BlackRock Ends 2015 Well, But Will Have To Combat Weak Conditions In 2016

BlackRock (NYSE:BLK) did well over the last quarter of 2015 to report a year-on-year increase in revenues despite the poor conditions prevalent in global debt as well as equity markets over the period. ^[1] Although revenues for the asset management giant nudged lower sequentially, the decline was almost completely due to a reduction in performance-related fees for the period. Notably, net inflows for the quarter reached $68 billion, with almost $16 billion in new cash flowing into cash management funds and roughly $54 billion in additions to long-term funds. This helped BlackRock report total assets under management of $4.65 trillion at the end of 2015 – reversing the trend of a decline for each of the previous two quarters.

There was a sharp increase in BlackRock’s operating costs, though, as the figure crossed the $1.7 billion mark for the first time in Q4 2015. This is more than 5% higher than the figure for the year-ago period, with a bulk of the increase coming from higher employee-related costs. As a result, the company’s operating margin fell to below 40% for just the third time in the last nine quarters – both the other instances being the first quarter of a year (Q1 2014 and Q1 2015), when employee-related expenses are elevated due to their seasonal nature.

While we expect BlackRock’s push into the retail investor market to add to costs in the near future, the company will have to watch expenses closely over the new couple of quarters, as market conditions are expected to remain bad over this period – putting pressure on the top line. That said, we maintain a $365 price estimate for BlackRock’s shares in view of the company’s strong position in the global asset management industry, and the immense growth potential that exists in exchange-traded funds (ETFs). The price estimate is roughly 25% ahead of the current market price.

See our full analysis for BlackRock

Q4 Inflows Focused On iShares 

BlackRock offers a complete range of investment products including actively-managed as well as passively-managed (indexed) equity and fixed income funds, ETFs (iShares) and multi-class asset funds in addition to currency, commodities and other alternative investment funds. While $53.8 billion in net new assets were added by BlackRock over the last quarter of the year, the growth primarily came from equity and fixed income iShares, which recorded inflows of $47.6 billion and $11.9 billion respectively – a total of $59.5 billion. 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 almost $1.1 trillion representing a market share of just under 40%.

The impending Fed rate hike weighed on indexed fixed income funds over the quarter, and resulted in outflows of $12 billion from these funds. On the other hand, actively-managed equity funds saw a reversal in fortunes over Q4 after a poor run over the first three quarters of the year to record inflows of almost $5 billion. This is great news for BlackRock, as active equity funds attract the highest fees as a percentage of assets among all its offerings – making them highly profitable in terms of margins. To put things in perspective, BlackRock’s active equity funds have a fee-to-asset ratio of almost 0.6% compared to a figure of 0.05% for passive equity funds. The company earned $497 million from active equity funds in Q4 (including performance fees), compared to $478 million in Q4 2014 and $450 million in Q3 2015.

Over the coming months, the expectation of more interest rate hikes by the Fed is likely to continue to result in outflows from indexed fixed income funds and fuel growth in fixed income ETFs. Also, BlackRock’s CEO expects the global equity market to remain depressed over the first half of the year due to worries about China’s economy as well as from continued reduction in oil prices. ^[2] Such a situation will also make indexed equity funds a less profitable option for investors in the near future – helping growth in active equity and equity iShares.

Cost Management Will Be Key To Maintaining Profitability

We have detailed the importance of cutting costs for BlackRock on numerous 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 has done quite well to keep costs roughly around the $1.65 billion mark over the last eleven quarters. But there was a noticeable increase in costs over Q4, as the figure went to $1.73 billion from $1.64 billion a year ago. While the increase can be partially attributed to acquisition-related costs of $23 million, the bulk of the change ($63 million) comes from higher employee-related costs.

Notably, BlackRock’s headcount has gone up from 12,200 at the end of 2014 to 13,000 at the end of 2015. This 6.5% increase in employee strength has brought in a proportional increase in costs. But BlackRock’s revenues have grown by less than 3% between Q4 2014 and Q4 2015 – resulting in a marginal reduction in operating profits. Operating margins dipped to below 40% in Q4 2015 from 41% in Q4 2014 and 42% in Q3 2015. With revenues unlikely to see any improvement over the coming quarters, and with Q1 costs being seasonally the highest for the year, margins are likely to shrink further in Q1 2016 – unless BlackRock consciously works towards cutting costs further. As you can see by making changes to this chart, a decrease of just two percentage points in margin figures by the end of our forecast period pushes our price estimate down by more than 5%.

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1. 4Q15 Earnings Release, BlackRock Investor Relations, Jan 15 2016 [↩]
2. BlackRock’s Fink Sees Another 10% Market Drop Before Rebound, Bloomberg, Jan 15 2016 [↩]