BlackRock: I Will Start Buying At Crisis Level Valuation (NYSE:BLK)

Brief introduction

BlackRock, Inc. (NYSE:BLK) is the world’s largest publicly traded investment management firm. The company has more than $8 trillion in assets across different strategies.

The strategies under BlackRock include different asset classes, offered to different types of clients and different investment styles.

Business mix

As can be seen below, BlackRock has a highly diversified business. With a huge $8.6 trillion of assets under management (“AUM”) as of 31 December 2022, the company generated $3.4 billion in base fees and securities lending revenue in the fourth quarter of 2022.

In terms of product type, equity makes up the majority, making up 49% of base fees and 51% of BlackRock’s total AUM. The second largest product type is fixed income, which makes up 24% of base fees and 30% of its total AUM.

In terms of geography mix, more than 60% of base fees and AUM come from Americas, with the second largest geography being EMEA, making up more than 20% of base fees and AUM. In terms of style, Active and exchange-traded funds (“ETFs”) bring in 85% of the base fees, while Index and Cash brings in the remainder 15% of base fees. Lastly, on client type, Retail, Institutional and ETFs bring in roughly a third of the base fees each.

Strong net inflows despite a challenging year in 2022

BlackRock had one of its fastest years of organic growth in 2021 as a result of favorable market dynamics, but the company’s real strength lies in its ability to attract net inflows even in a tough operating environment.

According to BlackRock’s Vice Chairman and CFO, he said this about the resilience of the BlackRock platform:

While 2022 was one of the most challenging market environments in over 50 years, clients around the world once again turned to BlackRock for advice and assistance to construct more resilient portfolios.

Despite it being one of the most challenging years on record for BlackRock in 2023, the company still saw net inflows ranging from $17 billion to $114 billion.

Strategy to deliver shareholder value

BlackRock’s strategy to deliver shareholder value is very straightforward. It involves three parts:

1. Organic growth
2. Operating leverage
3. Capital management.

Organic growth, as simple as it seems, can be challenging in the investment management industry as a result of inflows and outflows. Organic growth is crucial for BlackRock as it determines the valuation multiple in which the market is willing to prescribe to BlackRock. As can be seen in the earlier diagram, we can see that BlackRock has delivered positive organic growth in the last nine quarters, despite 2022 being one of the most challenging years for the industry. As a result, this shows that BlackRock’s customers are increasingly consolidating their portfolios with BlackRock. With the net inflows of $307 billion in a challenging year like 2022, BlackRock estimates that it captured more than a third of the long-term industry flows in 2022.

Another significant metric is that in the last five years, BlackRock saw $1.8 trillion net inflows into its business, accounting to 5% average organic asset growth, while the industry saw negative or flat flows during the period.

As can be seen below, BlackRock’s organic base fee growth premium has continued to grow over the years as a result of its strong competitive moat that has resulted in superior net inflows for the business.

As for the focus on operating leverage, we can see that the business saw 86% growth in AUM from 2016 to 2021, but the employee count only grew 38% and operating margin expanded 160 basis points during the period.

I think what’s important for its operating leverage strategy is that BlackRock is consistently investing in its business. Despite the macro backdrop being uncertain, BlackRock has continued to make long-term strategic investments in its talent and technology. As a result of this consistent investment across market cycles, BlackRock is able to generate industry leading organic growth.

BlackRock’s capital management strategy began in 2013. Since then, the company has repurchased $13 billion of its own stock, reduced shares outstanding by 13% and generated an annual compounded return of 15% for shareholders.

Impact of AUM changes on the business

While BlackRock may be seeing net inflows of more than $300 billion, the movements in price levels of its AUM could result in further downside from here.

As of the fourth quarter of 2022, the base fee and securities lending revenue was down 14% year on year. This was in-line with the respective price changes in the various asset classes in 2022.

While BlackRock is unable to control this element of its business, it will affect the business in the near-term if the prices of the different asset classes were to fall drastically and move in the same direction.

