Franklin Resources (BEN) increased its dividend by a hefty 20% last week, continuing its dividend growth streak dating back to 1981.
This dividend aristocrat has recently fallen on hard times, causing its stock price to drop by 37% over the last year. BEN’s stock now has a dividend yield twice as high as its five-year average yield, and it trades for a forward earnings multiple of just 12.6x.
Let’s take a closer look at the business, which has several notable strengths despite the fall in its stock price.
Franklin Resources is a global investment management firm with more than $725 billion in assets under management as of 1/31/16. It provides equity, fixed income, alternative, and custom solutions to a mix of retail (76% of assets) and institutional (24%) clients located in over 180 countries. Some of its largest funds include the Templeton Global Bond Fund and the Franklin Income Fund.
Most of its products are open-end mutual funds, and the company primarily makes money by charging a fee based on a percentage of the total market value of the assets it manages.
By asset type, approximately 40% of the company’s assets under management are in equity products, 42% in fixed income, and 18% in hybrid investments. Franklin Resources’ U.S. funds accounted for roughly 67% of its assets in fiscal year 2015.
As one of the largest investment managers in the world and with an operating history dating back more than 65 years, Franklin Resources has built up significant brand value in the industry. The company has been partnering with financial advisors and brokers for distribution of its products since the late 1940s, resulting in thousands of long-lasting relationships that are advocates of its funds.
The majority of Franklin Resources’ funds have also ranked in the top-half of their peer groups over the last 3-, 5-, and 10-year periods, helping the company significantly expand its asset base over time. The firm has a particularly strong track record in the fixed income business and is also well diversified by product type and geography, adding to its moat and durability.
As one of the largest players in the industry, Franklin Resources is also able to spread its costs over a larger pool of clients to keep its costs competitive and gain economies of scale. The asset management business mostly requires people and computers, which further boosts the company’s cash flows given the little amount of capital required to run the business.
Asset managers also benefit from recurring revenue and the long term trajectory of financial markets. Clients pay asset managers a fee each year to invest their money, and most will stay with a fund manager for multiple years. Many retail investors will even set an asset allocation plan and never touch it, giving companies such as Franklin Resources a long stream of revenue.
Furthermore, clients pay more fees as the value of their accounts rises. Financial markets increase in value over long periods of time, providing free growth for asset managers as long as their performance is “good enough” to retain existing clients.
Franklin Resources’ Key Risks
Investment managers live and die on performance and brand reputation. Unfortunately for Franklin Resources, the performance of some of its largest funds has lagged most peers’ results in recent years, leading to outflows.
As a result, the company’s total assets under management have declined from $872 billion in January 2015 to $728 billion as of the end of January 2016, a decline of 17%.
Poor performing asset managers, especially those with relatively high management fees, are seeing clients leave in favor of low-cost exchange-traded funds (ETFs) that simply try to match the market’s returns.
We think this is a real threat that will continue pressuring management fees lower and forcing smaller managers to consolidate in response. Franklin Resources is somewhat better positioned than its peers because of its economies of scale and product diversification, but it only has one ETF offering today.
The company recently hired a new head of global ETFs and will soon be launching a group of strategic beta ETFs, but the firm is certainly late to the party. However, Franklin Resources has over $8 billion in cash on the balance sheet it can use on acquisitions to gain exposure to areas of growth within asset management.
How ETFs can complement existing active funds is still being figured out, but it’s clearly becoming an increasingly important topic for mutual funds to figure out.
In addition to fee pressure and client redemptions in response to poor performance and the rise of passive investment products, the company’s near-term results are subject to market risk. Many of the firm’s funds have found themselves exposed to sour macro bets such as energy, distressed debt, and Ukraine.
If financial markets were to drop further, BEN’s stock would likely fall disproportionately lower. The strong dollar is also weighing on the company’s reported results since over 30% of its assets are international.
Dividend Analysis: Franklin Resources
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. BEN’s long-term dividend and fundamental data charts can all be seen by clicking here.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
Franklin Resources’ Dividend Safety Score is 86, which suggests that its dividend payment is safer than most stocks in the market. Even despite the company’s recent weak results (sales were down 15% last quarter), its payout ratios over the trailing 12 months are a very healthy 20%. As seen below, the company’s payout ratio has been in the teens most years it did not pay a special dividend. A low payout ratio gives Franklin Resources’ dividend plenty of cushion and room for growth.
Unlike some recession-resistant dividend stocks, Franklin Resources does not fare well during times of crisis. When the economy weakens, financial markets are often hit hard. This reduces the market value of Franklin Resources’ assets under management and often results in clients pulling out their money in a flight to safety. As seen below, the company’s sales fell by 30% during the financial crisis. BEN’s stock also dropped by 44% in 2008, highlighting the heightened sensitivity that asset managers have to broader financial markets.
Franklin Resources’ dividend safety is also helped by the company’s dependable free cash flow generation. The asset management business does not require much capital to operate and is very scalable as more assets come in the door, throwing off significant cash flow.
Most blue chip dividend stocks have competitive advantages that enable them to earn high returns on their invested capital. We can see that Franklin Resources has generated a mid-teens return on invested capital most years over the last decade, highlighting the strong profitability of large asset managers.
Franklin Resources also has a pristine balance sheet with over $8.2 billion in cash compared to $2.4 billion in debt. The company’s cash easily covers the total dividends it paid last fiscal year ($666 million) and allows the company to consistently repurchase its shares, which have declined by roughly 2% per year.
Franklin Resources’ dividend is extremely safe. The company has very low payout ratios, generates reliable free cash flow, and has a large chunk of cash on its balance sheet. Even if the market declines substantially, BEN’s dividend should remain very secure.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
Franklin Resources has grown its dividend by 16% per year over the last decade and by 23% per year over the last three years. It has also rewarded shareholders with special dividends in 2014, 2012, 2011, and 2009.
The company has an above-average Dividend Growth Score of 63, reflecting its 20% payout ratio, excess cash on the balance sheet, and proven commitment to shareholders. Franklin Resources most recently increased its dividend by 20% and has raised its dividend for over 30 consecutive years, making it part of the dividend aristocrats list. We expect double-digit dividend growth to continue.
BEN’s stock trades at 12.6x forward earnings estimates and has a dividend yield of 2.1%, which is roughly twice as high as its five-year average dividend yield of 1%.
Over the last decade, the company’s operating income has increased at a 4.8% compound annual growth rate. Its earnings per share have compounded by about 9% per year over the last five years, fueled in part by share repurchases (+2%).
If the company can improve performance and stabilize asset flows, we believe BEN’s earnings can return to a mid- to high-single digit growth rate (assuming the market also continues its gradual ascent). This would imply total return potential of 8-10% per year.
Given the company’s relatively low P/E multiple, relatively high dividend yield, and healthy balance sheet, it looks cheap at first glance. However, we believe there is higher than average risk of BEN remaining a value trap given asset outflows, deteriorating performance trends, and volatile markets.
Franklin Resources’ dividend is very safe for now and even carries above-average growth prospects, but the stock’s total return over the next few years is largely a bet on the company’s ability to slow asset outflows and get its performance back on track. The broader market environment also needs to remain favorable.
We continue to prefer asset manager T. Rowe Price for our Top 20 Dividend Stocks portfolio. T. Rowe Price arguably has a stronger brand, better performance, and pays us more right off the bat with a 3.1% dividend yield compared to BEN’s 2.1% yield.