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Why Is Legg Mason (LM) Down 10.3% Since the Last Earnings Report?

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About a month has gone by since the last earnings report for Legg Mason, Inc. (LM - Free Report) . Shares have lost about 10.3% in that time frame, underperforming the market.

Will the recent negative trend continue leading up to the stock's next earnings release, or is it due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important drivers.

Legg Mason Q1 Earnings Beat Estimates, Expenses Rise

Legg Mason reported positive earnings surprise of 53.5% in first-quarter fiscal 2018 (ended Jun 30). The company reported adjusted net income of $0.66 per share, considerably beating the Zacks Consensus Estimate of $0.43. However, results compared unfavorably with $0.79 recorded in the prior-year quarter.

Solid top-line performance and steady AUM were the tailwinds. However, escalating expenses remain a concern.

Including one-time items, Legg Mason reported net income of $50.9 million or $0.52 per share compared with $33.5 million or $0.31 in the year-ago quarter.

Revenue Rises, Expenses Flare Up

Legg Mason’s total operating revenue in the quarter came in at $793.8 million, up 13.4% year over year. The upsurge was mainly due to elevated average long term AUM and performance fees, along with revenues associated with the addition of Clarion and EnTrust. In addition, revenues outpaced the Zacks Consensus Estimate of $779.2 million.

Investment advisory fees increased 17.4% year over year to $713.7 million in the quarter. Additionally, other revenues climbed 10% year over year to $1.1 million. However, distribution and service fees were down 13.7% year over year to $78.9 million.

Operating expenses increased 10.0% to $686.6 million on a year-over-year basis. The rise was chiefly due to higher compensation and benefits (up 15.3%), and expenses related to impairment of intangible assets.

Adjusted operating margin of Legg Mason was 22.5%, significantly up from 11.3% in the prior-year quarter. Lower acquisition and transition-related costs led to the rise.

Solid Assets Position

As of Jun 30, 2017, Legg Mason’s AUM was $741.2 billion, down slightly year over year from $741.9 billion. Of the total AUM, fixed income constituted 55%, equity 26%, liquidity 10% and alternatives represented 9%.

AUM inched up 1.8% sequentially from $728.4 billion as of Mar 31, 2017, driven by positive market performance of $8.4 billion, long-term net inflows of $0.5 billion and $0.7 billion in positive foreign exchange. These positives were partially offset by liquidity outflows of $11.5 billion. Notably, change in category of $16.0 billion of separately managed account assets which were previously classified as Assets Under Advisement also positively impacted AUM.

Notably, long-term net inflows of $0.5 billion included equity inflows of $1.0 billion and fixed income inflows of $0.3 billion, partially mitigated by alternative outflows of $0.8 billion. Additionally, average AUM was $740.3 billion compared with $709.1 billion in the prior-year quarter and $718.9 billion in the prior quarter.

Strong Balance Sheet

As of Jun 30, 2017, Legg Mason had $491 million in cash. Total debt was $2.2 billion, while shareholders’ equity came in at $4.0 billion.

The ratio of total debt to total capital (total equity plus total debt excluding consolidated investment vehicles) was 36%, in line with the prior quarter.

Capital Deployment Update

Legg Mason repurchased 2.4 million shares at a total cost of $90 million in the reported quarter, while 0.3 million shares at a total cost of $12 million were repurchased under net share settlements of annual deferred compensation award vesting.

Outlook

Management expects non-pass-through performance fees to be around $5-$10 million in fiscal second-quarter 2018.

For fiscal second-quarter 2018, the compensation ratio is expected to be down in the range of 54–55%, reflecting seasonal compensation decline.

For fiscal 2018, management projects GAAP tax rate to be at the low end of a 30% to 35% range.

Targeted capital return for fiscal 2018 is around $450 million.

How Have Estimates Been Moving Since Then?

Following the release, investors have witnessed a downward trend in fresh estimates. There has been one revision lower for the current quarter.

Legg Mason, Inc. Price and Consensus

 

VGM Scores

At this time, the stock has an average Growth Score of C, however its Momentum is lagging a lot with an F. The stock was allocated a grade of B on the value side, putting it in the second quintile for this investment strategy.

Overall, the stock has an aggregate VGM Score of C. If you aren't focused on one strategy, this score is the one you should be interested in.

Based on our scores, the stock is more suitable for value investors than growth investors.

Outlook

Estimates have been broadly trending downward for the stock. The magnitude of this revision also indicates a downward shift. Interestingly, the stock has a Zacks Rank #3 (Hold). We are expecting an inline return from the stock in the next few months.




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