marchmeena29
Elevator Pitch
I maintain my Buy rating for Federated Hermes’ (NYSE:FHI) stock.
In my previous April 22, 2022 article for FHI, I touched on Federated Hermes’ alternatives/private markets business, and the potential impact of rate hikes. With this latest article, I do a review of Federated Hermes’ most recent Q2 2022 financial results announced last week.
I am positive on FHI’s top line and bottom line growth in the teens on a YoY basis and the QoQ increase in its Assets Under Management or AUM for the recent quarter. In the long term, Federated Hermes should continue to create value for shareholders by striking a healthy balance between growth (the potential for its alternatives/private markets AUM to scale up) and capital return (e.g. buybacks, dividends etc). This explains my Buy rating for FHI.
Decent Set Of Results For Q2 2022
Federated Hermes announced the company’s financial performance for the second quarter of 2022 with a media release issued on July 28, 2022 after the market closed.
FHI’s revenue expanded by a strong +18% YoY from $311 million in Q2 2021 to $366 million in Q2 2022. Federated Hermes’ most recent quarterly top line surpassed the Wall Street analysts’ consensus sales forecast of $363 million by +0.8%. I noted earlier in my late-April 2022 update for Federated Hermes that “rate hikes are expected to reduce fee waivers” for FHI, and this was exactly how things panned out. The company attributed its robust top line growth in the recent quarter “to a decrease in voluntary fee waivers” as indicated in its Q2 2022 earnings press release.
Diluted earnings per share or EPS for Federated Hermes also rose by +14% YoY from $0.56 in the second quarter of last year to $0.64 in the recent quarter. A mid-teens bottom line growth rate for Q2 2022 was great in absolute terms.
Notably, FHI’s Q2 2022 EPS did come in -9% below the sell-side analysts’ expectations, which might be due to higher-than-expected travel costs. Federated Hermes mentioned at its Q2 2022 investor briefing on July 29, 2022 that “travel and related expenses” increased because of “rebounding travel opportunities in Q2 as we move from the low travel volume during the pandemic.” Specifically, FHI’s travel costs jumped by +271% YoY from $898 million in Q2 2021 to $3,328 million in Q2 2022.
However, investors didn’t respond negatively to Federated Hermes’ EPS miss for the recent quarter. FHI’s share price only declined modestly by -2% from $35.02 as of July 28, 2022 to $34.31 as of August 3, 2022 following the company’s earnings release. It will appear that the market is focused on FHI’s robust top line and bottom line growth for the quarter in absolute terms, rather than its below-expectations earnings.
Money Market Fund Inflows Boosted FHI’s AUM
FHI’s Assets Under Management or AUM increased from $631.1 billion as of end-Q1 2022 to $631.9 billion as of end-Q2 2022, despite the fact that this is a challenging market environment for asset managers in general.
In my April 22, 2022 update for Federated Hermes, I highlighted that rate hikes will “drive money market AUM growth” for FHI, and this has come into fruition in the recent quarter. FHI has emphasized at the company’s recent quarterly results briefing that its “money markets assets increased about $19 billion” QoQ in Q2 2022 due to the “higher yields from continued elevated liquidity levels in the financial system” which make money market funds attractive “relative to deposit alternatives.”
As such, the strong money market fund inflows have helped to offset the market losses and fund outflows for other asset classes such as equity and fixed income. This allowed Federated Hermes to register positive QoQ growth in its AUM for the recent quarter.
Looking ahead, I expect FHI’s money market fund inflows to remain strong. In the current environment where other major asset classes like equities are delivering negative returns, there will be strong demand for assets that still deliver positive returns like money market funds, and investors will also need to park their cash somewhere when they exit other assets with money market funds being an ideal choice.
All Eyes On Alternatives/Private Markets Business And Shareholder Capital Return
Looking beyond the short-term financial performance and fund inflows/outflows for FHI, I think that good shareholder capital return and the growth potential alternatives/private markets business are the key investment merits for Federated Hermes in the long term.
I stressed in my earlier April 2022 article for FHI that “Federated Hermes’ AUM for alternatives/private markets” is “less than a quarter of the AUM for both equity and fixed income”, as a way of illustrating the long growth runway for its alternatives/private markets business. Recent disclosures imply that FHI’s alternatives/private markets business is still growing well, and the company continues to make decent headway in expanding the AUM for this asset class.
In the middle of May this year, Federated Hermes revealed that it was “awarded a $1 billion private equity mandate (referred to as Horizon III) from BT Pension Scheme.” It is noteworthy that BT Pension Scheme describes itself as “one of the largest pension funds in Europe” on its website, so this represents a huge vote of confidence for FHI’s alternatives/private markets business.
Separately, FHI also disclosed at its Q2 2022 results call that it “closed our direct lending higher than we expected.” Specifically, Federated Hermes is making reference to the fact that it “closed the second vintage of our European direct lending private market strategy with nearly $600 million of committed funding” which was better as compared to what it had anticipated previously.
On the topic of shareholder capital return, Federated Hermes has an amazing track record, and the company appears to be committed to sustaining a high level of capital returns in the future.
In the 20-odd years following since its listing in 1998, FHI has returned about 92% of its total earnings to its shareholders in the form of both dividends and share repurchases.
Looking forward, Federated Hermes assured investors at its recent quarterly earnings briefing that “we have a 5 million share (buyback) program that is approved and available to us, and we will remain active.” With regards to dividends, FHI has consistently paid out dividends in every year since 1998, and there are no reasons to expect this to change in the future. Federated Hermes currently boasts a decent consensus forward FY 2022 dividend yield of 3.2%.
Closing Thoughts
FHI stays as a Buy-rated name in my opinion. Federated Hermes’ recent Q2 2022 financial performance is satisfactory, and I am of the opinion that FHI will be a good long-term investment candidate considering its growth potential in alternatives/private markets and its commitment to shareholder capital return.
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