Our Order Pad | Magellan Financial Group (MFG:ASX) & Pinnacle Investment Management (PNI:ASX)

Candice: [00:00:09] Hello and welcome to talk money to me. I'm Candice Bourke 

Felicity: [00:00:13] and I'm Felicity Thomas and this is the need to know, wealth podcast where we make the complex simple. 

Candice: [00:00:18] Alright, alright, alright. So we're back once again with our order pad episode, and we're going to just jump straight into it straight into the pool because we're coming off the high from last week's episode with Grant Hackett. Now, before we do that, though, you guessed it, he comes our quick financial disclaimer. So our chat today is not personal advice, even though we are registered financial advisors at showroom partners. Please note that this podcast and the content discussed does not constitute as financial advice, nor is it a financial product. The content on this podcast is genuine nature, and you should seek appropriate professional advice before making any financial decisions. 

Felicity: [00:00:52] That's right. In fact, all companies discussed on our show are offered in good faith based on the facts known at the time and do not contain all relevant information in respect of the financial products to which they relate. So we're halfway through reporting season with 63 per cent of the ASX market having now reported. So a skew towards strength is showing through, with the median company beating consensus at the half yearly in line by 0.8 per cent.. Now this is a bates to outnumber misses by a ratio four to three. Pretty good. You know, that's an impressive showing, given that the Omnicom hit the economy has taken over the recent years. Now that said, this coming week could see a less rosy picture emerge as more domestic and consumer exposed stocks release results. So basically, what that means is we've had more debates than misses, which is very good, right? So that's showing a little bit more strength. However, we've got more reports coming up and it is more more in the domestic consumer exposed stocks. E-commerce, which we could see 

Candice: [00:01:54] more shocks and the unspoken truth about the ASX market is that generally the more misses are reported later at the latter half of the reporting season. So we'll see what happens the next few weeks to come because I guess market expectations and I guess all around earnings have actually been revised up, you know, from the profit guidance which has been seeing through the market beats that we've seen. So FY22 earnings growth estimate for the S&P, ASX 200 is actually pushed up by zero point five and a half a per cent over the last three weeks to now thirteen point six per cent. So this strength has really led by the upward revision cyclists you were saying, but mainly through, you know, the industries like financials and energy stocks. 

Felicity: [00:02:36] And by contrast to that, stocks in healthcare actually have suffered broad based earnings downgrades, which is

Candice: [00:02:42] really interesting, isn't it? 

Felicity: [00:02:44] Right now with rates, oil prices in geopolitics, buffeting market prices over recent weeks and volatility is extreme right now, leading to the many earnings boost has facilitated a somewhat unexpected day, writing in the markets PE multiple down to sixteen point six times, so it's now sitting a touch below its five year average.

Candice: [00:03:05] Yeah, because the PE multiples normally kind of around the 20 to 25 mark. Right. And I think it's interesting that we both said the same comment. You know, health care in a pandemic, why are those companies doing bad? Also, healthcare is a good hedge normally when markets are down. So we are I know, I know everyone says it, but we are really in these unchartered waters. So we spoke about it last time. And I think the reasons why we're in the uncharted territory is because of the supply chain concerns that's really dominating reporting season. So over the last week, we've been busy, you know, listening to the reports of and so Breville, Carsales, Nearmap, Orica, Tassler, the fishing salmon company, Treasury Wine, well-known wine company. They've all been talking about the same problem supply chain issues, and that's been negatively impacting all of their operations and the future outlook. So to counter these companies have been keen to highlight how they're strategically looking forward to building out their inventory, which will allow them, you know, to hopefully deal with these roadmaps in the future, because maybe we'll have more lockdowns. Who knows? Hopefully not touch wood. And interestingly, UBS, which we have research coverage at Shauwn Partners, their global economics team, have actually cited that they believe the inflation bottlenecks are now starting to ease. So we're going to watch this space really closely and keep you updated, guys. Hopefully, the analysts are correct on this prediction.

Felicity: [00:04:27] Yeah, that is good to hear, and I hope they are as well. All right, Candace. So you're actually going to add our very first sell onto the order pad. 

Candice: [00:04:36] Yeah, I know it doesn't get more exciting than that. Right, right. Ooh, this is exciting. So that's right, it's a sell for me today for the order pattern. And it's not actually a stock we've ever spoken about in our podcast before, and it's not a stock we hold in the order pad. 

Felicity: [00:04:51] Very suspenseful. What is your sell recommendation? 