However, I think it’s better to focus on the net inflows into the business rather than AUM movements as a result of changes in price levels. In theory, even if the AUM were to decline as a result of price declines across the board, as long as net inflows continue to be positive, over time, I expect BlackRock to be a stronger business as the price levels normalize.

Consolidation in the asset management industry

With the top five firms and top firm in the asset management industry making up 11% and 3% of the total industry respectively, I think we could see further consolidation in the sector in the years to come. As highlighted below, in cloud computing, the top five players make up 69% of the industry while in sales and trading, the top five players make up 42% of the industry’s market share.

Growth drivers

While BlackRock is huge, the opportunity in the ETF industry remains huge. Currently, the ETF industry AUM penetration is only 3% of the total market and 5% of the global equity market, while it is only 1% of the global bond market. As a result, there is still a long runway for the ETF industry as penetration remains low.

As a result, BlackRock expects that the global ETF AUM will continue to grow and by 2025, reach a total AUM of $15 trillion, up more than 80% from 2020. This will be driven by the trend passive investing through the use of ETFs, use of ETFs by institutional investors, and as barriers are removed for the use of ETFs for retirement purposes, amongst others. Another factor driving this is the rise of sustainable ETFs and index mutual funds. For BlackRock, its sustainable AUM grew from $11 billion in 2018 to $129 billion in 2021 as BlackRock rolled out more than 150 product offering related to this theme.

Delivering strong alpha in active

While there has been a shift to passive investing, BlackRock’s active strategies continue to play a role in providing customers with the opportunity to diversify and bring access to unique opportunities, while also leveraging on active strategies to take advantage of volatility and participate in sustainability practices.

BlackRock’s active strategies have done well in the past five years:

1. 5.4% of cumulative alpha net of fees generated over five years.
2. Customers received 2.2 times in alpha on a net basis for every dollar paid in fee, over the past five years.
3. $49 billion of cumulative outperformance net of fees relative to the benchmark.

Valuation

BlackRock trades at 16x 2024 P/E today, while the company is expected to grow at an EPS CAGR in the range of the mid-teens.

In my opinion, that’s not too expensive and in a normal market, this would have been attractive.

However, these are uncertain times.

I went back until 2007 to see what BlackRock’s trough valuation is.

The lowest valuation multiple recorded for BlackRock was in 2008, 2018 and 2020. These were all crisis years where the markets saw high volatility and huge price declines. The valuation multiple reached for all three years was 12x P/E.

Applying 13x 2024 P/E and my estimate of BlackRock’s 2024 EPS, my entry price for BlackRock is $520. The stock needs to fall around 17% in order to reach my entry price.

Risks

Market risks

As highlighted earlier, BlackRock could face downside risks in the form of market declines as a result of a deteriorating market environment. If so, this decline in market prices will lead to a decline in its AUM, resulting in a decline in base fees.

Competition

While the BlackRock brand name is strong, I think we have to be realistic in that there are other competitors out there in the industry. The main risk here is that the ETF industry might become increasingly commoditized as more players come in and differentiation amongst players remain low. If so, this could change the industry landscape as competition will be more at the price level which could bring downside risks to BlackRock.

Conclusion

There is no doubt that BlackRock, Inc. has a strong competitive moat that differentiates itself from other players today. This is a result of many years of consistent investment in its technology, innovation and talent. As a result of this strong competitive moat, BlackRock has seen stronger organic base fee growth from the market and continues to outperform the market in terms of industry flows.

On top of this strong competitive moat, BlackRock has a solid capital management strategy that delivers strong shareholders value through share repurchases and dividends.

On a valuation basis, I think it’s hard to justify buying BlackRock today. While 16x 2024 P/E is not necessarily expensive, it is just not de-risked enough in my opinion. As mentioned earlier, based on the trough valuation seen in crisis years like 2008, 2018 and 2020 of 12x, I derived an entry price for BlackRock, Inc. stock based on a slightly higher P/E multiple of 13x, which amounts to an entry price of $520. With the entry price at $520, BlackRock, Inc. stock needs to decline by 17% to reach my entry price.