T. Rowe Price (Excerpt From Our Recent Letter)
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The following is an excerpt from Eagle Point Capital’s Spring 2024 letter to clients. Every six months, EPC writes to clients to explain what we own and why we own it. The portfolio-specific portion of each letter is for clients only. Please contact us to learn more about investing with EPC.
T. Rowe Price is one of the world's largest asset managers with over $1.45 trillion of assets under management (AUM) today. The company operates a simple take-rate business model with high margins, sticky customer relationships, and high returns on equity. We view T. Rowe as a royalty on the long-term growth of the US stock market.
T. Rowe actively manages investments for clients around the world, primarily via mutual funds. The company has a dominant position in target date retirement funds, which saw $13.1 billion of inflows last year. T. Rowe acquired Retiree, Inc in 2023 to strengthen its relationship with retirement clients.
T. Rowe’s active ETF business is gaining traction and reached $2.7 billion of AUM. Oak Hill Advisors, T. Rowe’s leading private credit manager, launched OCredit with $1.5 billion. OCredit will allow wealth management clients to access the private credit market.
AUM, average fee rate, and operating costs drive T. Rowe’s earnings.
AUM decreased 2.8% to $1.36 trillion at year end. Outflows of $81.8 billion more than offset significant market appreciation. Outflows were expected to worsen in 2023, driven by a few large, anticipated redemptions in T. Rowe’s sub-advisory and institutional channels. These will not repeat. Flows should improve in 2024 but are likely to remain a headwind.
Performance ultimately drives AUM. T. Rowe benefits when US stocks perform well and when its strategies outperform their peers. T. Rowe’s strategies with the most substantial outflows in 2022 and 2023 had much better performance in 2023. 64% of T. Rowe’s funds beat their peer group medians for the year. That should translate into lower client redemptions and improved sales over time. Flows lag returns because investors tend to chase performance.
Fee rates have remained relatively stable between 42 and 43 basis points in recent years. We suspect that the active to passive shift and subsequent fee-compression that many asset managers experienced has largely run its course. Where fees have declined, it's been a shift in mix from higher fee equity strategies to lower fee fixed income strategies.
Operating expenses rose 4% in 2023 against flat revenue. Operating margins fell to 30.7%. T. Rowe’s costs are largely fixed, creating tremendous operating leverage. The company has been in this business for almost 90 years and manages its costs for the long run. They do not overreact to strong or weak markets.
T. Rowe is a highly free cash flow generative company. Over the last three years the company has returned 93% of free cash flow to shareholders, primarily through dividends. Last year the company raised its dividend for the 38th year in a row, a record few can match. The stock currently yields 4.2% and has $2.5 billion of net cash on its balance sheet.
Over the coming years we expect to see AUM grow at roughly 50-70% the rate of the S&P 500’s growth. Market appreciation should more than offset moderating outflows. Margins should normalize toward their historical average (~45%) and allow earnings to grow even faster than revenue.
Since earnings are sensitive to stock prices, an extrinsic factor T. Rowe cannot control, we cannot predict exactly what T. Rowe will earn in any given year. We’re comfortable with this because stock prices rise overtime. We have no idea what AUM will be next year, but are confident AUM will be higher five and ten years from now.
Normalizing margins and growing AUM should drive double-digit earnings growth, albeit in a lumpy fashion. Dividends and buybacks should push forward returns into the mid-teens. T. Rowe currently trades for around 15 times depressed earnings. This price affords us a margin of safety given the company’s quality and growth prospects.
T. Rowe has compounded shareholder value at more than 15% annually for the past 30 years. We believe the coming decade is going to be more of the same for those willing to be patient during inevitable bouts of turbulence.
For more on T. Rowe Price, see our original post on the business from July 2022 — T. Rowe Price: Compounding Machine on Sale.
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Disclosure: The author, Eagle Point Capital, or their affiliates may own the securities discussed. This blog is for informational purposes only. Nothing should be construed as investment advice. Please read our Terms and Conditions for further details.
Although I’m not in the business of market forecasting, the starting multiple of the S&P suggests the forward outlook for equity turns is not great relative to history. Do you think it may not be the most attractive part of the cycle to own such a strong play on equity market appreciation?
Although Buffett would not prognosticate on market direction, he has made similar observations at AGMs over the years when equities in aggregate were trading at valuations that borrowed from future returns.