Legg Mason Outshines, Revs Down

Legg Mason Inc.’s ( LM - Analyst Report ) fiscal first quarter 2013 adjusted earnings of 64 cents per share significantly outpaced the Zacks Consensus Estimate of 2 cents. However, earnings were well below the prior-quarter earnings of 88 cents per share.

A decrease in operating expenses reflecting quarterly savings related to the company's streamlining program and reduction in outstanding debt were the positives for the quarter. Yet, decline in total revenues and client outflows were the dampeners.

Adjusted net income came in at $88.6 million compared with $123.6 million in the prior quarter. Including one-time items, net loss came in at $9.5 million or 7 cents per share.

Performance in Detail

During the reported quarter, Legg Mason’s total revenue was $630.7 million, down 3% sequentially, impacted by decrease in average AUM, including a less favorable asset mix and lower performance fees. Moreover, revenues were also below the Zacks Consensus Estimate of $645.0 million.

Investment Advisory fees decreased 3% sequentially to $547.5 million. Distribution and Service fees declined 1% sequentially to $81.6 million. However, other revenues were up 6.7% sequentially to $1.6 million.

Operating expenses declined 3.8% sequentially to $554.6 million, attributed to fall in compensation and benefits, partly offset by higher distribution and servicing expenses and quarterly savings related to the company's streamlining program.

Adjusted operating margin for Legg Mason declined to 16.9% in the quarter under review from 21.0% in the prior quarter, mainly reflecting elevated costs related to fund launches in the quarter.

Assets Position

As of June 30, 2012, Legg Mason’s AUM was $631.8 billion, down 1.8% sequentially from $643.3 billion, driven by dispositions of $4.6 billion, market depreciation of $4.3 and client outflows of $2.6 billion. Fixed income represented 57% of consolidated AUM as of June 30, 2012, liquidity represented 19% and equity comprised 24%.

During the quarter, fixed income inflows were about $100 million and liquidity inflows were $1.2 billion. However, equity outflows were $3.9 billion. Average AUM was $635.5 billion compared with $670.8 billion in the prior quarter.

Balance Sheet

As of June 30, 2012, Legg Mason had approximately $0.8 billion in cash, compared with $1.4 billion in the prior quarter, while total debt was stable at $1.2 billion, down from $1.4 billion in the prior quarter. Shareholders’ equity was $5.5 billion, down from $5.7 billion in the previous quarter.

The ratio of total debt to total capital (total equity plus total debt excluding consolidated investment vehicles) was 17%, down from 20% in the previous quarter. The improved ratio indicates the repurchasing of $1.25 billion in debt held by a fund which is managed by Kohlberg Kravis Roberts & Co. L.P. ( KKR - Snapshot Report ) in May. Moreover, the company has issued $650 million of 5.5% senior notes due 2019 to finance its KKR debt buyback.

These actions reduced outstanding debt obligations by $350 million. We believe these strategic initiatives would help Legg Mason in strengthening its balance sheet and enhancing its capital structure.

Capital Deployment Update

During the quarter, Legg Mason repurchased 6.2 million shares.

Moreover, Legg Mason’s Board declared a quarterly cash dividend of 11 cents per share. The dividend will be paid on October 22, 2012 to shareholders of record as of October 4, 2012.

Peer Performance

One of Legg Mason’s peers, T. Rowe Price Group Inc. ( TROW - Analyst Report ) , reported second quarter 2012 net income of 79 cents per share, missing the Zacks Consensus Estimate by a penny. However, earnings compare favorably with 76 cents reported in the prior-year quarter. Higher-than-expected top line growth was a positive for the quarter. Yet, elevated operating expenses were a dampener.

Our Viewpoint

We believe 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. However, in the near term, assets outflows will remain a significant headwind. Yet with the restructuring initiatives and the cost-cutting measures, we expect operating efficiencies to improve, and dividend payments to continue to inspire investors’ confidence in the stock.

Shares of Legg Mason currently retain a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain a Neutral recommendation on the stock.