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Barclays: why we've upgraded Schroders and downgraded Jupiter

In a detailed note on the asset management sector Barclays reveals its top picks for 2014 and the firms it will be avoiding.

Barclays has upgraded its rating of Schroders and downgraded Jupiter, while maintaining overweight recommendations on Aberdeen and Hargreaves Lansdown and underweights on Henderson and F&C.

Analysts Daniel Garrod and Toni Dang explain their thinking on some of the UK’s largest listed asset managers.

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Aberdeen Asset Management

Share price (2 January): 490p

Price target: 580p (Overweight)

[The pair say] Aberdeen, managed by chief executive Martin Gilbert (pictured), has a strong equities performance track record and a favourable product mix effect is raising average revenue margins. The balance sheet is improving, with capital returns from the end of 2014 likely. Capacity constraints in the equities offering and further fixed income outflows appear the main threats to share performance, but these appear manageable.

The Swip acquisition is a positive, raising group assets under management to £336 billion but more importantly giving improved diversification. It reduces profit concentration on emerging markets/Asia to around 55% from 75%. The pure emerging markets asset base falls to circa 13% from the current 22% of assets under management. Swip has strengths in areas where Aberdeen wants to grow but does not have critical mass, such as investment solutions, UK bonds and property.

Upside case: Aberdeen is showing good progress on improving operating margins. With rising revenue margin trends and strong cost discipline, operating margins could hit 50% for the financial year 2015, causing earnings per share to rise to circa 41.5p. If re-rated to 16x 2015 estimated earnings, this would suggest an upside case of 665p.

Downside case: A market and flow reversal could cause 2015 operating margins to slump back to 39%. This could cause 2015 estimated earnings per share to fall to 32p. If de-rated to only 12x 2015 estimated earnings, this would suggest a downside case of 385p.

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Ashmore Group

Share price (2 January): 399.8p

Price target: 410p (Equal weight)

Ashmore is a quality niche franchise with strong revenue margins and cost discipline. Fund flow experience has been mixed in late 2013, with concern around industry redemptions from emerging markets post quantitative easing tapering. Trading at around 14.5x 2014 estimated earnings, Garrod and Dang believe the share price is fairly valued for flow momentum and revenue margin concerns.

Upside case: Garrod and Dang currently assume net inflow rates for the financial year 2014 of around 4% and 7% for 2015. If net inflow rate were to double to 8% and 14%, this suggests a June 2015 estimated earnings per share of around 34.5p. With a re-rating to 16x earnings, this suggests an upside case of 550p.

Downside case: Assuming net flows fall to -4% for financial years 2014 and 2015, this suggests an earnings per share for June 15 of 26p. With a de-rating to 10x earnings, this suggests a downside case of 260p.

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F&C Asset Management

Share price (2 January): 92.4p

Price target: 85p (Underweight)

Garrod and Dang highlight concerns around F&C’s ‘patchy fund performance, relatively low brand awareness amongst retail consumers and lower gearing to equity assets under management to benefit from the industry rotation out of bonds and the retail distribution review’. They believe the cost cutting story has run its course but say F&C lacks the drivers to deliver stronger earnings per share growth than its peers.

Pictured is Sam Cosh, Citywire AAA-rated manager of the F&C European Small Cap fund.

Upside case: Assuming equity markets rally 10% rather than Garrod and Dang’s base case of 5% in 2014, and retail net flows also increase from 7% to 15%, financial year 2014 estimated earnings per share rise to circa 10p. Assuming the shares get re-rated to a 15x price-to-earnings multiple, Garrod and Dang arrive at an upside case of 150p.

Downside case: Factoring in an equity market correction of -10% in financial year 2014, and a net outflows rate ex strategic partners of -5%, similar to financial year 2012, 2014 estimated earnings per share fall to around 7.5p. If the shares get de-rated to their trough multiple of 8x, Garrod and Dang arrive at a downside case of 60p.

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Hargreaves Lansdown

Share price (2 January): 1405p

Price target: 1560p (Overweight)

Garrod and Dang rate Hargreaves Lansdown overweight due to its strong ability to attract inflows, sticky asset base and leading position in the direct to consumer market. Garrod and Dang believe the retail distribution review will provide strong assets under administration growth stimulus as subscale IFAs exit the market and their orphaned customers seek to go direct, while revenue pressures will be manageable.

Pictured are co-founders Peter Hargreaves and Stephen Lansdown.

