Two Buys
For A
Stock Market Turnaround
By Patrick McKeough, editor
Wall Street Stock Forecaster
The
market downturn has been hard on companies that rely on strong
stock markets. Both T. Rowe Price and State Street are near two-year
lows. But both are cutting costs and paying down debt. Both stand
to gain from several long-term trends, including an aging population,
the globalization of stock and bond markets and increased use
of computer technology.
We feel that stock
markets will soon rebound, now that we're approaching the two-year
period before the next Presidential election. That makes it a
good time to buy these two stocks.
T. Rowe Price (Nasdaq
TROW $25; WSSF Rating: Average) sells its own no-load mutual
funds. It also provides brokerage and investment advisory services
to over eight million individuals, as well as over 450 institutions
like pension funds and trusts.
About 75% of T. Rowe
Price's revenues comes from investment management fees. In the
strong market rise of the late 1990s, the company's revenues
shot up nearly 60%, from $755.0 million in 1997 to $1.2 billion
in 2000. However, weak equity markets cut revenues in 2001 to
$1.0 billion.
Profits jumped from
$144.4 million or $1.13 a share in 1997 to $269.0 million or
$2.08 a share in 2000. But earnings fell to $195.5 million or
$1.52 a share in 2001.
In the second quarter
of 2002, earnings crept up to $51.9 million or $0.40 a share
from $51.2 million or $0.40 a share a year earlier.
If you disregard new
accounting rules that eliminated the routine amortization of
goodwill, profits in the first quarter fell 11.1%. A $4 million
loss from its investment portfolio compared with a $10.4 million
gain a year earlier, also slowed profit growth. Revenues fell
9.9%, to $236.1 million from $262.1 million.
At the end of 2001,
the company had assets under management of $156.3 billion, down
6.2% from $166.7 billion a year earlier. Weak financial markets
caused assets under management in the first half of 2002 to drop
4.8%, to $148.8 billion.
Although falling markets
have cut T. Rowe Price's management fees, investors are still
putting new money into its managed accounts and mutual funds,
particularly domestic stock funds. That helps boost profits since
the company earns higher fees from stock funds than income funds.
Total net inflows in the first half of 2002 amounted to $3.6
billion.
The company is also
slashing costs. It has cut 10% of its workforce in the past 15
months. Lower advertising spending and productivity gains from
new computer technology also cut expenses.
T. Rowe Price's balance
sheet is strong. It has $97.6 million in cash and only $57 million
in debt. It also spent $76 million in the first six months of
2002 on share buybacks.
The stock fell to a
two-year low of $23 last September. It now trades for 14.6 times
the $1.71 a share it will probably earn this year. The $0.64
dividend yields 2.6%.
T. Rowe Price is a
buy for long-term gains.
At June 30, 2002, it had $6.2 trillion in assets under custody. The company also acts as an investment manager for $770 billion in assets. Asset management provides about 85% of its revenues, while investment management fees supply the remaining 15%.
State Street's revenues grew at a compound annual rate of 14.1%, from $2.3 billion in 1997 to $3.9 billion in 2001. Profits before non-recurring items jumped from $380 million or $1.16 a share in 1997 to $661 million or $2.00 a share in 2001.
In the second quarter of 2002, State Street's profits climbed to $178 million or $0.54 a share from $174 million or $0.53 a share a year earlier. The latest results included a $21 million or $0.04 a share charge related to staff reductions. The company expects to recoup this charge in the second half of this year with savings from lower salaries and benefits. Revenues rose 3%, to $1.02 billion from $988 million.
State Street is an industry leader, and continues to attract new business without relying on acquisitions. Since the start of 2001, it has won contracts to manage $642 billion worth of new assets while competitors won only $182 billion worth. New clients include the State of North Carolina and Sweden's Second National Pension Fund.
The lack of acquisitions in the last few years cut State Street's need for new borrowings. Long-term debt fell to only 0.30 times equity at June 30, 2002, down from 0.33 times equity a year earlier.
State Street also does a good job cross-selling other services to existing clients. The recent market drop has generated interest in products that can help clients cut their risk. About a third of State Street's new servicing fee revenues in 2001 came from selling new services to existing customers.
Although the decline in world equity markets has hurt State Street, several long-term factors should spur growth for years to come.
Aging populations and a greater emphasis on global investments means more demand for pension fund management expertise. State Street should also gain from increasingly complex investing strategies, and pension fund managers' need to cut costs by outsourcing administrative functions.
The stock peaked at $68 in 2000, and is down 43% since then. It now trades for 17.6 times its likely 2002 earnings of $2.22 a share.
Dividends have grown at an annual compound rate of 16.8% over the last five years. The current $0.48 a share payment yields 1.2%.
State Street is a buy.
Editor's Note: Patrick McKeough, one of the world's top financial advisors, is editor of Wall Street Stock Forecaster, 250 Liston Rd., Ste. 700, Buffalo, NY 14223, 1 year, $99. The Wall Street Stock Forecaster is a 3-part investment advisory. It encompasses the monthly bulletin, the weekly email Hotline message and the monthly investment-planning supplement, The Wall Street Stock Portfolios.
