MFG in the BUY zone, page-321

Slight downgrade from morningstar but still seeing solid long term upside,

Latest recommendation report

Valuation: $50.50

Last updated:

06/10/21

Market Pricing Significant Downside for Magellan, We Think Not

Investment rating

Magellan has historically delivered above market returns with relatively low drawdowns. This has allowed it to rapidly grow scale in FUM to over AUD 110 billion and provides the foundation for continued earnings growth. While we don't believe it will be immune from the structural trend of investors moving to passive investments, ongoing competition among fund managers and major institutions in-housing their asset management, we think it's better placed than most active managers to address these headwinds. Magellan is moving beyond just managing money, to implementing new initiatives such as product expansion to attract new money. There are prospects of stronger inflows, notably from Australia's self-managed superannuation funds, the ageing demographic, and fee-conscious investors who were previously discouraged from investing with Magellan. However, continued strong performance will remain key.

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Recommendation impact (last updated: 06/10/2021)

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Event analysis

Market Pricing Significant Downside for Magellan, We Think Not

The last 12 months have been challenging for narrow-moat Magellan. The firm was first stung by the rotation to cyclical stocks in late 2020. Its holdings suffered disproportionately as the market wrestled with stocks particularly exposed to inflation and higher interest rates. Then came the Chinese policy reforms, drastically hurting its Chinese holdings Alibaba and Tencent. Consequently, the flagship Magellan Global Fund has lagged its index (over a trailing one-year period) for close to a year now. Investors clearly disliked Magellan's results, with current shares close to half its November 2020 height of about AUD 62 per share.

We believe this pessimism is overdone. At current prices, Magellan is priced worse than a passive fund. By our calculations, the market is factoring in a scenario akin to Magellan: (1) failing to meet its return target of 9% per year, and (2) suffering net outflows of AUD 20 billion over the next five years. On the latter, this is more than double Platinum Asset Management's cumulative outflows from fiscal 2016-2021. Such assumptions strike us as irrationally pessimistic--and we note Platinum had a weaker track record and less diversified clientele.

We lower our fair value estimate for Magellan to AUD 50.50, from AUD 55.50. We pare back our net flow assumptions, as its weak near-term performance is likely to hinder new money flows, but not to the extent the market thinks. Our valuation assumes cumulative net outflows of about AUD 7.5 billion from fiscal 2022-2024. Notably, we forecast greater leakage of AUD 4 billion from Magellan's retail funds, which are higher margin. We forecast lower institutional outflows as we understand most of Magellan's institutional clients contract it to deliver absolute returns of 10% per year (rather than beat a benchmark), which it comfortably delivered.

Our projected market returns for the group averages 9% per year from fiscal 2022-26. This is almost half of its five-year average of 16%.