BlackRock: An Excellent Blue Chip Investment Opportunity

In our previous post we discussed some of the key advantages of ETFs vs mutual funds. Today we will discuss a blue chip company which is well positioned to benefit from the shift towards ETFs: BlackRock (BLK)

Company Overview

BLK is the largest asset management company in the world with ~$9.1 trillion in assets under management. The company serves both institutional and retail investors across an extensive range of products. BLK product types include equity, fixed income, multi-asset, alternatives, and cash.

The company is a leader in the ETF space and 42% of the company’s base fees come from ETF offerings.

BLK is also a leader in the private investing space with ~$320 billion in alternative assets which is made up of ~$156 billion in private markets, ~$83 billion in liquid credit, and ~$81 billion in hedge funds and hedge fund solutions.

In addition to its leading asset management franchise, BLK has also developed a leading technology services business around its Aladdin product offering. Technology services accounted for ~8% of total 2022 revenue. The business is one of the fastest growing in BLK and has grown at a 15% CAGR over the past 5 years.

Strong Historical Performance

As shown by the chart below, BLK has a very strong long-term historical performance track record of delivering for its shareholders. Since the company went public in 1999, BLK has delivered a total return of more than 12,000% compared to the S&P 500 which has delivered a total return of 579%.

BLK has also performed well on a more recent basis. Over the past 5 years, BLK has delivered a total return of 83% compared to 73% for the S&P 500. Moreover, BLK has significantly outperformed the financial services sector which has delivered a total return of 39% over the past 5 years.

BLK’s solid stock performance has been driven by solid growth in its underlying business. BLK has experienced a 10yr EPS CAGR of ~8.4%.

Market Leader In A Highly Competitive & Fragmented Industry

The asset management business is highly competitive. BLK competes with traditional asset management firms such as Vanguard, Invesco, Fidelity, PIMCO, T Rowe Price, AllianceBernstein, Franklin Resources, Janus Henderson, Wellington Management, and many others. In addition to competing with stand alone traditional asset managers, BLK also competes with the asset management arms of larger banks such as J.P. Morgan Chase, Goldman Sachs, Morgan Stanley, State Street, The Bank of New York Mellon, UBS, and many others.

If that list of competitors was not enough, BLK also competes with players such as Blackstone, KKR, Apollo, Carlyle, and others in its alternatives business.

Despite BLK’s staggering AUM of ~$9.1 trillion, the firm controls just 3% of total asset management revenue.

Given the very high level of competition you might be tempted to think that BLK would have low profit margins. However, that is not the case. BLK has been able to consistently generate profit margins of ~30%. Comparably, competitors are operating with mid teen levels of profit margins.

Competitive Advantage Driven By Scale

BLK’s competitive advantage is driven primarily by its scale. The primary cost in the asset management business is labor as employee compensation and benefits accounting for ~50% of total expenses. Other significant costs include direct fund expenses and SG&A expenses.

Generally speaking, fees in the asset management business are charged as a % of assets. The result is a fund with $10 billion will often bring in 10x the revenue of a $1 billion fund. However, the actual cost to operate a $10 billion fund is not significantly higher than the cost to operate a $ 1 billion fund. A key driver of this is the fact that you do not need 10x the portfolio management and support team to manage a $10 billion fund vs a $1 billion fund. The key difference is just that the size of the positions is larger on a $ basis. This is especially true in the ETF business which is largely based off of passive indexes.

Another benefit due to scale is the fact that BLK has relationships with a vast network of customers. The company is able to offer investors a full suite of products ranging from passive index products to hedge funds to private investment vehicles all through one consolidated relationship. While BLK has competitors who are strong in different areas (e.g. T Rowe Price in active equities, PIMCO in fixed income, Vanguard in ETFs, and Blackstone in private fund) there is no other firm that has anywhere near the level of strength across asset classes and investment vehicles.

Finally, BLK’s scale means that it is the top customer for many sell side trading desks. This enables BLK to drive the hardest bargain to achieve lower transaction costs compared to smaller firms. Moreover, BLK is able to get superior access to highly competitive opportunities such as new issuances. These advantages have helped to contribute to strong performance with ~81% of active AUM currently above the peer median or benchmark for the past 5 year trailing period.

