Equity iShares, Cost Management Pump Up BlackRock’s Q2 Results

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BlackRock’s (NYSE:BLK) dominance in the rapidly growing exchange-traded fund (ETF) industry is evident from its second quarter earnings announcements, as the asset management leader reached nearly $1 trillion in assets for its iShares ETF offerings by the end of June. [1] While the company saw strong growth across asset classes, the growth in its asset base was spearheaded by equity iShares, which swelled 6% quarter-on-quarter to reach $774 billion by the end of Q2. Passively-managed equity funds and funds managing multi-class assets also saw decent growth, thanks to which BlackRock’s total long-term assets under management (AUM) grew to just under $4.3 trillion from $4.1 trillion three months ago. The total asset base now stands at an impressive $4.6 trillion, with market value appreciations of $153 billion, complementing net inflows of $40 billion for the period.

More importantly, BlackRock saw a significant improvement in its operating margins, which increased to 40.4% from 34.2% in Q2 2013 and 39.4% in Q1 2014. This is a commendable performance, as a bulk of the company’s growth in the quarter came from low-cost ETFs with a very small fee component – indicating that the margin gains can be attributed to stricter expense management by the company.

In view of the better-than-expected performance by BlackRock in Q2, both in terms of growth in its asset base as well as the improved operating margins, we have revised our price estimate for BlackRock’s stock upwards from $334 to $355. The new price target is about 10% ahead of the current market price.

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iShares Now Responsible For Nearly One-Third Of Total Revenues

Since BlackRock acquired iShares from Barclays Global Investors in late 2009, the investment product has seen the fastest growth among all that the company has to offer. The company is the undisputed leader in the ETF industry, with its $1 trillion asset base representing a market share of 38%. [2] And the brisk growth pace is not expected to slow down any time soon.

The company is doing well to cash in on the ETF growth story. Revenues from iShares (fixed-income and equity combined) were $799 million for the second quarter – 33% of the $2.4 billion in fund-related fee revenues for BlackRock. Assuming that the company made roughly $50 million from its multi-class asset and commodity iShares (revenues for which are not reported separately), iShares revenues were easily responsible for more than 30% of the company’s total revenues for the period ($2.8 billion). A better idea of the importance of iShares in BlackRock’s business model is demonstrated by the fact that this revenue share is achieved despite ETF assets forming just a little over 20% of the total asset base. The higher revenue potential from iShares compared to passively-managed funds explains this discrepancy and is something BlackRock will be looking to capitalize on to grow its top line in the future.

Cost Efficiency Remains Top Priority

We have detailed the importance of cutting costs for BlackRock on several occasions in the past, especially given its shifting focus on the retail investor market. This is because the largely untapped retail investor market is heavily influenced by the price of the products offered – requiring BlackRock to keep its fees from these products low. The company’s efforts to rein in costs have made a tangible impact on the bottom line over the recent quarters. BlackRock reported operating expenses of $1.66 billion in Q2 2014 – tad higher than the $1.63 billion in Q2 2013 and the $1.62 billion in Q1 2014. But the much higher growth in revenues for the period saw the cost benefits being transferred to the bottom line.

The table below shows the overall improvement in non-interest expenses as a percentage of revenue for BlackRock over the last three years. While expenses are likely to grow in the future given BlackRock’s plans to expand its operations geographically, we believe that revenue growth will outpace the rate at which expenses will grow over the coming years. This will result in a steady improvement in operating margins for the company.

Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014
65.0% 63.1% 65.1% 63.7% 63.8% 62.8% 62.3% 60.4% 62.9% 65.8% 60.9% 59.2% 60.6% 59.6%

As you can see by making changes to the chart below, which represents BlackRock’s actual and forecast operating margins, an increase of just two percentage points in margin figures by the end of our forecast period would push our price estimate up by more than 5%.

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Notes:
  1. 2Q14 Press Release, BlackRock Press Releases, Jul 16 2014 []
  2. iShares Brochure []