Franklin Resources (BEN) reported a decent earnings result this morning for its FY Q2 2017 quarter. The $1.6 billion top line result was inline with consensus however EPS was markedly better than expectations at $0.74 per share versus Street estimates at $0.67. Franklin continues to whittle down its expense base with year-over-year OPEX guidance now moved down to -3% year-over-year, which we outlined in our recent Black Book deck as a factor to be involved with the stock on the long side. In addition, Franklin investment flows continued to improve both sequentially and year-over-year with redemptions totaling -$11.0 billion in the quarter, compared to -$20.8 billion last year and -$14.4 billion last quarter. BEN stock continues to rise on "less bad" operating results assisted by cost cuts but we think the next leg of upside will be driven by performance and an improved operating environment for active asset managers outlined in our enclosed research deck.
We think BEN is experiencing an underappreciated performance revival with asset weighted Morningstars for its Top 100 funds up 1 full notch. This has historically resulted in a +50% improvement in flows within 6 months. Importantly, the firm's flagship Global Bond product has regained its 5 star rating, which should mean that outflow trends will improve.
With correlations in the S&P 500 and the MSCI World Index crashing to decade lows, active managers are entering a window where they can outperform benchmark. Looking at a time series of rolling 65 day correlations and the Barclay's Hedge Index (inverted right axis), shows active performance prospers in these environments.
A Franklin long position has a few outs if performance doesn't continue to improve and with $12 per share in net cash and $2 billion in annual free cash flow, the firm has great opportunities for strategic M&A, share repurchases, and dividend increases. We ran the proposed synergies on a Franklin/Invesco deal which would be +9% accretive to Franklin on a $40 per share proposed deal for IVZ.
Please let us know of any questions,
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
