BlackRock’s Towering ETF Presence Justifies $390 Share Price

Investors led BlackRock’s (NYSE:BLK) shares lower over trading on Thursday, April 16, despite the company posting a better-than-expected earnings figure for the first quarter of the year as it reported a sequential decline in total revenues for the second consecutive quarter. ((1Q15 Earnings Release, BlackRock Press Releases, Apr 16 2015)) Considering the fact that the reduction in revenues can be traced almost completely to lower performance-related fees compared to the previous and year-ago periods, we don’t think the sell-off in the company’s shares was warranted. This is especially the case since the world’s largest asset manager saw investors around the globe pour in more than $70 billion of new cash across its various offerings over the quarter. Despite negative foreign exchange movements for the period, strong improvements in valuation across asset classes coupled with these inflows helped the company’s asset base swell to an unprecedented $4.77 trillion by the end of Q1 2015.

We have increased our price estimate for BlackRock’s shares to $390. The new price target is slightly ahead of the current market price.

See our full analysis for BlackRock

All-Around Asset Growth In Q1 Is Impressive

BlackRock offers a complete range of investment products including actively-managed as well as indexed equity and fixed-income funds, ETFs (iShares) and multi-class asset funds in addition to currency, commodities and other alternative investment funds. Q1 2015 was one of those rare periods when BlackRock reported a quarter-on-quarter increase in assets for every single one of these fund offerings. And this was despite notable headwinds for the value of BlackRock’s assets outside the U.S. due to a strengthening U.S. dollar.

The cornerstone of BlackRock’s asset base remains its extremely popular iShares ETF offerings. 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 nearly 40%. Net inflows across BlackRock’s iShares offerings were $35.3 billion for Q1 2015 – a little more than half of the company’s total inflows for the period. These gains were split almost equally between BlackRock’s fixed-income and equity iShares.

The ETF growth story continues to drive results for BlackRock, with revenues from iShares (fixed-income and equity combined) reaching $814 million for the first quarter – 34% of the $2.4 billion in fund-related fee revenues for BlackRock, and almost 30% of its total revenues of $2.7 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 less than 24% of the company’s total long-term asset base of $4.46 trillion. And the sector has enormous growth potential

Another category where BlackRock did extremely well was its active fixed-income funds, which saw net inflows of $17.9 billion for the quarter. This helped boost the size of these assets to over $720 billion. These funds, along with BlackRock’s actively managed equity funds, attract the largest fees as a percentage of assets – making them the company’s most profitable offerings in terms of margins. To put things in perspective, BlackRock’s active fixed-income funds have a fee to asset ratio in excess of 0.2% compared to a figure of less than 0.06% for indexed fixed-income funds.

Elevated Employee Costs Largely Unavoidable, But Still Under Check

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 set fees for these products low. The company has put in considerable efforts over recent years to rein in costs, and the slight reduction in operating margins this time around should not really be seen as a cause for concern because of two reasons. Firstly, costs for the first quarter are anyway expected to be higher because of the bonus payouts as well as due to the company’s strategy of spending the most on marketing efforts at the beginning of the year. Secondly, it must be remembered that BlackRock’s strong growth in the ETF industry necessitates a larger workforce. The company has done quite well to report a growth of just 2.2% in total operating expenses year-on-year, even as its headcount swelled by almost 7% from 11,500 to 12,300 over the same period.

The chart below captures BlackRock’s historical operating margin as well as our operating margin forecast for the company. While expenses are likely to grow steadily in the future as a result of the company’s plans to expand its operations geographically, we believe that revenue growth will outpace the rate at which expenses will grow over coming years. This will result in a steady improvement in operating margins for BlackRock. As you can see by making changes to this chart, 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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