A new capital markets report by Goldman Sachs analyst Alexander Blostein provides differing views of two brokerages in the wealth management space. He issues a buy recommendation for LPL Financial, which he says is one of the "most underappreciated growth stories" in the industry. He believes the firm’s shares are undervalued and that recruiting activity and net new assets should rebound later this year in the wake of the coronavirus hit. Meanwhile, Blostein downgraded shares of Raymond James Financial from neutral to sell, arguing that the firm’s revenue streams are cyclical and likely to face pressure amid market swings.
Raymond James, like many financial services firms, has been struck particularly hard by the market rout and rate cuts stemming from the coronavirus pandemic. The stock has fallen almost 50% since mid-February, when it touched over $100 a share.
Raymond James’ revenue mix will face pressures, Goldman says, with 51% of the mix tied to the equity markets, 16% tied to interest rates and 13% tied to investment banking and capital markets/trading. That compares to LPL’s more “pure-play” model, Blostein says.
While Raymond James’ pretax margins grew 300 basis points since fiscal year 2015, much of that growth was due to higher interest rates.
“As the rate backdrop has turned and Fed Funds has returned to the lower bound, we expect the reverse to be even sharper and deeper as we do not expect management will have capacity to significantly taper the expense growth curve and for it to inflect negatively along with revenues,” the report said.
Margins could compress to 13.7% in fiscal year 2020 and 11.4% in fiscal year 2021, compared with 18.2% in fiscal year 2019.
Blostein also argues that the firm’s valuation is richer than other firms in the space, and as investors shift their focus back to earnings, valuation discrepancies should be reset. After peaking on Feb. 20, the firm’s stock outperformed peers; its shares were down more than 45%, compared with peers' 50% drop on average. It’s trading at 11.7 times price-to-earnings, compared with an average 7 multiple for peers.
A Raymond James spokeswoman declined to comment. Earlier this week, the firm said it was deferring “face-to-face” advisor recruiting meetings and deferring some advisor transitions already underway for the duration of the coronavirus pandemic. Net assets are falling as cash sweeps surge and interest rates fall.
But the Goldman report offered a more favorable view of independent brokerage LPL Financial, saying it is “one of the most underappreciated organic growth stories in Capital Markets." Blostein said the stock’s recent sell-off after the Fed's emergency rate cuts "provides the most compelling buying opportunities we see in our coverage," with shares now trading at just under six times estimated earnings for 2021, and at $41, the stock is below Blostein's "hypothetical zero-rates-into-perpetuity" valuation analysis of $50 a share—meaning the price Goldman Sachs thinks the firm is worth even if LPL lost all hope of making significant revenue off of interest rate spreads.
Blostein believes LPL’s revenue streams are somewhat immune to market volatility and that recruiting activity will pick back up in late 2020. He also expects the environment to create mergers and acquisitions opportunities for LPL, as smaller advisory firms look to partner with more stable firms and smaller broker/dealers come under pressure. Several private-equity-backed b/ds carry higher levels of debt, creating opportunities for LPL to buy.
The firm should also benefit from its scale: It is the largest independent broker/dealer in the space.
“We expect LPLA would see incremental scale benefits—driving margins higher, maximizing cash yields, leveraging advisor technology across a wider platform and selling acquired advisors LPLA’s Business Solutions,” the report said.
“Our firm’s financial strength and stability are a differentiator in our industry,” said an LPL spokeswoman, in a statement. “In times of disruption, we are able to remain focused on our advisors, increasing access to service and support and providing the capital and capabilities to enable their business continuity.”
While Blostein expects growth of net new assets for the firm to slow down in the second quarter, organic growth rates should reach 9% by the fourth quarter, due to pent-up demand. “Moreover, we expect potential challenges with some of the smaller firms in the space to accelerate amid ZIRP (zero interest-rate policy), providing for an ample organic growth opportunity for LPLA.”