T. Rowe Price Group, Inc. (NASDAQ:TROW) Q2 2023 Earnings Call Transcript

T. Rowe Price Group, Inc. (NASDAQ:TROW) Q2 2023 Earnings Call Transcript July 28, 2023

T. Rowe Price Group, Inc. beats earnings expectations. Reported EPS is $1.79, expectations were $1.73.

Operator: Good morning. My name is Gigi, and I’ll be your conference facilitator today. Welcome to T. Rowe Price’s Second Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode until the question-and-answer period. I will give you instructions on how to ask questions at that time. As a reminder, this call is being recorded, and will be available for replay on T. Rowe Price’s website shortly after the call concludes. I will now turn the call over to Linsley Carruth, T Rowe Price’s Director of Investor Relations.

Linsley Carruth: Hello, and thank you for joining us today for our second quarter earnings call. The press release and a supplemental materials document can be found on our IR website at investors.troweprice.com. Today’s call will last approximately 45 minutes. Our CEO and President, Rob Sharps, and CFO, Jen Dardis, will discuss the company’s results for about 15 minutes, and then we’ll open it up to your questions. We ask that you limit it to one question per participant. I’d like to remind you that during the course of this call, we may make a number of forward-looking statements and reference certain non-GAAP financial measures. Please refer to the forward-looking statement language and the reconciliations to GAAP in the supplemental materials as well as in our press release and 10-Q. Now, I’ll turn it over to Rob.

Rob Sharps: Thank you, Linsley, and thank you all for joining us today. While equity outflows continued in the second quarter, we saw improved performance in a number of important investment strategies. Stronger equity markets helped lift revenue from first quarter levels, and we identified substantial cost savings that will allow us to meaningfully slow expense growth while continuing to pursue our strategic initiatives. On today’s call, I’ll give an overview of our investment performance followed by a brief update on the key milestones we’ve reached in advancing our strategic initiatives. Jen will then provide a detailed view of our financial results before we take your questions. Overall, second quarter investment performance was encouraging with reasonably solid results across asset classes and the percentage of funds outperforming their peers increasing from the prior quarter.

The U.S. large-cap growth franchise outperformed this quarter, with blue chip growth stock and large-cap growth posting top-quartile results versus peers and beating their benchmarks. Our U.S. equity research and mid-cap value strategies continued to deliver strong performance. In contrast, the large-cap value franchise, a bright spot in 2022, gave back some of its relative outperformance in the first half of 2023. However, the long-term results remain favorable. Our target date franchise delivered another strong quarter of performance with all of our flagship retirement funds ranking in the top quartile. Performance in fixed income and international equity was solid as well, with the majority of funds in both segments outperforming peer groups and a number of products, including global multisector bond and U.S. high yield, in the top decile for the quarter.

Our global stock, overseas stock and several of our municipal bond strategies were top-quartile performers in the second quarter and all have strong three-, five- and 10-year performance track records. Despite these gains, organic growth remains under pressure. As we reported, net outflows for the second quarter were $20 billion. The sales and redemption patterns that we saw in the first quarter largely continued in the second. U.S. equity outflows were primarily driven by U.S. large-cap growth strategies as market demand remained muted and we saw the lagging impact of past investment performance on sales and redemptions. International and global outflows slowed with improved market demand and better performance. Fixed income net flows declined from the prior quarter as rates rose and demand softened.

Target date products had net inflows of $2.4 billion for the quarter. To protect our ability to invest in our corporate strategy and deliver for our clients, we are proactively managing expense growth. We are pursuing a number of efforts to manage expenses, drive efficiency and create a cost structure that’s appropriate for the size and scale of our firm today. Jen will discuss these efforts in greater detail, but since the fourth quarter of 2022, we have taken steps to remove or reallocate over $200 million in run rate costs for 2024. This work partly reflects ongoing company and industry challenges, but also reflects a broader commitment to efficiency, process improvement and durability, driving a culture of continuous improvement in innovation with an agile mindset.

Institutionalizing this work will allow us to better invest in our corporate strategy and continue to deliver for our clients even in challenging times. Our corporate strategy is focused on areas where we believe we have the greatest opportunity for growth and long-term success. In the second quarter, we advanced efforts to deepen our client partnerships, expand our investment in operational capabilities, and continued to broaden our global reach. We’ve made important hires and met some key milestones. We are making steady progress in bolstering our USI Wealth channel by fortifying partnerships with the largest intermediary firms in the industry. Clients expect compelling investment strategies offered in a variety of vehicles to meet their needs, and we made progress delivering on both this quarter.