Candice: [00:04:55] So the business, I think, is a sell is Magellan Financial Group. The ticker on the ASX is MFG market cap of four billion. So big company diversified. But financials and a falls within the top ASX 100. So for any of you that are listening who aren't maybe familiar with the name, Magellan Financial Group is a Sydney based fund manager responsible for the management of institutional, wholesale and retail funds, so investors like you and me in mainly global equities and listed infrastructure strategies. So they're not stock pickers of the Aussie market, but their fund is listed on the Aussie market. Now, Hamish Douglass has been labelled in the past as the Warren Buffett Down Under. And he's really been the main driver seat of Magellan since 2006, 30 per cent of the 45 billion funds under management. You know, they're a big player in the fund business has actually been sourced through retail channels, so regular investors buying on the A6 and the balance is actually institutional mandate. So, you know, large pension funds, for example, write a Magellan IPO back in 2012, and the company's been one of Australia's fastest growing managers since inception. 

Felicity: [00:06:07] So that sounds all really well and good. But I mean, what's gone wrong? You know, why is this now a sell? 

Candice: [00:06:12] Well, as you know, in the funds management business, it's really all about inflows. So how much more new investors you're attracting or existing, but topping up and your outflows, how many investors, how leaving your funds and for what reasons? And that's how the market really measures success in these funds in these diversified financial businesses. So for MFC? The net outflows remains, you know, really elevated in our opinion and combining with them defending their high fees. I think this just makes for a tough environment going forward. 

Felicity: [00:06:42] Yeah. And I think what also is important to note is their performance fee, right? And you know, historically, Magellan did outperform, but the last couple of years he hasn't actually outperformed. He's been fairly defensive 

Candice: [00:06:55] and we'll go into that because I think that's definitely a key point. Two reasons why I think it's a cautionary sell at the moment. And I think because if you pack out all the recent report, the key message that MFG were portraying was it's going to refocus on its core funds management business. That's good with an indefinite end to the further investment in Magellan Capital Partners. They also declared a monster dividend of $0 10 partially franked because obviously we're investing offshore, so you can't get the full 100 per cent franc there, and that's in a range of 90 to 95 per cent payout ratio for the business profit after tax. Plus, everyone loves when a fund manager, they're going to buyback the shares, which also naturally also does push up the share price. In theory, it should. So overall, the report was okay, and we did see the share price jump 18 per cent on the day of reporting, which was Friday the 18th the Fed. However, he's the catalyst. I think Magellan has remained steadfast in defending its high fee retail fees. So that was your point, Felicity, which we think this could actually prove long term strategic as a misstep to what would be otherwise a circuit breaker. You know, and that's because they haven't really killed the lights out like they have in the past. And as such, the earnings sustainability looks to remain an ongoing issue. How can they retain their 90 to 95 per cent payout ratio if earnings are going to decline, right? So that's a flag. And I think also it's going to contribute more ongoing snowball effect with potentially more net outflows. There's limited evidence of a turnaround in the global funds management performance. We know equities is going to be tough in the years to come. So retail investors may accelerate their outflows, in my opinion.

Felicity: [00:08:40] Okay. And so just to clarify, when you say they have high fees, what fees are you referring to?

Candice: [00:08:46] Yeah. So across there, I think there's about six or seven nail funds within Magellan. The fee ranges from about one point thirty five per cent per annum to about one point five percent per annum. In the world that we live in, where we're always driving costs down in funds management businesses, that's quite high versus a good comparison might be the WAM capital. They, you know, kind of range in a fee of one percent to one point twenty five per cent. And their global fund, which is super similar to the Magellan products, is sitting around one point twenty five percent. And of course, if you compare that to ETFs, funds are more expensive. You know, the typical fees for ETFs at around 0.5, 2.5, five percent for passive funds. And obviously, you're going to pay a little bit more if you're expecting more active ETF, that's more like one percent and the 

Felicity: [00:09:30] performance phases, right? 

Candice: [00:09:31] As well. Yeah, it was a 20 percent performance fee. Yeah. So parking the fees to one side, there's other risks that I say at the moment. So earnings are forecast to decline by an average of 6.7 per cent per year for the next three years, although on paper value, the dividend of ten point two seven percent seems super attractive. It's not well covered by these earnings and therefore not sustainable. Profit margins continue to decline. They reported thirty nine point nine per cent let's round up to 40 versus prior years of 60 percent and also addressing the. Elephant, the room, the recent turnover and reshuffled the board, CEO, C-suites, Hamish stepping down as chairman and MD for health reasons. Look, investors don't like those announcements and unfortunately, when there's bad news is always bad news to follow. And the stock actually fell 12 to 13 per cent that day on the on the back of that announcement to an all time low of sixteen point fourteen. So unfortunately, yeah, these factors contribute to tough times ahead for the Magellan share price. 

