Navigating its Way
Shares of Magellan Financial Group (ASX:MFG) have drifted downwards so far in 2018 with growing trade tensions, international political developments and mixed fund inflows serving as headwinds for the internationally-oriented investment specialist. Nonetheless, the shares have delivered impressive returns for shareholders since our initial recommendation and as we have confidence in the company’s model for long-term success we recommend holding.
May FUM update
May 2018 was a quiet month on the flows side, with Magellan experiencing net outflows of $47 million, which included net retail outflows of $57 million and net institutional inflows of $10 million. Total FUM (Funds under management) hit $67.354 billion, up 1.7% month-on-month and marking a 29% increase year-on-year.
At the end of May 2018 retail FUM was $18.685 billion, representing a 19.6% increase from a year earlier. Retail FUM represented approximately 27.7% of total at the end of May 2018. Magellan’s Institutional mandates are diversely split from Australia/NZ, the United States and Rest of the World as shown in the table below. The bulk of funds (~76%) are deployed into global equities and Magellan (ASX:MFG) also lists infrastructure as a separate category.
Source: Magellan (ASX:MFG)
Magellan’s focus is on international equities, although the company did acquire Australian equities specialist Airlie Funds Management earlier this year at the same time as buying US wealth group Frontier Partners.
Combined the deals cost Magellan around $140 million. We view targeted acquisitions as a lever Magellan can pull to complement its existing strengths and grow.
Airlie had over $6 billion in FUM at the time the strategic acquisition was announced in February and historically has targeted institutional and high net worth clients. The business has an impressive track record of growth given its relatively short span of operations (~6 years). The tie-up with Magellan provides retail access and distribution to Airlie and it will operate as a separate brand with its own stock-picking team having stayed in place. There was a high-profile lost mandate from Australian Super in the news, although this is understood to have already been factored in.
Magellan (ASX:MFG) has targeted the broader retail market for growth with this highlighted by the IPO of the Magellan Global Trust last year, at considerable short term expense. And as we have noted previously, Magellan had ramped up their investments in marketing activities “in order to grab the self-directed market”. As this is a sizable niche and as a largely ignored segment of the market it offers an opportunity for Magellan. A marketing partnership with Cricket Australia was a short-lived exercise though, with Magellan pulling out from the deal following the ball tampering scandal.
The primary focus for Magellan remains international and US-based Frontier Partners has been the company’s distribution partner in North America since 2011. Frontier is a registered investment advisor focussed on distributing specialist funds to North American institutional investors. This joint alliance (pre-acquisition) had brought in circa $12.8 billion in FUM and has been pivotal to Magellan’s presence and expansion in North America.
Magellan (ASX:MFG) has built its strong reputation via demonstrating respectable ‘investment chops’ in international markets and this has included long-term investments in several household US-listed names.
Accordingly, Magellan (ASX:MFG) shares tend to ebb and flow whenever there is turmoil on Wall Street and other major international markets.
The recent imposition of trade tariffs by the Trump administration and prompt retaliatory actions from the Chinese government on a range of US goods has again heightened trade war fears, which have been a lingering concern for much of 2018. Investors abhor the threat of a trade war as a full-blown tit-for-tat imposition of tariffs and the like is generally considered to result in higher input costs across the impacted industries and slower global economic growth. The more wide-ranging are the actions undertaken by the various authorities involved and the greater is the expected impact on growth.
This would result in pressure on equity prices, impacting income and fund flows for companies of Magellan’s ilk.
While we are cognisant of the risks involved on this front, we continue to believe the risks of full-scale “trade war” will prove overblown given that countries worldwide have become far too interdependent to resort to deep and broad trade prohibitions. Instead, we view much of the current rhetoric as posturing.
We also view Magellan’s investment style and business model as serving to mitigate some of the risks. Magellan’s stock-picking teams focus investment on companies that have proven resilient to cycles and have stood the test of time, generating solid shareholder returns. While that doesn’t mean those stocks will prove immune to short-term corrections, it enhances the prospects for adequate returns through cycles.
Magellan (ASX:MFG) ‘fishes’ in international waters as this is where most of the investment opportunities are located and many of these international-listed companies are more likely to benefit from the huge technological and industrial shifts occurring around us, along with the rise of emerging market consumers.
For example, the flagship Magellan Global Fund (ASX:MFG), which had a fund size of A$9.75 billion at the end of February had 10 US-listed companies as its largest positions, but the geographical source of revenue is more diverse than one might expect at first glance. Excluding, banking giant Wells Fargo and home improvement retailer Lowe’s, the rest of the corporate titans in the list are true multinationals. Accordingly, only 45% of the fund’s exposure is attributed to the US, as can be seen in the bottom pie chart below the top 10 holdings list and sector exposure. The listed shares include some names in common with our US equities research coverage. Click the following links to access our latest coverage on Apple, Alphabet, and Wells Fargo respectively.
Source: Magellan (ASX:MFG)
Of course, by investing internationally, Magellan is also able to scale to large fund sizes without hitting significant constraints on its investment style and it is a differentiator within Australia, with relatively few peers that have such a strong track record of international investing.
Magellan’s business has significant scale advantages and the business has delivered strong results over the long-term. The 2018 interim statutory profits took a hit from the costs associated with the launch of the Magellan Global Trust, but on an underlying basis were strong. Revenue increased almost 28% year-on-year to $195.8 million, driven by management and services fees.
Source: Magellan (ASX:MFG)
Profit after tax and Magellan Global Trust net offering costs came in $53.5 million, representing a fall of around 39% from a year earlier. Adjusted for the costs associated with the launch of the trust, profit was some 25% higher year-on-year at $109.2 million. Accordingly, the underlying result was a strong one and the company hiked its interim dividend roughly 16% to 44.5 cents, fully franked.
Turning to the charts, on the daily, prices are flirting with the 50-day moving average (red line) at $23.50. A move back above support at $22.89 is a positive. For the short-term technical outlook to improve, a sustained break above the aforementioned 50-day moving average is required. Should this favourable scenario unfold, then this would likely trigger a resumption of the medium-term uptrend.
Turning to the monthly chart, support continues to be largely respected around the 61.8% Fibonacci retracement (blue set of retracements). Prices are however flirting with this level, and need to hold their ground to avert a move towards the next layer of support at $19.76.
Summary
Magellan (ASX:MFG) is backed by strong management, and a push into the self-directed market should yield rewards over the medium-term. Magellan Financial Group’s business is scalable and opportunities exist for more targeted acquisition activity. This, in combination with its established track record, growing product range and business infrastructure, suggests to us that Magellan Financial Group can continue to grow earnings over the medium-term.
Currently, Magellan (ASX:MFG) shares trade on 17.6x forecast FY18 earnings, falling to 15x times the following year. The projected yield over the same time frame expands from 4.4% to 5.0%.
Magellan (ASX:MFG) Financial Group will remain held in the Fat Prophets Portfolio.
