The Fairfax press is reporting that analysts at investment bank Credit Suisse have slapped a $26 share price target on international equities manger Magellan Financial Group Ltd (ASX: MFG).
Part of the basis for the upward revision to the share price target is reportedly the strong retail fund inflows that Magellan is now attracting to its global equities and infrastructure-focused managed investment schemes. Aside from the sine qua non of investment performance, the key earnings driver for mid-sized fund managers is net fund inflows as revenues are earned as a percentage of total funds under management (FUM).
Magellan has a top track record of growing FUM over the last five years via institutional business development initially, although now it's consistently cranking retail FUM flows thanks in part to new distribution agreements. It now has healthy relationships with platform providers such as AMP Limited (ASX: AMP) and the financial advice businesses of the likes of Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC).
Frank Casarotti as Magellan's head of retail distribution is well connected as a former Colonial First State employee and Magellan's success in widening its distribution network is reflected by retail inflows that have consistently hit around the $200 million+ mark during 2016.
Ironically, Magellan is now largely taking advantage of investor demand for products that the big banks declined to adequately develop themselves several years ago. This demonstrates the advantages investors can gain in owning shares in nimble, founder led and innovative fund managers that can move quickly to capitalise on investor demand for new products or asset classes such as exchange traded funds or income-generating and infrastructure-focused funds.
Moreover, as a young founder-led business Magellan retains a tight control over its key overhead in total employee remuneration and employee recruitment. This means it enjoys excellent operating leverage and high margins thanks to its low cost-to-income ratio, while offering a strong focus on shareholder returns thanks to the alignment of the employees and investors' interests. This is in stark contrast to other (unnamed and uninvestable) ASX-listed fund managers with little cost discipline or focus on the long-term performance of the overall business.
Outlook
Surprisingly, I was able to buy Magellan shares for $21.21 on October 6 when they offered a fully franked trailing yield of 4.2% on around 18x trailing earnings. Analyst coverage of the business is surprisingly limited and mixed at best, with some predicting falling earnings and dividends in financial year 2017 on the back of varying performance fees.
On a short term basis, given FUM has already lifted 4.5% in the first quarter of FY17 with a reasonable expectation for more healthy inflows and a stronger US dollar in the first six months of calendar year 2017, I expect it will marginally beat FY16's profit thanks to some tight cost controls despite the unknown of gross performance fees.
However, as an investor I prefer to look to the long term and believe there's little to stop Magellan going on to double its FUM to say $85 billion over a five-year plus time horizon. In September 2011 it had just $2.6 billion under management and it now has a far bigger reputation, networks, and operational capability as the foundations for more long-term success. This means the stock is probably still good value at around $22.35 today, especially if you're smart enough to take a long-term view.
