Description

Raymond James (RJF), a high quality brokerage firm based in Florida, has gotten smoked in the October market sell off.  With the stock down 28% from its peak just 3 months ago, RJF has traded down from a multiple of 13.6x to 9.8x forward 12 month earnings.    While the stock did fall a bit over 50% in 2008, the company’s earnings actually only dropped by roughly 35% from 2008 to 2009 (from $1.93 to $1.25).  Interestingly, its P/E ratio fell from 15.5x to 10x at the bottom, but only for a brief period of time in early 2009. For most of Q4 2008 RJF traded between $15 and $20 per share, or around 14x earnings.

The market today seems already to be pricing in a large decline in earnings despite a record 2018 year across the board (FYE is September).  Revenue was up 14%, adjusted pretax earnings were up 17%, and EPS grew a whopping 40%. With runrate EPS at $6.72, a down 35% EPS year would put RJF stock at $61 per share assuming a similar 14x earnings multiple.  That would be downside of 15% in a year after dividends.

On the plus side, assuming 10% EPS growth for a couple year (well below its historical average EPS growth rate), and the stock trading back to its normalized 15x multiple (about average), would imply upside of 64%, to $120 per share with dividends.  We like this kind of asymmetric risk reward.  Even more we like the quality of management and the business at Raymond James.

Basics

Business

Raymond James is a regional broker with 7800 financial advisors.  The business was founded by Bob James in 1962 (whose son Tom took over as CEO in the early 1970s), went public in 1983, and is still run conservatively in a variety of businesses:

1.       The Private Client Group is the 6th biggest in the US.  PCG is 68% of total company revenue, and 45% of pretax profit.  4600 of their advisors are independent, and carry their own overhead and costs. This offers a more variable cost structure, which is particularly important during bear markets.  In 2009, compensation costs actually fell from 68% to 66% of net revenue. Overall RJ brokers administer (AUA) of $756BB, about half of which are in fee-based accounts. The company’s aim is to grow its advisor base by 5% per year.  Coupled with market gains, PCG has grown revenue at a 12% CAGR over the past 5 years. Despite fee pressure from ETF’s and the threat of robo-advisors taking share, to date these have had limited impact on PCG’s top or bottom lines. Wealthier retail clients simply need more financial services in tax and estate planning, asset allocation and insurance not available from a computer program.

2.       RJ Bank is a bit over 35% of pretax income, with a solid depository franchise almost entirely originated from its PCG clients (via a cash sweep program).  Deposits of $19BB fund a conservative book of $18BB of loans to 1) C&I customers, 35%, 2) CRE 15%, 3) residential mortgage customers 15%, and the rest in a mix of margin loans and tax exempt loans.  Cost of funding is low given the cash sweep program in place (63 bps), and NIM’s averaged 3.27% last quarter. This business is obviously tied to the PCG business, with 16% loan growth compounded over the past 5 years.  In 2008-2009, losses did tick up but were overall quite manageable given their focus on conservative underwriting (i.e. no subprime, no doc or home equity loans to speak of). Their loans a typically bigger syndicated offerings.

3.       Asset Management.  With $250BB in AUM, asset management operates primarily in 2 buckets:  funds managed by brokers (on either a non-discretionary or discretionary basis) totaling $173BB, and directly managed institutional accounts and funds ($62BB).  The directly managed funds are marketed under a variety of brands in their Carillon Tower Advisors platform, and have seen some outflows in the past few years (although inflows in 2017 and 2018), similar to other active managers and mutual fund operators.  Fees are a bit higher than industry average, but haven’t seen much pressure given they manage significant assets in small cap and mid cap strategies. The PCG side flows are quite positive, as many broker relationships lead to FA’s managing their accounts portfolios directly.  There has been no fee compression here, but more accounts moving to a fee based, broker managed model.

4.       Capital Markets.  The one segment not driven by the Private Client Group.  Capital Markets is a lumpy business focused on equity & fixed income trading, and typical investment banking underwriting and M&A advisory services.  Last year CM was 7% of pre-tax, down 35% from the year before. M&A advisory has been strong, but trading and underwriting have been quite weak. Expect this business to bounce around with market conditions.

