Perpetual: Result 2014

The strong recent performance of international fund managers – such as Platinum Asset Management and (especially) Magellan Financial Group – evidently hasn’t escaped the attention of the folks at Perpetual.

After several years of poor performance, Perpetual outsourced the management of its international share fund to US-based Wellington Management back in 2011 (see our update on 16 Aug 11 (Buy – $23.07)), but performance has only got worse, with the fund in the bottom quarter of comparable funds over the past one, three and five years.

Needless to say that does little to attract money to manage and, while it’s also not costing the company much, it means it’s missing out on this lucrative area of business. It also serves as a blot on the company’s copy book, with all its other flagship funds performing so well (ten out of twelve in the top quarter over three years and eleven out of twelve over five years).

So Perpetual has launched a new in-house Global Share Fund, which it has been incubating with its own seed capital over the past three years. The timing is due to the fund’s outperformance of 15 percentage points (pps) over the past year, helping it to outperform by 11 pps a year over two years and six pps a year over three years. However, on their own, the performances of 2013 and 2012 are less propitious, with an outperformance of seven pps and an underperformance of one pp respectively.

Perpetual has hopes for the fund to attract $1bn in capital over the next three years, but whether this is achieved will depend on whether the future performance is more like 2014 than 2012.

Perpetual says the fund’s costs are running at about $5m a year and, although it will officially charge 1.1% a year (plus a performance fee), institutional clients will pay less. Assuming that overall it matches the 83 basis point margin the company made from managing equities in 2014 (up from 82 bp in 2013), it would make a profit before tax of $3.3m if it hits its target – about 2% of the group total.

Costs will increase if the fund grows beyond the targeted $1bn, but not as quickly as the revenue, so the profit from the fund could become quite significant if it’s able to establish a good performance record. That's a big if, though, so while it makes sense for management to roll the dice, we’re reluctant to take anything for granted.

Hitting its straps

Which is fine, because the evidence from Perpetual’s 2014 result is that the rest of its business (ie almost all of it) is starting to hit its straps.

The cost savings portion of ‘Transformation 2015’ is now largely complete (ahead of schedule and budget) with annualised cost savings of $54m, and Perpetual is now moving onto growth. To this end it has had a shot in the arm from the acquisition of The Trust Company which, in the six months to June (its first full half), added $5.4m (33%) to Perpetual Private’s profit before tax (PBT) and $3.4m (23%) to Perpetual Corporate Trust’s PBT, while adding an extra $1.4m (16%) to corporate costs.

The integration of Trust Co is apparently going well and management upgraded its target for annualised cost savings of ‘at least $15m’ to $18-20m, while keeping the total integration costs at $30m.

Excluding Trust Co, Perpetual Private increased PBT by 72%, due largely to operational leverage on higher fees from increased funds under management (FUM), while Perpetual Corporate Trust increased PBT by 20% as securitisation markets begin to find their feet again after the post-GFC lull.

Money flowing in

Investment management, though, remains Perpetual’s most important business – contributing almost two-thirds of PBT in the second half – and the omens are positive here as well. Although the short-term performance is dependent on market fluctuations (and drove divisional PBT up 30% over the year), longer-term prospects are supported by the strong long-term performance of shares and the mandated flow of money into superannuation – APRA expects super assets to grow at 6% a year from $1.9 trillion in 2014 to $8.4 trillion by 2040.

Given the performance of Perpetual’s funds, you’d expect it to continue to attract its fair share of the money, and it’s comforting to see that it’s flowing in the right direction again, with net inflows in each of the past four quarters for the first time since 2010 (see Perpetual fourth-quarter inflow from 15 Jul 14 (Buy – $48.38)).

As ever, free cash flow was strong, amounting to slightly more than the net profit, and the company ended the year with net cash of $241m.

Based on underlying earnings for 2014, the stock is trading on a price-earnings ratio of 21, which is set to fall to 17 in 2015 based on the consensus forecast, although we’ll take that with a pinch of salt at this stage.

The share price is now up 29% since we upgraded it just over a year ago in Pulling the trigger on Perpetual on 19 Sep 13 (Buy – $38.72), and 4% since 15 Jul. It’s now grazing our Buy price of $50, but we’re happy to wait for some clear space before downgrading. BUY.

Note: Our model Growth and Income portfolios own shares in Perpetual.