Doors close on Perpetual

Since Fund managers spring a leak on 2 Feb 12 (Hold – $20.25), Perpetual’s share price has risen 21%.

Mr Market’s unrestrained enthusiasm has been driven by three factors. First, there’s talk of a spot of shareholder activism: Corporate raider Gary Weiss has indicated he will try for election to Perpetual’s board. But there’s no guarantee he’ll succeed and, even if he does, boardroom turmoil is invariably disruptive.

Second, Perpetual’s first half profit beat expectations due to cost reductions under previous chief executive Chris Ryan. Perhaps those expectations were set deliberately low to generate what analysts call a ‘positive surprise’ and anyway, as we said in yesterday’s update—23 Feb 11 (Hold – $23.59)—the result wasn’t as good as it looked regardless.

Finally, new chief executive Geoff Lloyd has been appointed with a mandate for further cost reductions. Lloyd did little to inspire confidence at yesterday’s presentation and his plan, now that the stock is up 21%, is largely priced in.

These developments don’t change some important issues.

Money has been flooding out of Perpetual funds over the past six months, as explained in Fund managers spring a leak. There’s also the risk that former star fund manager John Sevior attracts some of the company’s funds when he establishes his own ‘boutique’ funds management business later this year (although his focus is likely to be lower margin institutional money).

FUM falls

Perpetual’s funds under management (FUM) has fallen to $22.9bn and it seems inevitable that it will fall further, no matter what Lloyd does. Even if he cuts another $15m from the cost base immediately, the lower FUM means profit in 2013 will fall.

Assuming that level of cost reductions—and no improvement in markets—Perpetual’s 2013 earnings per share will be around $1.27, placing the stock on a forecast PER of 19. Assuming accelerating outflows and management turmoil, this isn’t an attractive multiple.

Our intention was to downgrade the stock to sell above $24.00, which is what we’re doing now. Be aware, though, that under some circumstances this downgrade will prove incorrect. If sharemarkets strongly rebound, so will Perpetual’s profits (and share price) because of the company’s operating leverage.

There’s also the possibility that, after a succession of chief executives, the board is finally serious about improving the company’s performance with a restructuring; certainly the pressure for them to deliver is mounting. Perhaps Geoff Lloyd is the right man for the job.

Finally, a takeover or corporate raid on the share register could make the Sell recommendation look premature. If someone else believes they can release the value within Perpetual, then another bid is possible. Just don’t expect anything like the $38 a share offered by private equity firm KKR 18 months ago.

Selling out

Mr Market has been speculating on these issues over the past month, which explains why the share price has jumped. But we believe this confidence is misplaced, which means the stock is giving shareholders an opportunity to exit.

Perpetual hasn’t been a successful recommendation but nor has it been a disaster. Shareholders should be able to exit with either a small profit or a medium-sized loss. Unless you are bullish on sharemarkets, we don’t recommend you continue to hold Perpetual (or if you do, make sure your holding represents less than 5% of your portfolio).

If the price falls substantially we’ll revisit the situation but are now directing attention to more attractive opportunities. We’re consequently selling our holdings from the model Growth and Income portfolios (see below), too. SELL.

We’re selling 331 shares from the Growth portfolio at $24.43 to raise $8,086.33 (realising a small loss). We’re also selling 400 shares from the Income portfolio at $24.43 to raise $9,772.00 (realising a small profit).