Dividend Aristocrats In Focus Part 10: Franklin Resources

When it comes to dividend investing, the Dividend Aristocrats are the “cream of the crop.” The Dividend Aristocrats are stocks in the S&P 500 Index, with 25+ consecutive years of dividend increases.

[REITs]

There are thousands of stocks to choose from, many of which pay dividends. But the Aristocrats have profitable businesses, and the ability to grow their profits. This gives them the ability to withstand recessions, and continue increasing their dividends each year.

Franklin Resources (BEN) has increased its dividend for 36 years. The stock has a dividend yield below 2%, but it makes up for this with 10%+ annual dividend increases. For example, the company raised its dividend by 11% in 2017.

After a couple of difficult years of declining assets under management, Franklin Resources has returned to growth this year. It could continue to raise its dividend by double-digits each year, which makes it an attractive stock for dividend growth.

Business Overview

Franklin Resources is an investment management company. It was founded in 1947 in New York, by Rupert H. Johnson Sr., who had previously managed a Wall Street brokerage firm.

He named the company after Benjamin Franklin, the founding father who was viewed as a symbol for frugality, saving, and wise investments.

Today, Franklin Resources manages the Franklin and Templeton families of mutual funds. A breakdown of the company’s assets under management, by investment objective and sales region, is below:

Source: Q3 Earnings Presentation, page 3

This is a difficult time for Franklin Resources. 2015 and 2016 were very challenging years for the company. In 2015, revenue and earnings-per-share declined by 6% and 13%, respectively. Things only got worse the following year—in 2016, revenue fell 17%, while earnings-per-share declined 11%.

The declines were due to under-performance across several of the company’s flagship funds. Weak performance is a big problem for an asset manager, because it typically results in lower assets under management.

When funds do poorly, investors take their money elsewhere. This has caused Franklin Resources’ fundamental deterioration, as assets under management is a key driver of revenue and earnings.

The good news is, assets under management have returned to growth in 2017. For example, at the end of September, assets under management were $753.2 billion, up 3% from the same period last year.

Still, Franklin Resources’ assets under management exceeded $880 billion at the end of 2014. As a result, the company has a long way to go to regain the ground it has lost.

Growth Prospects

Despite the difficult operating environment, there are reasons to be optimistic about the company’s long-term growth. The U.S. is an aging population. There are thousands of Baby Boomers retiring every day. Combined with rising life expectancies, there is a great need for investment planning.

There should always be a need for the financial services provided by Franklin Resources. The company has seen assets under management increase again in recent periods.

Source: Q3 Earnings Presentation, page 3

This could serve as a strong fundamental backdrop for Franklin Resources over the long-term.

In addition, cost cuts are helping drive an earnings recovery. Earnings-per-share rose 6% in the first three quarters of the fiscal year, even though revenue declined 5% in that time.

Franklin Resources cut operating expenses by 5% over the first three quarters, which included cuts in marketing and distribution costs, as well as reduced compensation.

Plus, since the company is still solidly profitable, it can use some of its excess cash flow to repurchase stock.

Source: Q3 Earnings Presentation, page 11

Franklin Resources reduced its diluted share count by 5% so far in 2017, which helps boost earnings-per-share growth.

Accretion to earnings growth is even stronger when the price of a stock declines. This is an advantage of consistent profitability—the company can use short-term dips in the share price as an opportunity to buy back its own stock at a lower price.

Competitive Advantages & Recession Performance

There are not many competitive advantages in the financial services industry. Asset management is a highly competitive business. The ability to retain clients depends largely on performance. If funds perform worse than their benchmarks, clients typically are quick to withdraw their funds.

However, Franklin Resources does have a few advantages over its competitors. The first, and perhaps most important, is brand recognition.

Franklin Resources has been in operation for 70 years. In that time, it has developed a strong reputation among investors, for its expertise and investment abilities.

And, Franklin Resources has huge assets under management, which allows the company to offer a wide range of investment opportunities to bring in clients.

Unfortunately, these competitive advantages do not help the company during recessions. Franklin Resources performed poorly during the Great Recession:

• 2007 earnings-per-share of $2.37
• 2008 earnings-per-share of $2.24 (5.5% decline)
• 2009 earnings-per-share of $1.30 (42% decline)
• 2010 earnings-per-share of $2.12 (63% increase)
• 2011 earnings-per-share of $2.89 (36% increase)

As you can see, earnings-per-share fell steeply in 2009 during the worst part of the Great Recession. This should come as no surprise, since investment managers are not recession-resistant businesses.

During recessions, stock markets typically decline. This prompts many investors to sell their stocks out of fear, which causes lower assets under management and fees.

That said, Franklin Resources recovered quickly, and saw earnings jump in 2010 and 2011.

Valuation & Expected Returns

While Franklin Resources’ fundamentals have worsened in recent years, the good news is investors are not paying a high price for the stock.

In the past four reported quarters, Franklin Resources had diluted earnings-per-share of $3.07. Based on its recent share price, the stock has a price-to-earnings ratio of 14.6.

This is well below the S&P 500, which has an average price-to-earnings ratio of 25.4. Of course, the reason for Franklin Resources’ low valuation is its declining earnings.

However, if the company can recover and return to earnings growth, the current price could prove to be a good value.

An expanding price-to-earnings ratio could generate significant returns. Separately, future returns will be due to earnings growth and dividends.

ValueLine forecasts 4% earnings growth for Franklin Resources in 2017, and 8% growth in 2018. This may be a reasonable base of expectations. A potential breakdown of returns is below:

• 6%-8% earnings growth
• 1.8% dividend yield

In this scenario, long-term returns would reach approximately 8%-10% per year, and possibly much greater if the stock price-to-earnings ratio rises above 14.

Final Thoughts

Franklin Resources’ assets under management declined in 2015 and 2016, but is back to growth. It may take another year or two to recover what it had lost, but the company is still growing earnings, thanks to cost cuts and share buybacks.

With a low valuation, Franklin Resources could be a buying opportunity for value and dividend growth investors.