On June 15, we launched five fully-transparent active equity ETFs, which are already generating client interest and inflows. Our existing lineup of 15 ETFs now at $1.5 billion in AUM is steadily building momentum. We continue to fill out our roster of SMA strategies with the addition of four muni and two equity SMA strategies this quarter. We finalized the seed commitment for our first joint co-branded product with OHA, T. Rowe Price OHA Select Private Credit Fund, or OCredit, and closed for our business development company, or BDC, election filing on June 30. The filing is a key legal milestone for the launch, which is planned for later this year. We also hired a Head of U.S. Intermediary Alternative Sales and we’ll continue to invest in resources and expertise to support this effort.

We closed on our acquisition of Retiree, Inc., which will enhance our ability to expand and retain relationships with pre-retiree and retiree clients by providing tax aware retirement income and social security claiming strategies. With this acquisition, we demonstrate our commitment to expanding and evolving our already strong retirement capabilities. So, while our flows continue to reflect lingering challenges, we are making clear progress. Our work on driving efficiencies and managing expenses will allow us to continue to invest to deliver for our clients and support future growth. I’m impressed by the resiliency and commitment of our associates and I remain confident in the long-term fundamental value that a global active investment management firm like T.

Rowe Price can deliver no matter the environment. I’ll now turn to Jen to cover our financial results for the second quarter.

Jen Dardis: Thank you, Rob, and hello everyone. I will begin today by reviewing our financial results and will provide additional detail on our expense management efforts before we open the line for questions. As reported, our adjusted earnings per share was $2.02 for Q2 2023 versus $1.69 in Q1 2023, an increase from both higher revenues and carefully managed expense growth. Q2 2023 EPS was also favorably impacted by a lower quarterly effective tax rate. We ended the quarter with $1.4 trillion in AUM, an increase of $58 billion from March 31, 2023, driven by market appreciation and partially offset by net outflows. Our average assets for the quarter were $1.36 trillion, up from Q1 2023, but down almost $50 billion from Q2 2022.

As Rob mentioned, we posted $20 billion in net outflows for the quarter. Across the entire complex, we continue to see clients taking longer to make decisions based on current market volatility, which is resulting in lower sales and net inflows than we’ve seen in prior years. Industry-wide, active equity and fixed income fund flows have been muted for over a year. We expect that this slowdown is cyclical and will revert to more normal patterns as the direction of interest rates, inflation and the likelihood of a recession become clearer. Also consistent with last quarter, our U.S. large-cap growth equity products drove a majority of the outflows, and we are seeing performance-related lower sales and elevated redemptions from a range of clients.

It will take some time for the recent performance improvement in these products to slow the outflows. Positive inflows for the quarter included U.S. equity research, capital appreciation, international core and all-cap opportunities. We also had net inflows to international fixed income, driven by Global Investment Grade, Global Multisector and Euro Corporate Bond. However, the inflows to international fixed income were more than offset by outflows from our U.S. fixed income stable value and floating rate products. Our target date net inflows were $2.4 billion for the quarter. While this was down from Q1, keep in mind that first quarter flows are typically the strongest given that a higher proportion of planned decisions happen around year-end.

In the first half of the year, we recorded $9.9 billion of net inflows to our target date products. In response to changing market conditions and more available capacity, we have reopened to new investors, some of our previously closed products, including mid-cap growth, small-cap growth and emerging market equity, which we expect will support future sales and net flows. We also continue to evaluate the capacity levels for other closed strategies, and we’ll consider reopening these in the future. Our Q2 adjusted net revenues were $1.6 billion, including $1.4 billion of investment advisory revenue, that was up from Q1 2023 on equity market gains. Our effective fee rate was 42.3 basis points, back to the same level it was in Q4 2022 after a slight uptick in the first quarter of 2023.

Our adjusted operating expenses were a little over $1 billion, which was generally flat to the first quarter of this year, but up 8.3% from the second quarter of 2022. The year-over-year change was largely driven by the change in capital allocation-based income related compensation. As a reminder, in second quarter last year, there was negative capital allocation-based income, which created an expense offset. Excluding the compensation expense related to capital allocation-based income, adjusted operating expenses were up 1.8% over the same period last year, with compensation and related costs up less than 1% year-over-year. We continue to forecast our 2023 adjusted operating expense growth, excluding capital allocation-based income related compensation expense, will be in the range of 2% to 6% over the comparable full year 2022 amount of $4.1 billion.

Based on current market conditions, we still expect to land at or below the midpoint of this range. As Rob mentioned, we are pursuing a number of efforts to proactively manage our expense growth and drive efficiency. Last week, we internally communicated the difficult decision to eliminate approximately 2% of our existing positions globally. We have also slowed the pace of hiring and headcount growth by closing select open positions across the firm. All of these actions have been based on a careful review to make sure we are aligning our resources to best support our clients and drive long-term growth for the firm. Based on our current pace of hiring against our strategic initiatives, we expect headcount at the end of 2023 to be modestly higher than the start of the year, even with the reductions I just mentioned.