Felicity: [00:10:30] Yeah, I think there has been a lot of instability, right? And no one likes instability. Yeah, you also mentioned possible outflows due to retail investors that are not happy with the fund's recent performance. Could you elaborate further on that one?

Candice: [00:10:43] Yeah. So one of the flagship funds within the Magellan suite since inception has not actually outperformed the benchmark. And as we know in the fund's management world, you live and die by your performance. So since inception, the return has been ten point four or five percent. Sounds good, but whenever you compare it to a benchmark, he did not swim the first swimmer there because the benchmark performed twenty one point thirty five per cent in the fund. That's a tough that's a tough benchmark, right? The fund is aiming for the stars and there and it's a mainly a growth returns that they're looking for. So they're on paper aiming to strive for nine percent net of fees over the economic cycle. I mentioned earlier WAM, it's always good to compare these performances to others. So the WAM Global Fund, it's running performance since inception has been eleven point one percent and it's actually generated an alpha, beating the benchmark at one point five percent.

Felicity: [00:11:36] Look, I also read in their reports they're offering an option. So what are your thoughts on the Magellan options? 

Candice: [00:11:41] Yes, correct. And I think the market may be got lost in the dividend announcement, and they didn't go through the options as much, which is fine. But you know, this is why it pays to have an advisor and a research house covering and just offering a different perspective. So in a nutshell, the options, I think, will complicate the capital structure and add more complexity. So how it works Magellan is going to offer shareholders one four eight bonus options accessible at the share price strike rate of thirty five point over the next five years. Optimistic share price is now 21 bucks. Guys remember that employees at the same time are also going to receive 10 million in options at the same time for the same terms. So that's good. They're invested alongside the retail investors, but this adds unnecessary complexity on two fronts. Firstly, the fair value of options given to employees may actually trigger income tax, which raises questions as to how they will be funded by employees, noting employee loans already are underwater given the recent stock price declines. And we estimate that the tax implication for employees are still kind of getting worked out 

Felicity: [00:12:47] because I usually have actually pay that tax in the year they get the options, which is kind of frustrating. 

Candice: [00:12:52] Correct. And then the other point I think is important to note is that the share count dilution for the options will be dynamic based on the share price. So this will result in increasing dilution towards the exercise price of $35. So if the upsides achieved hope it is, this could result in circa eight per cent increase in the share price with a notional value of one point one billion. So I think it's interesting to see who in the next five years will take it up if anyone will, and also inside the business who will take it up. Like key stakeholders, we always talk about skin in the game, right? 

Felicity: [00:13:27] That's it. I think that's definitely one to watch. So look, giving yourself preference, what do you think the share price could potentially drop to? 

Candice: [00:13:35] So looking in hindsight and not that that's a prediction, but it's important to note in the last six months, the share price has effectively halved from its levels around $40, now trading around twenty one point fifty per share. So I think the downwards pressure will continue to hang around for the short term for those reasons mentioned earlier, and we have a valuation of it reaching $17 as fair value. Hence, I'm not a buyer at these levels and I'd rather be taking profits if that's applicable based on your cost base or waiting for the share price to come off like it did with the Hamishe announcement 16 box. If you report, then you're up sort of 30 percent already in the short term. Great. Happy days, but I'm not a buyer until we get to those levels. 

Felicity: [00:14:15] Yeah, that's a good point.

Candice: [00:14:17] Now, before we hear the next segment in our old iPad from Felicity, which I believe is a buyer, we're just going to take a short break to hear from our sponsors. 

Candice: [00:15:35] So we're back and what stock are you bringing to the order pad this week, Felicity? 

Felicity: [00:15:39] So I actually thought, I'm going to counter your cell with a buy of a diversified financial manager. So my idea today is Pinnacle Investment Management. Now the code is P and I on the ASX. The 52 week range has been between eight point sixty two and 1893. Now it's currently trading around the ten point seventy $11 mark. The market cap is $2 billion, so it's actually a bit bigger than my usual peaks and also provides a dividend yield of three and a half percent. Wow. 

Candice: [00:16:11] This is like so unheard of for you.