As shown by the chart below, BLK has significantly outperformed its peers over the past 15 years.

Moreover, advantages to scale continue to accrue to top players. The total AUM share of the top 5 asset management firms has increased from ~13% of $75 trillion of assets in 2016 to ~16% of $108 trillion in assets in 2022.

Growth Expectations Going Forward

Currently consensus estimates call for BLK to grow earnings by 1.4% in 2024 and 13.1% in 2025. One of the great things about BLK is that it benefits from rising asset prices overtime. While assets rise and fall, they tend to rise over the long-run. The result of this is that BLK can experience significant volatility from year to year based on movements in markets. Historically, public equities have returned ~10% each year on average while bonds have returned closer to ~5%. Over the long-run rising asset prices will serve as a growth tailwind for BLK. Moreover, the company also has significant growth opportunities due to further market share gains.

Despite its size, BLK currently accounts for just 8% of asset management industry AUM. Thus, there is significant room for market share growth as BLK will continue to benefit vs smaller rivals due to scale.

Additionally, the company’s technology segment represents another key drive of growth as Aladdin currently has captured just 11% of its total addressable market.

Dividend & Buybacks

As shown by the chart below, BLK has a long history of increasing its dividend. Currently, the company pays a quarterly dividend of $5 per share and the stock has a dividend yield of ~3%. BLK has also returned capital to investors via buybacks resulting in a share-count reduction of ~11.8% over the past 10 years. The company has ~6.3 million shares currently authorized to be repurchased under its existing share repurchase program.

Valuation

If you have read this far in the article you probably expect that this is where the BLK investment story gets less exciting as one might expect the company to trade at a premium valuation due to its strong history and competitive advantages. However, that is not the case.

BLK trades at 18x consensus estimated FY 2023 earnings and 17.7x consensus estimated FY 2024 earnings. Comparably, the S&P 500 is trading at ~18x consensus 2024 earnings. Thus, BLK is essentially trading inline with the S&P 500.

On a relative basis, BLK is attractive as the firm has above market growth potential. BLK is poised to benefit from rising asset prices overtime, additional investing inflows, and market share gains from smaller players. These factors should enable BLK to grow earnings at an above market rate for a long period of time.

BLK generally trades at a premium to peers such as T Rowe Price (forward P/E of 13.8x) or Franklin Resources (forward P/E 8.7x) or Invesco (forward P/E 8x.) However, this premium is well deserved as BLK is best positioned in the ETF and passive space. Comparably, other industry players have more to lose than BLK from the shift from active products towards passive products.

Additionally, BLK is attractive on a valuation basis relative to its own historical norm. As shown by the chart below, BLK is trading towards the low end of its historical range.

Risks To Consider

While BLK is a great company with a great outlook there are important risks which investors should be aware of. One potential risk is that BLK comes under increased regulatory scrutiny due to its size. Regulators could determine that BLK has become too and put limits around its ability to grow. While this seems unlikely given the fact that BLK controls just 3% of total asset management revenue it is a risk as regulatory changes can be unpredictable. Another potential risk to consider is that BLK may face revenue challenges as investors shift from active to passive products. Even if assets remain at BLK, a shift from active to passive is a negative for the firm as active products tend to have higher fees. However, investment dollars tend to be sticky and the shift from active to passive will likely be a slow process over many years.

Conclusion

BLK is a leader in the asset management business and has built a fabulous business with a high degree of recurring revenue and high profit margins.

The company has a strong long-term performance record of creating value for investors despite operating in a highly competitive industry.

BLK is poised to continue benefiting from its scale going forward and has a number potential earnings growth drivers.

Despite a strong history of generating above market returns and an industry leading competitive position, BLK trades at an earnings multiple which is inline with the S&P 500.

For these reasons, I believe BLK represents an attractive investment opportunity and is poised to outperform broad market indexes and other financial services companies going forward.

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