THE HEDGEYE EDGE
We think that Federated Investors (FII) is set up for upside being that its core business should experience both an increase in profitability and volume. FII is a leader in the management of money market funds, an asset class that has been out of favor for the bulk of this cycle.
However, even marginal rate hikes from the Federal Reserve would greatly improve the profitability of money funds. Secondly, cash products tend to be attractive in the latter part of the economic cycle as investors get defensive and move out of risk assets.
The company is conservatively managed with a solid balance sheet and solid free cash flow dynamics. FII pays a 3% dividend yield which ensures return on the stock as the core money fund business improves both profitability and balances.
INTERMEDIATE TERM (TREND)
The company has been waiving over $300 million in revenue on an annual basis for its clients to maintain a slight net positive yield on the $250 billion it manages in money fund assets. As short yields increase on the margin, the firm will recapture some of these forgone fees. The entire fee waiver opportunity is $0.50 per share in earnings and with current annual baseline earnings at $1.50 per share, this creates potentially growth of over 30%+.
There are few financial companies that are as asset sensitive as FII and, given this earnings trajectory, we think that makes the stock appealing into 2016 and 2017.
LONG TERM (TAIL)
Over the past 7 years, more than $1 trillion has been redeemed in money funds and reallocated to stock and bonds, sourcing the big bull market in risk assets. With the economic cycle eclipsing 72 months, we think it is time to get defensive.
In addition to improved profitability from even marginal rate hikes, this $1 trillion becomes a longer-term opportunity for all money fund markets as investors reallocate and back out of risk assets in the latter stages of this market/economic cycle.
With roughly 9% market share in industry money fund assets, FII will recapture these funds as they come back out of stock and bond markets. We have modeled +$200 billion in positive money flow for the money fund industry in 2016 and +$400 billion for 2017. This assumption reflects some conservatism allowing for some funds to remain outside the money fund channel.