Waddell & Reed Financial (WDR): Additional Margin Compression Is Likely - Piper Jaffray

Piper Jaffray Waddell & Reed (NYSE: WDR) analyst, Jason Weyeneth, noted that with guidance for two thirds of a 10% targeted expense reduction initiative to hit in '16, severance and other restructuring costs over the next few quarters, and a sizable decline in revenues from asset attrition and changes to their distribution platform, considerable further margin compression appears likely. The analyst, anticipates full year margins to decline over 900 bps to 18% before rising to just over 20% in '17. No change to Neutral rating. The firm lowered its price target to $25 (from $28).

The final DOL rule softened the potential implementation costs, but the long-term impact on the business still appears uncertain in our view. Given the planned changes to modernize the brokerage platform with the "Project E" initiative and the changes embedded in the final DOL proposal, the incremental costs (consulting, legal, website, field processing) are expected to only be "seven figures."

Management was pleased with changes in the final rule around the best interest contract exemption (BIC) and softened stance regarding proprietary products. However, revenue could be at risk as assets migrate to non-proprietary products owing to the combination of the new fiduciary standard and WDR's deteriorating relative performance rankings as a result of recent poor product performance.

WDR trades at a ~20% P/ E discount to peers (on our below-consensus estimates) with 28% of its market cap in excess capital, the fundamental overhangs in our view are too large to get more constructive. We believe a clear bottoming of flows, sustained improvement in investment performance, and better insight into the impact from DOL are needed for relative valuation to materially improve.

For an analyst ratings summary and ratings history on Waddell & Reed click here. For more ratings news on Waddell & Reed click here.

Shares of Waddell & Reed closed at $21.53 yesterday.

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