Waddell & Reed Beats by a Nickel

Waddell & Reed Financial Inc.’s ( WDR - Analyst Report ) third quarter 2012 operating earnings of 61 cents per share were ahead of the Zacks Consensus Estimate by a nickel. This also compares favorably with earnings of 46 cents in the prior-year quarter.

Better-than-expected results benefited from augmented top line, partially offset by higher expenses. Further, enhanced assets under management (AUM) and solid balance sheet were among the positives. Moreover, gross sales across all the revenue channels, except Advisory channel, decreased.

Net income (including the loss from discontinued operations) for the reported quarter was $8.5 million or 10 cents per share compared with $39.8 million or 46 cents per share in the year-ago quarter.

Performance in Detail

Waddell & Reed’s operating revenues for the reported quarter were $293.4 million, up 4.6% from $280.3 million in the year-ago quarter. However, operating revenues lagged the Zacks Consensus Estimate of $312.0 million by 6.0%.

Overall, gross sales fell 19.5% year over year to $5.2 billion. Redemptions were $4.6 billion, down from $6.4 billion in the prior-year quarter. Inflows deteriorated significantly from $1.3 billion in the previous-year quarter to $826 million in the reported quarter.

At the Advisors channel, revenues bolstered 11.5% year over year to $78.2 million. Gross sales for the quarter were $906 million, up 4.5% from $867 million in the year-ago quarter. Net outflows were $75 million compared with $133 million in the third quarter of 2011.

At the Wholesale channel, revenues dipped 2.3% from the prior-year quarter to $44.7 million. Similarly, gross sales decreased 10.0% from the year-ago quarter to $3.6 billion. Net inflows, however, improved 21.8% from the prior-year quarter to $670 million.

Gross sales at the Institutional channel were $721 million, down 55.6% from $1,625 million in the year-ago quarter. Likewise, net inflows during the quarter were $231 million, down 74.5% from the year-ago quarter.

Waddell & Reed’s operating expenses surged 3.5% year over year to $213.6 million. The increase was primarily due to higher underwriting and distribution expenses as well as rise in compensation and related costs.

Operating margin of 27.2% in the reported quarter improved from 26.4% in the prior-year quarter.

As of September 30, 2012, AUM totaled $94.8 billion, up 22.3% from $77.5 billion as of September 30, 2011 and 6.4% from $89.1 billion as of June 30, 2012. Both the increases were driven by positive market action and organic growth.

Balance Sheet

As of September 30, 2012, cash and cash equivalents and investment securities were $545 million. Moreover, long-term debt totaled $190 million and stockholders’ equity was $568 million.

Share Repurchase

During the reported quarter, Waddell & Reed repurchased 213,000 shares. This brings the year-to-date shares repurchased to 1.2 million shares at a total cost of $36 million.

Divestiture

On October 29, Waddell & Reed signed a definitive agreement to sell Legend group of subsidiaries to First Allied Holdings Inc. The deal is expected to close in January next year, subject to regulatory approvals.

Peer Performance

Similar to Waddell & Reed, Lazard Ltd.’s ( LAZ - Analyst Report ) third-quarter 2012 earnings also beat the Zacks Consensus Estimate by a nickel. Better-than-expected results reflect enhanced assets under management (AUM) and a strong capital position. Yet, a decline in the top line and increase in expenses were the downsides.

Our Take

Waddell & Reed’s sustained growth and history of boosting shareholders’ value through meaningful capital deployment activities are impressive. However, persistently volatile equity markets and significant intangibles on its balance sheet are expected to mar profitability in the upcoming quarters.

Though we remain optimistic considering the competitive ranking of Waddell & Reed’s funds and its efforts to control cost in the upcoming quarters, irregular investment performance and rising competition obscure our outlook.

Waddell & Reed currently retains a Zacks #1 Rank, which translates into a short-term Strong Buy rating.