital of £16m versus earnings retained by the business of £615m.

Does the business possess an asset-strong balance sheet? 

Yes.

At the last count, cash was £386m, various investments came to £161m while debt was zero.

There are no defined-benefit pension obligations.

Does the business convert profits into free cash?

Yes.

Year to 30 June20102011201220132014
Earnings (£m)160.0189.0181.5202.2130.8
Equity dividend paid (£m)(82.2)(93.4)(101.0)(105.2)(112.5)
Increase in cash and investments (£m)92.447.131.683.4(25.4)
Cash and investments (£m)413.0460.1491.7575.1549.7

The last five years have seen aggregate reported earnings of £864m, of which £494m has been distributed as dividends.

Of the remaining £370m, a mighty £229m has then found its way to ASHM’s cash hoard and investment portfolio.

The rest — £141m — went mostly on paying dividends to minority subsidiary investors (£19m), that acquisition (£58m) and extra tax (£18m). A further £29m was lost due to adverse currency movements.

Something to note: One remarkable feature of ASHM’s accounts is that the business required plant, property and equipment of just £3m to produce operating profits of £165m during 2014.

Does the business enjoy a competitive advantage?

Maybe.

Fund-management companies aren’t renowned for durable competitive advantages. Instead, FUM is attracted or withdrawn based on investment results — which as we all know can fluctuate! For what it is worth, here’s an extract from ASHM’s 2014 annual report summarising its approach:

Ashmore’s investment processes combine global and domestic teams, and macro views with deep analysis of individual investments. The result is successful long-term track records across its Emerging Markets investment themes.

Disciplined investment committees take a long-term, specialist approach and manage portfolios actively so as to access the full range of opportunities available within the large and diverse Emerging Markets asset class. Funds are managed by investment teams and there is no promotion of a star manager culture.

One operational advantage ASHM does enjoy is incredible economies of scale.

Operating margins have averaged a stratospheric 66% during the last five years, in part due to staff members being able to handle greater FUM…

Year to 30 June20102011201220132014
Average FUM ($bn)31.346.063.972.275.2
Number of employees152182251280290
FUM per employee ($m)205.9252.7254.6257.9259.3

… and a lid being kept on staff costs as a proportion of total revenue.

Year to 30 June20102011201220132014
Total revenue (£m)281.4342.8334.2355.6294.1
Employee cost (£m)(58.8)(71.5)(73.0)(82.3)(66.1)
Employee cost/total revenue (%)20.920.921.823.122.5

I am pleased the majority of staff costs are ‘variable’ and are determined as a percentage (20% of late) of annual profits.

Does the business produce a respectable return on equity?

Yes.

Return on average equity for 2014 was £133m/£639m = 21%. Strip out the cash and investments from the equity base and the 2014 calculation tops 100%. My sums indicate similarly eye-popping numbers for earlier years.

Does the business employ capable executives?

Yes.

Mark Coombs led the aforementioned management buy-out in 1999 and has since overseen ASHM’s progress as chief executive. Mr Coombs is in his mid-50s, so succession plans are not an obvious requirement at present.

Does the business employ good-value-for money executives?

I think so.

Since ASHM’s flotation Mr Coombs has received a £100k basic salary  — a very low wage for a FTSE 350 chief exec. However, Mr Coombs has collected bonuses totalling a substantial £22m during the same time. I am pleased no bonuses were declared during the ‘setback’ years of 2009 and 2014.

Does the business employ owner-orientated executives?

Yes.

Mr Coombs boasts a 41%/£808m stake, which I trust gives him the ‘owner’s eye’ when it comes to looking after all ASHM shareholders. Plus Mr Coombs’ investment is currently delivering a £48m annual dividend, making him very much dependent on ASHM’s payout for his total income.

I am pleased ASHM’s option scheme is under control via an employee benefit trust (EBT). The EBT holds 38 million shares (5% of the share count), which will be released to employees as and when they exercise their 30 million options.

To prevent substantial share-count dilution from exercised options, ASHM regularly buys shares for the EBT. Shares worth some £146m have been pumped into the EBT during the last five years and I am happy that expense has been adequately reflected as a cost in ASHM’s income statement.

Does the business enjoy reasonable growth prospects?

Not in the short term.

