BlackRock Leverages iShares Success To Post Strong Q3 Results Despite Headwinds

BlackRock (NYSE:BLK) successfully navigated through the volatile conditions in the equity and debt markets in the third quarter, reporting strong earnings figures for the period on Wednesday, October 14. ^[1] Although the asset management giant reported a reduction in its base fee revenues compared to the previous and year-ago quarters, a surge in performance-related fees more than made up for the shortfall and raised total revenues to record levels. BlackRock also did well to maintain margins at roughly the same level as the two comparative periods – allowing it to comfortably beat investor expectations from its results.

The gains over Q3 can be primarily attributed to total inflows of $50 billion for the quarter, with net inflows into long-term funds crossing $35 billion. This marks a notable reversal from the $7.3 billion in net outflows for the previous quarter. Clients added more cash to nearly all of BlackRock’s fund categories, except for passive equity funds and multi-class asset funds which saw minor outflows. Adverse changes to market valuations and unfavorable exchange rate movements hurt all fund classes, though, and dragged down the size of total assets under management to $4.5 trillion – a reduction for the second consecutive quarter from the record high of $4.77 trillion seen at the end of Q1 2015.

We have reduced our price estimate for BlackRock’s shares marginally from $385 to $374 to account for the impact of suppressed asset valuation levels on the company’s short-term performance. The new price estimate is roughly 15% ahead of the current market price.

See our full analysis for BlackRock

iShares Continue To Fuel BlackRock’s Growth Engine

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. While nearly all these offerings reported net inflows over Q3, a bulk of the new funds came from BlackRock’s highly 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 asset base of roughly $1 trillion representing a market share of almost 40%. Net inflows across BlackRock’s iShares offerings were $23.5 billion for Q3 2015 – representing nearly half of the total inflows for the quarter and more than two-thirds of the inflows to long-term funds. Fixed income iShares led the way, roping in $18.2 billion.

BlackRock’s active fixed income funds also fared well in the third quarter, with net inflows crossing $8.7 billion. This is the third consecutive quarter with strong inflows, a trend driven by the expected hike in benchmark interest rates by the Federal Reserve. BlackRock’s active fixed income funds have reported total inflows of almost $36 billion over the first nine months of the year (second only to the $38 billion in new cash for fixed income iShares), and we expect this figure to increase further in Q4.

This is great news for BlackRock, as actively managed funds attract relatively high fees as a percentage of assets – making them one of 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 passive fixed income funds. The company earned $402 million from active fixed income funds in Q3.

BlackRock Keeping An Eye On Costs

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 low fees for these products. The company has put in considerable efforts over recent years to rein in costs, and the efforts seem to be paying off in terms of lower ancilliary costs. Total operating expenses were marginally lower year-on-year despite the fact that employee-related costs were 5% higher in Q3 2015 compared to Q3 2014. The gains have come entirely from lower general and administration costs. Although costs edged up marginally over the previous quarter, this is to be expected given the increase in headcount from 12,400 to 12,900 as well as the higher performance-related compensation costs this time around.

The chart below captures BlackRock’s historical operating margins 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 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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1. 2Q15 Earnings Release, BlackRock Press Releases, Oct 14 2015 [↩]