Upside case: Assuming Vantage’s financial year 2015 flow rate is boosted by the retail distribution review stimulus to 35%, this suggests 2015 estimated earnings per share of 49.5p. If the stock gets re-rated to around 35x, this suggests an upside case of £17.30.

Downside case: Assuming Vantage’s financial year 2014 net flows become disrupted by the retail distribution review and fall back to around10%, this suggests a 2015 estimated earnings per share of 44p. De-rating the stock to around 18x, this implies a downside case of £8.00.

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Henderson

Share price (2 January): 228.2p

Price target: 205p (Underweight)

With circa 55% of assets under management in equities and 43% of retail assets under management, Henderson has good gearing to a market recovery. However, having re-rated to 15-16x, the stock now looks expensive compared with its peers with similar or even higher gearing to UK retail investors.

In addition, the Tiaa-Cref joint venture is earnings dilutive, which means the stock offers no earnings growth in financial year 2014. Pictured is chief executive Andrew Formica.

Upside case: Henderson has a strong concentration on equities assets under management. With a broad market recovery, inflows in 2014 could total 8% and market movements could boost assets under management by 8%. This could cause earnings per share to rise to around 15.5p. With a re-rating to 16x, an upside case would be 250p.

Downside case: With a strong market correction in equities, outflows in 2014 could total -5% and market movements could reduce assets under management by -5%. This could cause 2014 earnings per share to fall to circa 12p. With a de-rating to 11x, a downside case would be 132p.

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Jupiter Fund Management

Share price (2 January): 386p

Price target: 410p (Equal weight, downgraded from overweight)

Jupiter has a leading position in UK retail. However, of late its flow momentum has been held back by manager rotation and retirements. The average revenue margin is high, which could put the name at risk from increased manufacturing pricing pressures. The valuation at around 14x 2014 estimated earnings is in line with its peers.

Pictured is Edward Bonham Carter, who will step down as chief executive in March and hand over to Maarten Slendebroek.

Upside case: Assuming equity markets rally 12% rather than Garrod and Dang’s base case of 6% in 2014, and the net flows rate also increases from 6% to 12%, financial year 2014 estimated earnings per share rise to circa 30p. Assuming the shares get re-rated to a 16x price-to-earnings multiple, Garrod and Dang arrive at an upside case of 480p.

Downside case: Factoring in an equity market correction of -10% in financial year 2014, and a net outflows rate of -10%, 2014 estimated earnings per share fall to around 23p. If the shares get de-rated to their trough multiple of 12x, Garrod and Dang arrive at a downside case of 275p.

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Man Group

Share price (2 January): 86p

Price target: 94p (Equal weight)

Man’s AHL performance recovered then reversed in 2013. Flows improved in Q3 2013, with the first net inflow in over two years. However, management’s gross sales outlook appears pessimistic for 2014, with CTA funds still impacted negatively by market volatility.

Pictured are Neil Edwards and Stephen Harker, the + rated pair who co-manage the Citywire Selection GLG Japan CoreAlpha fund.

Upside case: In Garrod and Dang’s base case, they assume an inflow rate for financial year 2014 of only 1% and apply a 14x valuation to their projected 2014 estimated management fee profit before tax. If the flow recovery was stronger to 10% and management fees were valued at a higher 16x, Garrod and Dang’s target price would rise to 115p.

Downside case: If Man continued to suffer strong outflows of -10% and management fees were valued at a lower 12x, Garrod and Dang’s target price would fall to 76p.

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Schroders

Share price (2 January): 2605p

Price target: 3010p (Overweight, upgraded from underweight)

Garrod and Dang rate Schroders overweight due to its improving flow momentum now that the Richard Buxton headwind is receding (pictured is his replacement on the Schroder UK Alpha Plus fund, AA-rated Philip Matthews). The group has an attractive equity market gearing, with an impressive international distribution franchise and strong balance sheet.

Upside case: Assuming Schroders’ financial year 2014 flows return to 2010’s level of around £27 billion and net revenue margins can be maintained at 56 basis points, 2014 estimated earnings per share could be around 175p. At an 18x price-to-earnings multiple and with excess capital of £2.51 per share, this suggests an upside case of circa £34.00.

Downside case: Assuming Schroders’ financial year 2014 flow slowdown is severe, to zero, and net revenue margins fall to 52 basis points, 2014 estimated earnings per share might be only around 138p. At a 13x price-to-earnings multiple and with excess capital of £2.51 per share, this suggests a downside case of £20.50.

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