Invesco Downgraded to Underperform

We have lowered our recommendation on Invesco Ltd. ( IVZ - Analyst Report ) to ‘Underperform’ from ‘Outperform’ based on the volatile capital markets and continuously rising operating expenses. However, the company’s first-quarter results were in line with the Zacks Consensus Estimate aided by growth in revenue, offset by higher non-interest expenses.

Increasing operating expenses remains a concern for Invesco. Though a reverse trend was seen in the third and fourth quarter of 2011, operating expenses have been on the rise in the last few quarters primarily due to higher compensation costs. Though the company has adopted a prudent approach to reduce its costs over the last few years, the impact is not expected to be felt in the near term.

Despite the economy showing signs of recovery, the volatility in financial markets is expected to continue, which in turn could limit the upward potential of the share price in the near-to-medium term. We saw some effect of the volatility during the last few quarters as redemptions increased. Investors’ confidence is expected to get hampered by the substantial rise in Invesco’s long-term net outflows

Moreover, significantly high debt level could restrict Invesco from procuring additional finance for working capital, capital expenditures, acquisitions, debt service requirements or other purposes. Also, the company could further get exposed to unfavorable economic and industry conditions, which, combined with its high debt obligation, might drag it to a relatively disadvantageous position.

However, not everything is bad about this asset management company. Invesco’s core business trends are witnessing gradual improvement. Also, over the last several quarters, the company has significantly improved its asset diversification, distribution, investment performance and profitability, both organically and inorganically.

Further, Invesco is an asset for yield-seeking investors. In April, the company hiked its quarterly dividend to 17.25 cents per share, an increase of 41% from the prior-quarter level. Also, during the first quarter, the company repurchased $75.0 million worth of shares. The increased capital deployment activities are expected to boost investors’ confidence in the stock.

Overall, Invesco is well-positioned to benefit from the improved global investment flows, resulting from its broad diversification. However, the volatile U.S. dollar, higher level of debt and increasing competition remain the matters of concern.

Currently, Invesco retains a Zacks #4 Rank, which translates into a short-term Sell rating. One of its peers, Franklin Resources Inc. ( BEN - Analyst Report ) retains a Zacks #3 Rank (short-term Hold rating).