Back in my days as a financial advisor, I used several of the Franklin/Templeton mutual funds managed by Franklin Resources (BEN), recalls Jim Pearce, editor of Investing Daily's Personal Finance.
It was among the first fund companies to recognize the long-term growth opportunities in developing markets while also offering a wide variety of taxable and tax-free bond funds.
That asset has become a liability this year. Rapidly rising interest rates have decreased the value of fixed-rate bonds while the soaring American dollar and global supply chain disruptions have been a headwind for companies operating overseas. For those reasons, its assets under management (AUM) decreased from $1.6 trillion a year ago (through August 31) to $1.4 trillion this year.
Since earning a management fee based on the value of its AUM is Franklin’s primary source of income, that dynamic has directly impacted Franklin’s top-line revenue. During the quarter ended June 30, Franklin reported operating income of $404.7 million this year versus $478.1 million the year prior.
As a result, Franklin’s net income for the quarter declined from 86 cents per diluted share a year ago to 50 cents this year. That’s a big drop and largely explains why its share price has fallen from $35 last November to $23 in late September.
That decline has hurt growth investors, but income investors have felt none of that pain. Over the past four years, Franklin has steadily raised its quarterly cash dividend from 23 cents per share in 2018 to 29 cents this year. At a share price of $23, that equates to a forward annual dividend yield of nearly 5%.
Franklin is not sitting on its hands waiting for global macroeconomic conditions to shift back in its favor. Instead, it is proactively building its alternative assets business which its President and CEO, Jenny Johnson, states is “less correlated to the public markets.” To that end, Franklin recently acquired two alternative asset managers that will more than triple its AUM in that category.
A saving grace for Franklin is that it can quickly revise its cost structure to offset declining revenue. As a result, its adjusted operating margin narrowed only slightly during the most recent quarter from 36.5% to 35.3%. At the same time, its adjusted effective fee rate actually increased from 38.9 basis points to 39.5 basis points (1 basis point = 1/100 of 1%).
I don’t expect BEN to start rallying until it becomes apparent that the Fed is close to done raising interest rates. Once that happens, the American dollar should reverse direction while bond prices stabilize. At that time, all of Franklin’s major asset classes should appreciate, driving up its AUM and thereby the fees it earns off of them.
The excess cash flow resulting from the above scenario could induce Franklin to raise its dividend by more than the customary 4% or the company may elect to pay an extra “special cash” dividend as it did in 2018 so I am adding Franklin Resources to the Income Portfolio with a buy limit of $28.
