Artisan Partners Asset Management: Still A Good Investment After A Runup (NYSE:APAM)

Investment Thesis

Artisan Partners Asset Management Inc. (NYSE:APAM) just reported its Q4 numbers. I wanted to give an update on the company’s performance since my last coverage of the company, where I assigned it a buy, and since then the share price has appreciated 46% (dividends included) against the S&P 500’s (SPY) 24% appreciation. The company’s performance has remained relatively stable over the last three quarters, which is a good sign that shows its resiliency in turbulent markets. Cash outflows are not as prevalent as in the previous quarters, which may mean the company will see increases in client numbers over the next quarters if the macro environment doesn’t get worse. I am reiterating my buy rating on Artisan Partners Asset Management shares and upping my fair value price target (“PT”).

Update on Financials

As of Q3 2023, the company had around $198m in cash and equivalents against the same unchanging amount of debt throughout the years of $199m. This is a great position to be in – plenty of cash and not overleveraged – in my opinion. The annual interest expense is easily covered by the company’s EBIT, 35 times over, so the company is not at any risk of insolvency.

In terms of revenues over the last year, the company saw a slight bounce since Q2 2023, and in Q3, the company saw a y/y increase in revenues as compared to the other two when the comparison wasn’t as favorable. Q1 saw almost 17% decline, while Q2 saw a little over 3% decline.

In terms of margins, we can see only slight improvements to the bottom line, however, it’s better than nothing. Since the improvements to the bottom line didn’t come from efficiencies in the operations, it is not an ideal situation for the company. I would have preferred to see gross and EBIT margins improving, which then would have led to an improvement in the bottom line. This way I have a feeling that net margins will keep fluctuating over time and may come down if gross and EBIT margins will continue to come down in the future.

Unsurprisingly, the company’s ROA and ROE have also seen an improvement due to the higher bottom line. These metrics have been very good throughout the years, which means the management is competent at utilizing the company’s assets and shareholder capital efficiently and is creating value. Furthermore, the company still boasts an impressive ROTC, which measures how efficient the management is at allocating capital available to profitable projects. I usually look for at least 10%, and here APAM managed more than double. For such companies, I don’t mind paying a little extra premium to own.

Overall, APAM seems to have done decent over the last three quarters since I covered the company. The balance sheet is very strong and is not overleveraged. I would like to see efficiencies coming from streamlining operations, which would improve gross and EBIT margins, and less through gains/losses on investments, which tend to fluctuate quite a lot over time.

Numbers from Earnings

GAAP and non-GAAP EPS come in at $0.92 and $0.78, respectively, beating estimates of $0.69 and $0.74, while also beating on the top line by around $6m.

The company also reported just as expected around $400m in net cash outflows from clients who chose not to reinvest their distributions, which is not as bad as it was in the previous quarters, however, assets under management, or AUM, increased around 10% to $150.2B.

I expected AUM to increase since the markets went up in the last quarters quite considerably, and I am happy that the net outflows were relatively low. We can also see an increase in operating margins y/y, which is a very good thing to see considering these were going lower over the past 3 quarters.

Overall, I would say the report was decent and pretty much what I expected to see. A strong overall market boosted APAM’s numbers, and this led to improved efficiencies and higher profitability. It wasn’t an outstanding beat, but it was better than nothing.

Comments on the Outlook

I would like to see this momentum continue, however, when it comes to asset managers, they are dependent on the overall market sentiment and outlook. I would like to see the company improve its margins through operational efficiencies and not because the broad market was going in its favor, which made the company more profitable. If operational efficiencies happen, then you can be sure they will stay there in the long run.

In terms of AUM, I would like to see cash inflows dominate the next quarters rather than outflows, as we have seen for the last few quarters. However, as I mentioned, it’ll all depend on the overall economic outlook, and whether the investors will be skittish because inflation isn’t coming down as quickly or is much more sticky, while interest rates will have to remain higher for longer.

The good news is that cash outflows have reduced quite a bit. In Q1, the company saw $1.3B outflows, Q2 saw $1.1B, and Q3 saw $1.3B, so a net cash outflow of $400m may be a sign that the clients are not as afraid anymore and we may see inflows very soon. Customer retention is going to play a major role in the company’s top line performance. An increase in AUM through market appreciation also plays a supporting role, but ultimately the company needs to retain and gain new clients over the long run, and when AUM naturally increases through better market conditions, this should help the company attract more clients.

Valuation

It’s been quite a while since I covered the company back in March of 2023, so I went ahead and updated my model also since interest rates have changed quite a bit in the last while.

For revenue growth, I went with around 3% CAGR over the next decade, which I think is rather conservative. The company managed around 5% over the last 3 years and around 4.2% over the last decade. This will provide a bit more room for error in case my calculations are not as accurate because in the end they are subjective and depend on the person’s perspective of the company’s potential. I went ahead and modeled a more conservative and a more optimistic case, to give myself a range of possible outcomes. Below are those estimates and their respective CAGRs.

For margins and EPS, went with much higher costs and expenses that will come down gradually over the next decade and the company will be as efficient as it was just a few years ago, which I think is still on the more conservative side since FY21 saw even better margins overall. Below are those estimates as compared to FY22.

For the discounted cash flow, or DCF, model, I went with an 11% discount rate and 2.5% terminal growth rate. I wanted to be more conservative so, I went with 11% instead of 10% for that extra margin for error. Furthermore, I discounted the final intrinsic value calculation by another 15% just to be on the safer side. It is not as much of a discount as I did back in March, which was 25%, but I feel like such a high ROTC and a great balance sheet warrant a lower discount. Additionally, my revenue and margin estimates were on the lower end in my opinion, so I feel a 15% discount is sufficient.

With that said, APAM’s intrinsic value is around $45.5 a share, which means the company is still trading at a discount to its fair value.

Risks

Everything will depend on the overall macroeconomic outlook in 2024. This will dictate what people do with their capital. If investors think there’s a lot more pain ahead, they will most likely continue to withdraw their capital and keep it in cash until more certainty is back in the markets and global economies. There are still mutterings of the possibility of a soft landing, where the U.S. economy doesn’t go into a recession and inflation numbers continue to come down to the FED’s goal of around 2% to 2.5%. If that happens, I expect APAM to perform rather well over time, but if anything goes wrong and the economy falls into a recession, nothing will save the company’s share price, or any other company for that matter.

The money managers at APAM have done a commendable job over the last decade since its inception, making a lot of money for their clients. The risk may come from them becoming subpar, and underperforming the overall passively managed accounts that have little to no fees. This will push out a lot of the investors from their funds in favor of competition or just an outright buy-and-hold strategy of major ETFs.

Closing Comments

Even after such a runup in share price since my last article, Artisan Partners Asset Management Inc. seems to have improved enough to warrant a price target upgrade. The time will be quite volatile for a bit during its earnings day, but if the share price comes down on some noise and the company’s thesis remains intact, I will consider it as a good time to accumulate more shares or start a position. Therefore, I reiterate my buy rating on Artisan Partners Asset Management Inc. shares and will be looking to start a position post earnings.