Federated Hermes: Take a look at recent acquisitions and upcoming earnings

Guido Mieth

Summary in seconds

I continue to give Federated Hermes a buy investment grade (NYSE: FHI) shares.

I assessed Federated Hermes’ financial performance for the second quarter of this year in my previous update for FHI written in August 4, 2022. This article focuses on the recently completed acquisition of FHI and a preview of the company’s upcoming third quarter earnings release.

My bet is on Federated Hermes announcing above-expected earnings next week. Additionally, I believe that FHI should continue to execute more M&A deals in the future, which should be positive for the company’s medium-term growth prospects. Considering these factors, I keep my buy rating for Federated Hermes unchanged.

Recent M&A transaction

Earlier this month, Federated Hermes disclosed that the company had completed “the acquisition of CW Henderson & Associates, Inc., a specialist in municipal bond SMA (separately managed accounts) products.”

Specifically, the CW Henderson takeover increased FHI’s municipal bond AUM (assets under management) by +26% to $16.8 billion. This M&A transaction also helped grow Federated Hermes’ SMA assets by +9% to $29.0 billion.

Federated Hermes’ decision to acquire a company focused on municipal bonds appears to be a sound move based on a review of some of FHI’s most recent quarterly metrics.

In particular, FHI highlighted in its second quarter 2022 earnings briefing that its Municipal High Yield Advantage Fund and Conservative Municipal Micro Short funds were among the “fixed income funds with positive net sales.” for the last quarter, even though “most fund bond categories had net redemptions.” As such, it makes sense that Federated Hermes would expand its municipal bond AUM by acquiring CW Henderson.

On a broader level, this recent M&A deal could mark an inflection point for FHI’s inorganic growth strategy and prospects.

Federated Hermes’ organic growth record has been disappointing, implying that inorganic growth or mergers and acquisitions is a key driver for the company’s future. For reference, FHI’s five-year average annualized organic growth in assets under management was just +0.2%, according to the morning star to research.

On the company’s second-quarter investor call, Federated Hermes noted there are “a lot of opportunities” and stressed that it was “still active and available” when asked about the potential for future acquisitions. In my opinion, FHI can positively surprise the market with better than expected future growth driven by mergers and acquisitions.

FHI Third Quarter 2022 Earnings Overview

In an announcement issued on October 6, 2022, FHI said it would release its third quarter financial results on October 27, 2022.

Federated Hermes had made earnings per share or EPS below expectations for the past two quarters. The company’s actual normalized EPS for the first quarter of 2022 and the second quarter of 2022 were below market expectations by -9.3% and -9.1%, respectively. Therefore, it is natural to wonder whether FHI’s upcoming third quarter earnings release will meet Wall Street analysts’ expectations.

But analysts have become more conservative in their financial forecasts for FHI as the company’s results disappointed the market in the previous two quarters. The market consensus normalized EPS projection for Q3 2022 for Federated Hermes has been reduced by -7.9% over the past three months.

Based on S&P Capital IQ financial data, the sell-side estimates that FHI reached a normalized EPS of $0.70 for the third quarter of 2022. This equates to a -4.0% year-over-year net income contraction for the business.

Federated Hermes’ key differentiator as an asset manager is its focus on money market assets, which accounted for approximately 70% of its assets under management at the end of June 2022. Thus, the short-term performance of FHI should be reasonably good in the current environment of rising rates. On its Q2 2022 earnings call, Federated Hermes mentioned that “higher short-term rates will benefit money market funds.” Coupled with the fact that FHI’s earnings expectations for Q3 2022 aren’t that high, as the consensus numbers show, I see a good chance that FHI will deliver a higher earnings next week.

Valuations and redemptions

Federated Hermes’ current valuations are undemanding and the company plans to continue its share buybacks. The decline in FHI’s share price should be limited by these two key factors.

FHI is currently valued by the market at 11.7 times the normalized P/E for the next twelve months, which is below the average 10-year P/E multiple of 13.7 times. In a scenario where Federated Hermes’ P/E multiple returns to the long-term historical average with no change in expected future earnings, FHI’s stock price could potentially rise by +17%.

Additionally, Federated Hermes indicated that the company will still be repurchasing its own shares for the foreseeable future, which should support its share price. FHI noted on its last quarterly earnings call that the company “will remain active” with the “5 million stock program (in number of shares rather than dollars) that is approved and available to us.”

Final Thoughts

FHI continues to be classified as a buy. Federated Hermes valuations are inexpensive, and I believe the stock may revalue in the future, with acquisitions being a key driver of above-expected growth for the company.

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