Interim results published in February showed client FUM down a thumping 15%, or $11.3bn, to $63.7bn, with management fees down 11% to £135m. Operating profits would have slumped 23% to £84m, too, were it not for favourable currency movements actually lifting them to £105m.

The sole figure heading in the right direction was the dividend, up 2%.

The FUM performance loss of $6.2bn experienced during the six months was considerable when recalling the aforementioned $9.9bn performance gain registered during the previous five years:

5 years to 30 June 20146 months to 31 Dec 2014
Start FUM ($bn)24.975.0
Performance ($bn)9.9(6.2)
Net client subscriptions ($bn)40.2(4.5)
Disposal ($bn)-(0.6)
End FUM ($bn)75.063.7

Within February’s results, Mr Coombs admitted some large client investments in Russia were not working out as expected:

High conviction positions in countries such as Russia, where asset prices fell as sentiment deteriorated during the period, caused some mark-to-market underperformance against the benchmark index, and a bias towards higher yielding and longer duration assets also detracted from relative performance.

Nonetheless, Mr Coombs reckoned the situation within emerging markets generally should be seen as a buying opportunity:

Ashmore enters 2015 with Emerging Markets asset prices at attractive levels after nearly two years of challenging market conditions. Fixed income spreads are wider than at any time since the onset of the global financial crisis and consistent with tighter US monetary conditions than are likely to be seen this year. Similarly, equities continue to offer attractive value across a broad range of Emerging and Frontier markets. This is a favourable backdrop for Ashmore’s value-based investment processes to establish positions in order to deliver longer-term performance for clients.

Whether clients take the same view is of course a different matter.

ASHM also confirmed only 56% and 37% of its FUM were outperforming their relevant benchmarks over three and five years respectively. I must admit, those figures do not look that great for attracting new clients.

Does the share price stand a good chance of becoming a bargain?

I think so.

I’ve calculated ASHM’s enterprise value (EV) to be its £1,981m market cap less its cash of £386m and less its investments of £161m… but plus the group’s regulatory required capital of £73m.

That gives a total of £1,507m or 213p per share.

Assuming i) FUM stays at $63.7bn, ii) the management fee rate remains at 60 basis points, and; iii) £1 continues to buy $1.50, I reckon annual management fees could now be running at £262m.

Assuming no performance fees are collected and other costs remain the same, I reckon operating profits could be £166m and earnings might be around 18.5p per share.

The potential P/E on my EV and EPS calculations is therefore 213p/18.5p = 11.5. The trailing 16.55p dividend supports a decent 5.9% income, too (although the dividend is not covered well by my EPS estimate).

Those ratings do not look expensive to me.

That said, ASHM has not really traded at nose-bleed multiples in the recent past. My sums indicate the 433p share-price high reached in May 2013 was equivalent to an EV-based P/E of 16. The dividend yield at the top was a reasonable 3.5%, too.

During the banking-crash lows, however, I recall the shares traded close to 100p — equivalent to about 6 times profits and an 11% yield.

So you could argue the current ratings are somewhat in the middle-ground.

Is it worth watching Ashmore?

Yes.

ASHM offers three important features for me — the presence of a founder-entrepreneur at the helm, some very impressive accounts and a share-price rating that may already offer reasonable value.

Long-term outperformance will require ASHM’s investment managers to improve their returns for existing clients — and then attract more clients and FUM. ASHM has a 20-year record of investing and my gut feel is that the company is undergoing temporary rather than permanent difficulties.

That said, there is nothing to stop ASHM’s portfolio managers losing more ground to their benchmarks and its FUM shrinking even further. And even if FUM does stabilise, ASHM’s revenue may still contract as clients demand further fee cuts.

Anyway, I’ve always found the very best time to buy fund managers is when their FUM and/or the wider markets are depressed and their share prices are on the floor. Clearly some clients have become fed-up with ASHM and have jumped ship, but I don’t think the share price has become overly disillusioned just yet.

Indeed, I have seen ASHM (and fellow emerging-market fund manager City of London Investment) trade on single-digit P/Es during rough times before… and rough times will one day return. So for now I am minded to await a single-digit P/E at ASHM before contemplating any investment.

Maynard Paton

Disclosure: Maynard does not own shares in Ashmore.

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