Legg Mason Reiterated at Neutral

We maintain our Neutral recommendation on Legg Mason Inc. ( LM - Analyst Report ) based on its strong cash position and ongoing success of its targeted streamlining plan. However, asset outflows remain a concern with aggregate net client outflows of $22.6 billion and dispositions of $20.8 billion for the nine months ended December 2011.

In January, Legg Mason reported fiscal third-quarter 2012 earnings of 55 cents per share significantly outpacing the Zacks Consensus Estimate of 27 cents per share. Including one-time expenses of $42.3 million related to the transition costs in the quarter, net income came in at $28.1 million or 20 cents per share.

Quarterly earnings were below the prior-year quarter and prior quarter’s earnings of 73 cents and 61 cents per share, respectively. Results declined on a year-over-year basis, due to lower revenue, partially muted by lower operating expenses. Moreover, reduced assets under management (AUM) were on the downside. Sequentially, benefits from AUM improved were offset by increased operating expenses.

Legg Mason has been strongly working on improving its operating efficiencies through its key initiatives that include cost cutting, innovative product solutions to client base, tapping sound investment capacities and expanding distribution relationships. In May 2010, the company announced an initiative to streamline its business model and reduce its costs. Notably, in 2011, the company completed the most significant phase of its plan.

The plan, which is scheduled to be completed in fiscal 2012, projects $140 million in expense reductions. These initiatives are expected to create value for clients and shareholders.

Moreover, Legg Mason remains committed to increasing shareholder’s wealth. The company is effectively deploying capital through share repurchase and dividend payment. The company utilized its cash by announcing a 30% hike in dividend in May 2011.

Additionally, Legg Mason completed its plan to buyback $400 million worth of common stock by the end of fiscal 2012. We expect such measures to instill investors’ confidence on the stock of the company.

On the flip side, though, during the third quarter of fiscal 2012, the financial environment in the U.S. began to recover from concerns regarding economic issues related to the European debt crisis and the unprecedented downgrade to the U.S. credit rating, overall decline in the equity markets was recorded over the nine months ended December 31, 2011.

Therefore, the current volatility in the financial markets along with the government regulations increases the chances of interest rate fluctuations in the funds business of the company. In addition to that, economic challenges are expected to linger.

However, we believe that Legg Mason has the potential to outperform its peers in the long run, given its diversified product mix and leverage to the changing market demography. Assets outflows remain a significant headwind in the near term, though trying to improve in the volatile markets.

Yet considering the restructuring initiatives and cost-cutting measures, we expect operating leverage to improve. Share buybacks will also continue inspiring investors’ confidence in the stock.

Legg Mason currently retains its Zacks #3 Rank, which translates into a short-term ‘Hold’ rating. The company’s closest competitor – BlackRock Inc. ( BLK - Analyst Report ) also retains a Zacks #3 Rank.