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Legg Mason Outshines Estimate

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Legg Mason Inc.’s (LM - Free Report) fiscal second-quarter 2012 earnings of 61 cents per share significantly outpaced the Zacks Consensus Estimate of 38 cents. Reported quarter results included special U.K. tax benefit of 13 cents and transition-related costs of 7 cents per share.

Earnings were below the prior-year quarter and prior quarter’s earnings of 76 cents and 73 cents per share. Results declined due to lower revenue and total assets under management (AUM), offset by lower operating expenses.

Adjusted net income came in at $87.6 million compared with $109.1 million in the prior quarter and $115.0 million in the year-ago quarter. Including one-time expenses, net income came in at $56.7 million or 39 cents per share.

Performance in Detail

During the reported quarter, Legg Mason’s total revenue was $669.9 million, down 0.7% year over year due to decreased average AUM and lower performance fees, partly offset by augmented advisory fee yields resulting from favorable asset mix.

On a sequential basis, revenues plunged 7.0% due to less favorable asset mix, low performance fees and a decline in average AUM. Moreover, revenues were also below the Zacks Consensus Estimate of $685.0 million.

Investment Advisory fees inched up 0.3% on a year-over-year basis, but declined 6.5% sequentially to $582.8 million. Distribution and Service fees inched down 7.0% year over year and 6.8% sequentially to $85.8 million. Other revenues were up 1.2% year over year but down 13.9% sequentially to $1.3 million.

GAAP operating margin of Legg Mason improved 16% in the reported quarter from 14% in the prior quarter and 13% in the prior-year quarter. Operating expenses decreased 9% sequentially and 4% year over year to $563 million, attributed to an increase in savings resulting from the streamlining effort.

As of September 30, 2011, Legg Mason’s AUM was $611.8 billion, down 7.7% sequentially from $662.5 billion, driven by market depreciation, including foreign exchange, coupled with client outflows of $17.6 billion. On a year-over-year basis, AUM was down 9.2% from $673.5 billion. Fixed income represented 58% of consolidated AUM as of September 30, 2011, liquidity represented 18% and equity comprised 24%.

During the quarter, fixed income outflows were approximately $8.8 billion, liquidity inflows were $3.1 billion and equity outflows were $5.7 billion. Total client outflows increased to $17.6 billion from $3.7 billion. Besides, average AUM was $643.3 billion, down 4.1% from $670.8 billion in the prior quarter and 2.3% from $658.6 billion in the year-ago quarter.

As of September 30, 2011, Legg Mason had approximately $1.1 billion in cash compared with $1.2 billion in the prior quarter, while total debt was stable at $1.4 billion. Shareholders’ equity was $5.6 billion, down from $5.7 billion in the prior quarter. The ratio of total debt to total capital (total equity plus total debt excluding consolidated investment vehicles) was 20%, up from 19% in the prior quarter.

Share Repurchase and Dividend Update

In second quarter of 2012, Legg Mason had repurchased and retired 7.6 million shares of common stock.

Legg Mason’s board declared a quarterly cash dividend of 8 cents per share on its common stock. The dividend is payable on January 9, 2012 to shareholders of record as of December 14, 2011.

Performance by Competitors

In Legg Mason’s peer group, T. Rowe Price Group Inc.’s (TROW - Free Report) third-quarter 2011 earnings of 71 cents per share were significantly up from 64 cents reported in the prior-year quarter. Higher-than-expected top-line growth, partially offset by higher operating expenses, cumulated in improved performance. However, the quarter’s earnings were below the Zacks Consensus Estimate by 2 cents per share.

Our Take

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 demographics in the market. 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 leverage to improve, and share buybacks to continue inspiring investors’ confidence on the stock.

Legg Mason currently retains its Zacks #4 Rank, which translates to a short-term Sell rating. However, considering the fundamentals, we are maintaining a Neutral recommendation on the stock.

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