Most of the costs related to the recent reduction in force will be incurred in the third quarter and are already included in our expense guidance. As we move forward, we remain committed to finding ways to be more efficient and drive a culture of continuous improvement. For example, we are evaluating our current real estate use in light of our new hybrid work approach, with the objective of slowing our occupancy and facilities expense growth. It will be some time, however, before any impact to expenses from real estate would be realized. In total, between the expense efforts we took last year and this year, we will have removed or reallocated over $200 million in operating expenses versus the run rate for 2024. This financial discipline will allow us to continue investing in our strategic initiatives to support future growth, while positioning us for low-single digit adjusted operating expense growth in 2024, excluding the impact of capital allocation-based income related compensation.

We will refine these estimates as we get closer to year-end. As always, this estimate is based on current market levels and we could choose to adjust it if markets rise or fall significantly. Shifting to capital management, we found some buying opportunities in May and June, bringing our year-to-date share repurchases to over 420,000 shares at an average price of just over $107 per share for $45 million in total. We remain opportunistic in our approach to buybacks. However, given continued market uncertainty, we are being patient in the process. Supporting our recurring dividend remains a top priority, and in the first half of 2023, we returned over $600 million to stockholders. Our balance sheet remains strong, and we have ample liquidity to support both our seed capital program and potential M&A.

We are confident in the efforts we’ve identified to drive efficiency and slow our expense growth, as we continue to manage the business to support our clients and return the firm to organic growth over time. As Rob said, institutionalizing this work will allow us to better invest in our corporate strategy and continue to deliver value for our clients even in challenging times. With that, I’ll ask the operator to open the line for Q&A.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Ken Worthington from JPMorgan.

Ken Worthington: Hi, good morning, and thanks for taking my question. Performance has improved in a number of your most prominent growth funds. And while outflows were still elevated in 2Q, are you seeing any early indications that the better near-term performance is starting to positively impact the net sales outlook? And if so, what distribution channels are benefiting? And if not, which channels would you expect to come back more quickly to reflect the improved performance, given your comments that the timeline for decision making has been extended?

Rob Sharps: Yes, Ken. Good morning. Thank you for the question. This is Rob. With regard to the large-cap growth franchise, as you note, meaningfully better performance in the second quarter and year-to-date. With regard to whether the improved performance is translating into better flows, the direct answer is, at the margin, but it’s way too early to call this a trend. Our experience suggests that performance impacts flows with a lag that for institutional buyers, the three- and five-year numbers are important considerations. And while we have a very compelling performance on a year-to-date basis and attractive performance on a one-year basis, we do have further work to do on the three- and five-year numbers. In terms of what channels you might pick the early signals up or where you would expect it to improve earliest, it would be in USI Wealth and in the individual investor business.

I think, again, the more sizable institutional decision making tends to more heavily weigh three- and five-year. I think the pattern we would expect to see is a lessening of redemptions and then eventually a more meaningful pickup in gross sales. If I take a step back and talk about flows broadly, it’s clearly the missing ingredient. Overall, I’m feeling better about things. I think we’ve been very front-footed in putting ourself in a position where we can invest against our strategic initiatives yet kind of have an appropriate level of expense growth. For now at least the market has given us a lift in revenues and we’re working really hard to put ourselves in a position where we can return to organic growth. As it stands today, the industry conditions are challenging.

There is a lot of money on the sidelines. I don’t think that will last forever, but it’s difficult to know when it will ultimately come back. We’ll need to continue to drive improved performance. And ultimately, we’ll need to execute against our strategic initiatives to become more central with our existing clients and to reach more clients. My sense is if you look at historical patterns, if we execute against those things and investors come off the sidelines and begin to invest with a more long-term orientation again, we should see meaningfully less in the way of outflows in 2024 and demonstrate that we can put the company on a path back to organic growth at some point in 2025. If I look at all of the leading indicators that I’m seeing right now, it suggests to me that we’re experiencing the worst of the pressure on flows, which is another way of saying I wouldn’t expect the run rate in the back half of the year to be greater than what we saw in the first half of the year.

And as we work our way through ’24, we think we’ll see, as I say, noticeably less in the way of net outflows. But again, there are some things that have to happen in terms of the industry backdrop, in terms of our investment performance, which we’re deeply focused on and I’m encouraged by, and again, with regard to execution against all of our strategic initiatives.

Operator: Thank you. One moment for our next question. Our next question comes from the line of Finian O’Shea from Wells Fargo Securities.