We are reiterating our BUY rating on Lazard Ltd. (NYSE: LAZ) and raising our target price to $40 from $35 following the company’s 3Q earnings report. Revenues exceeded our expectations in 3Q as financial advisory revenues rose to their highest level of the year.
While business confidence has been shaken by the pandemic, and some financial advisory transactions have been delayed, we continue to see solid demand for Lazard’s experience in capital structure, capital raising, debt negotiations and restructuring.
Lazard is also gaining advisory share relative to large and mid-sized advisors. It ranked fifth in financial advisory revenues for the year ending September 30, below only Goldman Sachs, JPMorgan, Morgan Stanley, and Bank of America.
In our view, Lazard remains a compelling secular growth story with a clean balance sheet and a focused business model.
We see room for P/E multiple expansion as operating margins and market share increase. The dividend, which was last raised by 7% in April 2019, yields a generous 5.6%. Although the dividend represents a payout ratio of 77% on our 2020 earnings forecast, we note that Lazard has a strong cash position and is committed to returning all excess capital to shareholders.
LAZ shares are down 15% over the past year, compared to an 8% advance for the broad market.
On October 29, Lazard reported 3Q20 earnings of $0.67 per share, down from $0.76. Revenue fell 3% to $569 million, as a 1% increase in financial advisory revenue was more than offset by an 8% drop in asset management fees. Adjusted net income fell 14% to $76 million.
Increased M&A and restructuring activity helped the financial advisory segment, while a 3% decline in average AUM (to $226 billion) hurt the asset management segment.
EARNINGS & GROWTH ANALYSIS
While business confidence has been shaken by the pandemic, and some financial advisory transactions have been delayed, we continue to see solid demand for Lazard’s experience in capital structure, capital raising, debt negotiations and restructuring – as companies work to increase liquidity and strengthen their financial and operational efficiency. On the 3Q earnings call, management noted constructive conversations with companies regarding financial advisory activity. We believe that Lazard’s broad and deep coverage – by geography and industry – distinguishes it from boutiques, while its focus on advisory distinguishes it from large banks. We now look for a 12% decline in revenues in 2020, and a rebound to 9% growth in 2021.
In the asset management business, average AUM declined 3% in 2019 and was down another 3%, year-over-year, as of the end of 3Q20. However, a healthy rebound in asset values since April has boosted management fees, and management expects benefits from investments in new strategies and product extensions. At the same time, outflows for active equities remain a challenge.
Compensation was 60.0% of revenue in the first three quarters of 2020, up from 57.5% a year earlier. Management attributed the increase to higher amortization associated with prior-year awards and lower revenues. The company expects to achieve a compensation ratio in the mid- to high 50s on both an awarded and an adjusted basis. Noncompensation expense was only 18.1% of revenue in 3Q20, down from 21.3% a year earlier, aided by lower business development and travel costs; the company’s goal is to keep this ratio between 16% and 20%. In 3Q19, Lazard began a business realignment, including the elimination of 200 positions, in an effort to control costs.
FINANCIAL STRENGTH & DIVIDEND
The company has a low long-term debt/cap ratio and high liquidity. Lazard acts mainly as an advisor; it does not provide financing for transactions or otherwise commit its own capital in order to complete transactions.
Lazard last raised its quarterly dividend by 7% in April 2019 to $0.47 per share, or $1.88 annually, for a yield of about 5.6%. Given near-term earnings pressure, we expect the dividend to remain at $1.88 in 2020 and 2021. The company also declared a special $0.50 per share common stock dividend in January 2019. Special dividends have included: $1.30 per share in January 2018, $1.20 per share in both January 2017 and February 2016; and $1.00 per share in February 2015. Special dividends have provided a healthy boost to total returns.
Lazard suspended buybacks in 2Q, but in the first quarter of 2020, it repurchased 2.9 million shares for about $95 million. Share buybacks primarily offset dilution from share issuance and have not meaningfully reduced the diluted share count. The company had a remaining buyback authorization of $306 million as of September 30, 2020.
MANAGEMENT & RISKS
Lazard is led by Chairman and CEO Kenneth M. Jacobs, who has been in those roles since 2009.
While Lazard has diversified its revenue in recent years, revenue is still highly dependent on fees earned from advising clients on financial transactions and fees earned on assets under management. Lazard also earns fees if its investment funds exceed return hurdles, but these typically account for only 5%-10% of asset management revenues. Thus, Lazard’s revenues can be volatile and tough to predict from quarter to quarter.
Advisory revenues are dependent on levels of CEO confidence as well as on stock valuations and conditions in the financing markets. Large companies remain flush with cash, financing markets are functioning well, and interest rates remain at historically low levels.
With regard to risks related to financial regulatory reform, we note that Lazard does not have a proprietary trading desk or commit its own capital to private equity or real estate funds. As a result, the Volcker Rule has no direct impact on the company.
Lazard derives about 54% of its revenues from corporate advisory and the balance from institutional asset management. In normal markets, Lazard has been able to consistently grow assets, but the average P/E for large publicly traded active asset managers has been hurt by lower fee rates as more assets are invested in passive index strategies.
We expect Lazard to continue to benefit from its leading market position in financial advisory.