BlackRock Rides ETF Wave To Post Exceptional Q3 Results

BlackRock (NYSE:BLK) reported a strong set of earnings for the third quarter on Wednesday, October 15, with the world’s largest asset manager comfortably beating expectations on the back of its extremely popular iShares ETF offerings. ^[1] Although the company saw its assets under management shrink from $4.59 trillion in Q2 to $4.52 trillion in Q3 due to unfavorable movements in market valuations as well as exchange rates, a strong demand for equity iShares and money market products resulted in net inflows of $39 billion over the quarter. This helped total revenues reach a record $2.85 billion for the period. Coupled with BlackRock’s effective cost management initiatives, this resulted in a record $1.16 billion in operating income for the company in Q3.

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iShares Remain The Largest Source of Revenue

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. BlackRock is the undisputed leader in the ETF industry, with its nearly $1-trillion in iShares assets representing a market share of almost 40%. And the brisk growth pace is not expected to slow down any time soon.

Revenues from iShares (fixed-income and equity combined) were $831 million for the third quarter – 34% of the $2.5 billion in fund-related fee revenues for BlackRock. Most of these revenues were due to equity iShares, which roped in $708 million over the period. This represents almost 25% of the company’s total revenues for the period ($2.85 billion). The importance of iShares to BlackRock’s business model is demonstrated by the fact that this revenue share is achieved despite ETF assets forming just about 20% of the total asset base. The higher revenue potential from iShares compared to passively-managed funds explains this discrepancy and is something BlackRock has been keen on exploiting over recent months by targeting retail investors with low-cost ETFs.

Better Cost Management Helps Boost Bottom-Line Growth

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 recent quarters. BlackRock reported adjusted operating expenses of $1.63 billion in Q3 2014 – a sequential reduction from the figure of $1.65 billion in Q2 2014. As revenues grew considerably over the same period, the ratio of adjusted operating expenses to total revenues hit a lowest-ever figure of 57.3% for this quarter.

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. 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 margins by the end of our forecast period pushes our price estimate up by more than 5%.

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1. 3Q14 Earnings, BlackRock Press Releases, Oct 15 2014 [↩]