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Legg Mason Inc.’s (LM - Analyst Report) fiscal second quarter 2013 adjusted earnings of 75 cents per share significantly outpaced the Zacks Consensus Estimate by 19 cents. Moreover, earnings were well above the prior-quarter figure of 64 cents per share.

Better-than-expected results reflected higher top-line growth, aided primarily by improved investment advisory fees and other revenues. Moreover, net client inflows in the quarter were a positive. Yet, elevated operating expenses acted as a dampener.

Adjusted net income came in at $100.1 million compared with $88.6 million in the prior quarter. Including one-time items, net income came in at $80.8 million or 60 cents per share.

Performance in Detail

Legg Mason’s total revenue was $640.3 million, up 1.5% sequentially, driven by an increase in average AUM and higher performance fees coupled with one additional day in the quarter. Moreover, revenues were above the Zacks Consensus Estimate of $634.0 million.

Investment Advisory fees climbed 1.7% sequentially to $556.6 million. Distribution and Service fees elevated slightly to $81.9 million. Moreover, other revenues were up 12.5% sequentially to $1.8 million.

However, operating expenses climbed 1.1% sequentially to $560.6 million, attributed to rise in compensation and benefits, partly offset by lower distribution and servicing expenses and reduced occupancy expenses. Adjusted operating margin of Legg Mason improved to 21.2% in the quarter under review from 16.9% in the prior quarter.

Assets Position

As of September 30, 2012, Legg Mason’s AUM was $650.7 billion, up 3% sequentially from $631.8 billion, driven by market appreciation of $20.7 billion and net client inflows of $0.2 billion, partially offset by dispositions of $2.0 billion.  Fixed income represented 57% of consolidated AUM as of September 30, 2012, liquidity represented 20% and equity comprised 23%.

During the quarter, liquidity inflows were about $9.7 billion. However, equity and fixed income outflows were $5.7 billion and $3.8 billion, respectively. Besides, average AUM was $639.4 billion compared with $635.5 billion in the prior quarter.

Balance Sheet

As of September 30, 2012, Legg Mason had approximately $0.9 billion in cash, compared with $0.8 billion in the prior quarter, while total debt was stable at $1.2 billion. Shareholders’ equity was also unchanged at $5.5 billion on a sequential basis.

The ratio of total debt to total capital (total equity plus total debt excluding consolidated investment vehicles) was 17%, in line with the previous quarter.

Capital Deployment Update

During the quarter, Legg Mason repurchased 3.6 million shares.

Moreover, Legg Mason’s Board declared a quarterly cash dividend of 11 cents per share. The dividend will be paid on January 7, 2013 to shareholders of record as of December 12, 2012.

Peer Performance

One of Legg Mason’s peers, T. Rowe Price Group Inc. (TROW - Analyst Report) reported third-quarter 2012 net income of 87 cents per share, topping the Zacks Consensus Estimate by 3 cents. Moreover, earnings compared favorably to 71 cents reported in the prior-year quarter. Higher-than-expected top-line growth and increased assets under management were the positives for the quarter. Yet, elevated operating expenses acted as 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.

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