Felicity: [00:16:14] Was where's the growth? It really was the future earnings that see negative earnings. Yeah, exactly. 

Candice: [00:16:22] So, OK, so makes money good, positive and love it. And it's a pretty big. But diversify financials. 

Felicity: [00:16:28] That's it. Diversified financial, which is where you kind of want to be at this point in time. So Pinnacle is actually a multi affiliate with minority equity stakes in 16 different investment management boutiques for which it provides global distribution and support services. So the aggregate of FUM of is about ninety three point six billion, with P and I's effective share of thirty six point four billion. So they own quite a large part of the aggregate farm of all of these managers. Now you would have heard a lot of these names that are actually under their umbrella, but maybe not know that they're a part of Pinnacle. So a few of my favourites and the largest by if and which is funds under management in the credit space is actually metrics with 23 percent callable capital, 35 percent and Plato income maximiser 42 percent. In the equity space, you've got one of our favourites, Hyperion, and they actually own forty nine point nine percent of that. You've got Antipodes 23 per cent, fire trail 23 per cent, as well as Saphira, which is then micro to small cap manager. So a lot of really, really great household names there, really? Yeah. 

Candice: [00:17:36] And we are definitely familiar with these names and you might be as well because particular in the equity space, their funds have really outperformed lately. So they're getting a lot of press on that, which is great. 

Felicity: [00:17:45] Well, that's it. Hyperion has continuously outperform for the last 10 years, but I think we are getting into a tricky time now where they're hyper growth may not be as favourable. We shall see. Now, the affiliates have a huge product suite across a variety of different investment options and classes, as well as different investment vehicles. So I think unlisted managed funds, ETFs, you know, your listed investment companies, Alex and your listed investment trusts, so yorlets. However, the reason I've actually chosen this for out what Pod is. Its three pillar horizon strategy provides a multiple avenues for long term growth, with a 14 percent per annum earnings outlook for FY 22 to 25, which I think is organically driven. You know, we believe that Penny is improving diversification some affiliate to cycling, strong performance against the more turbulent backdrop for growth equities. And management has pointed to significant offshore opportunities. So there's about 135 million of dry powder, which could actually transform Penni into an all weather global multi affiliate with reduced earnings volatility and improved resilience. So I think that Penei has the ability for this substantial organic growth run rate with operating leverage in particular, like I said, because of the fact that it's diversified, right? Unlike Magellan, that's just focussed on global growth. Penny has its, you know, toes in all different honey pots 

Candice: [00:19:11] and also offers different investors, different products, ETFs, unlisted managed funds so they can be diversified in their performances, their fees 

Felicity: [00:19:19] and different strategies. Value growth, income. They've got a little bit of all. 

Candice: [00:19:24] And when you say dry powder 235 million, that's purely meaning ammunition for more potential M&A in the future to buy into more stakes of businesses. 

Felicity: [00:19:32] And that's what I was going to go through a little bit later that they're actually growth strategies to buy smaller funds as well as seed new funds, which is pretty exciting, which you would have seen with Fire Trail that smaller ex Macquarie fund. 

Candice: [00:19:44] Okay, so that's all interesting and makes sense. But explain to us, I guess, how the funds business is going to grow because we know that's how these businesses are measured and success, right? 

Felicity: [00:19:55] That's it. So look, the existing capabilities can support farm of three times the current aggregate fund. So like I said earlier, it's almost 94 billion. Now, this may not all materialise. However, even with the modest conversion of 20 per cent of capacity headroom, it adds 50 per cent profit upside. So we believe that Penny's proven ability on execution and distribution suggests the potential for multi-year above average net inflows. So you mentioned inflows were important. We think Penny is going to have those inflows, and that's going to be about eight percent per annum up to fifth y 25. So rather than you're negative, I think you were negative. This is. Positive, right? 

Candice: [00:20:35] Yeah, so that's a tick. That's interesting, very much so. 

Felicity: [00:20:38] Yeah, it is. And they're also recycling institutional capacity into higher margin retail, so that can actually help insulate the revenue margin pressures. This combination actually results in operating leverage at the affiliate level, where aggregate cost income ratio can reduce further. So what I mean by that is currently, if you actually look at the allocations, they've got sixty nine point eight billion in institutional versus twenty three point eight billion in retail. And what they're actually going to look at doing is getting more into retail. 