5.       Other. Usually costs associated with legal reserving and regulatory fees. There is some consulting costs in here.  These fees are beginning to stabilize, but also can be volatile.

Strategy

Management’s aim is grow at a slow and steady pace.  They will make occasional acquisitions here and there, but they tend to be small tuck in style deals that fit in culturally.  Their ability to accretively acquire smaller competitors is impressive given they prefer slow organic growth. Morgan Keegan and Alex Brown were a couple examples of larger deals that worked out better than expected.  In 2011, RJF paid 14x for Morgan Keegan, and in 2012 EPS was up 15%. Alex Brown and the 3Mac deals in 2016 partially were responsible for the company’s 46% EPS growth in 2017. (it is hard to differentiate between organic and acquired earnings growth, but management has described both these transactions as stellar deals).

Long term, since 2002, EPS has compounded at a 15% growth rate.  The 10 year EPS CAGR is 13%. ROE’s were 16% in FY 2018, and averaged 13% over the past decade.

Book value per share has also grown impressively:

On pretty much any metric or over any time, RJF stock has outperformed the market.  Since 2000, RJF has returned 12.3% vs the S&P 500 at 6%. The five year outperformance is 18.7% vs 13.8% for SPY (even after this recent almost 30% drop).  The 5 year XLF has returned 13.3%, 5.4% lower then RJF.

Recent Results

Here is a model of their income statement.  Management does a good job of walking analysts through each line item on the IS, where I have made comments.

Overall I’ve modeled mostly per management’s comments in the Conservative column above.  This is a below Street estimate of where earnings will shake out in 2017, assuming flat equity markets.  I think assuming zero growth in a number of areas is pretty conservative, and why these EPS numbers turn out lower than Street 2009 estimates.  In the Downside column, I modeled a 2008 to 2009 scenario – where various segments see a drop in revenue similar to then, and the market falls 30-40%.  EPS would fall by 33%. The company intends to buy back 1.8 to 2.0mm shares in FY 2019, some of which could be accelerated given the stock’s drop.

The upside case is looking out to 2020, with EPS compounding at 10% per year.  Given 4-5% broker recruiting, 4-5% equity market gains plus a few buybacks should enable $7.83 in EPS in 2020, give or take.  At 13-15x, where the stock has traded typically in 2017 and 2018, upside is $120 with dividends in a couple years.

Even Street numbers for 2019 at an average multiple would take the stock back to over $100, where it just was a few months ago.

The best comps are Ameriprise AMP and LPL Financial.  LPLA trades at 11x, and AMP trades at 9x. Both are also significantly discounted from typical multiples.  In fact, AMP was just written up on VIC I noticed while finishing this piece. It is also a solid regional brokerage firm, and probably stays at a discount to RJF given its insurance businesses (legacy long term care in particular seems an overhang).

Full disclosure I worked at RJF from 1993 to 1997.  I can say first hand that management (back then it was Bo Godbold and Tom James, HBS alumni) was top notch, conservative, and recruited talent from the best schools.  Plenty of New York bankers were willing to move to Florida, get paid a 25% discount to market, and live a higher quality lifestyle than that available in the Northeast.  Management is also quite careful with spending, bordering on being cheap. Given their tight rein on costs, management expects to keep comp costs below 66.5% of net revenue, and aim to generate 18% plus pre-tax margins.  ROE’s under the current tax regime should stay north of 15% over time. Raymond James’ 2009 ROE’s, the worst going back to 2003 as far as I looked, were still a respectable 7.9%.

Lastly, their balance sheet is solid today, with a BBB+ rating.  Excluding deposit liabilities, cash exceeds their debt giving them plenty of capacity to fund growth, dividends, buybacks, etc.  Like any well run financial, they generate tons of cash and require little in way of capital to grow.

Risks

Market declines, reputation risk, AUM declines/outflows

Catalyst

Earnings, buybacks, market recovery