Candice: [00:21:06] Yeah, because obviously we saw with the Magellan announcement, if you underperform and you lose an in-store client, that could be 30 percent of your overall revenue, right? There are big client you don't want to piss off. So the more diversified in your book and I guess optimal 50 50 in store and retail is is a good number, but we don't run funds management. So I just kind of thought that's a good balance.  

Felicity: [00:21:29] Well, that's it, right? And like we know in retail, retail pay higher fees as well. So what I'm trying to say here is there's potential for an increase in fees when they distribute more

Candice: [00:21:39] of it to the retail side. 

Felicity: [00:21:40] Exactly, exactly. 

Candice: [00:21:42] Okay. So the fee is important and I guess the performance fee potential, what about that side of things? 

Felicity: [00:21:49] Right. So Pino has material exposure to performance fee FUM, so about $31 billion, which is 33 per cent across 18 strategies. So the relevance of the performance fees is actually increasing as retail becomes a larger part of the fund mix. So, you know, generally managers do charge about 20 per cent performance fees. You know, performance fees are actually normally considered volatile and non-recurring revenue through different 

Candice: [00:22:17] cycles because they have to hit the benchmark.  

Felicity: [00:22:19] Well, exactly, and not something you'd rely on, but they're actually expecting it to be about 30 percent of their overall fund, which is kind of interesting. So our bottom up fund level modelling suggests a normalised two percent alpha, which equates to performance fees revenue of 70 million per annum over the next three years to five 25 versus consensus of about 100 mile per annum. So, you know, our UBS price target and I guess modelling is a little bit lower than consensus, but we'll go down through that a little bit later. 

Candice: [00:22:50] So I guess, like all things with forecast, we need to wait and see to see if they can deliver on these expectations over the next three years, right? 

Felicity: [00:22:58] Yeah. And I think at current levels of stock is pricing in no actual value for the performance phase. Well, that's good. Yeah, I like a little bit of a cherry on top. You know, just look at Hyperion. In 2021, the performance fees were twenty point four million as they absolutely knocked it out of the park, you know, so hopefully it might not be Hyperion, but it might be, you know, more of the credit managers. 

Candice: [00:23:16] Yeah, definitely. Like as inflationary talks are geopolitical concern. Do we go more defensive as a fund? You know, I think that's really interesting, and they did smash up the park in 2021. Let's see how they deliver in 2022. 

Felicity: [00:23:29] It's going to be a tricky year, but yeah, they are really great managers with a lot of experience. Now to summarise why, I believe this is a buy where we are really attracted to the and I multi affiliate business model and prospects to drive long term earnings growth by its Horizon strategy. So one is organically significant capacity in operating leverage from existing strategies to they're setting new batiks and three, they're acquiring established boutiques. Now, future acquisitions have the potential to diversify even further the business and add to earnings resilience from cycling factors due to no real style in asset class. 

Candice: [00:24:10] Yeah, diverse range. That's it. All right. So I guess in summary, really paying I way more diverse across more asset classes in the options that they provide. So that that means products, right ETFs or unlisted listed LICs versus Magellan is sort of a one stop shop for the global equities side. So let's talk about price targets and upsides and all the fun stuff that you think paying I 

Felicity: [00:24:34] will get to. Yeah, so look, it's a buy for pay and I, you know, it trades on twenty four point four times a flat 23 per day with 14 percent per annum. Earnings growth outlook. The risk to this recommendation would be sustained equity market downturn. Obviously, none of us want that or a credit cycle. So consensus price targets fifteen point six one with upside of forty five point seven per cent from current prices, and UBS is a little bit more conservative, like I said earlier, with a $14 price target or 80. 

Candice: [00:25:03] So that's the order pad for another week. We hope you enjoyed it. Send us your thoughts, comments, feedback on any stocks that you're currently watching because we'd love to hear what you're liking or not liking at the market in the moment. Don't be afraid to reach out to us through our social media channels, not just Aussie stocks, but a global. We're afraid of nothing here. Talk money to me. So before we sign off, please remember, although Felicity and I are financial advisors at short partners, as always, the discussion today does not constitute just financial advice or personal advice, as always. Reach out to professional financial adviser before making your financial decisions. 

Felicity: [00:25:38] That's right, and look what we probably will do. We've had some questions come through about particular stocks we may actually have listed as stocks and kind of give our thoughts on it in the need to know episodes to make a little bit more juicy for you. So feel free to reach out to us on our social media channels or send us an email which is displayed in the show notes below. Make sure you follow us on App Talk Money to Me podcast The Daily Market Updates Until Next Time