Results from LPL Financial (LPLA) again impressed, highlighting its best-in-class organic growth and spending discipline, while also benefiting from a significant rate option. In the medium to long term, continued channel expansion and the addition of new services to support financial advisors should also drive revenue growth, with sustained double-digit % organic growth within reach. Given the fee and earnings growth momentum, I believe LPLA should trade at a higher P/E multiple in the teens (in line with its high-growth wealth management peers). Still, with stocks trading at an undemanding P/E of 13 to 14 times for fiscal 2023, the LPLA offers attractive value for investors.
End the year on a positive note with organic growth momentum
Perhaps the key element of LPLA’s latest quarterly report was its impressive Net New Assets (NNA) growth, bringing the full-year NNA to $119 billion (13% annualized growth). Recruited assets of $89 billion over the year certainly helped, with the $17 billion added in Q4 21 resulting in a doubling from the prior year. Encouragingly, advisors win both ways: gaining new clients and expanding the wallet share of existing clients through the addition of new capabilities and technologies to the platform. At the same time, the modernization of services and operations is helping to improve the advisor experience at LPLA, helping it expand into other affiliate channels and accelerating advisor onboarding to the platform.
Looking ahead, I see progress in the Business Solutions segment as key – alongside the growing number of advisors (now at 19,876), Business Solutions services are increasingly being used, with subscriptions doubling to 3k+ il a year ago (also up about 15% sequentially). As a result, the segment now contributes $28 million in revenue per year while increasing the differentiation of its advisor offering and, therefore, a stronger relationship. In addition to the new Paraplanning offering launched last month (a service that builds financial plans for advisors), LPLA has other solutions in the pipeline, including tax planning and high net worth services, all of which should boost continued growth in the years to come.
Customer cash balances to produce interest rate benefits
Encouragingly, LPLA client cash balances increased +13% sequentially to $57 billion (4.7% of total assets), which bodes well given the current bullish environment. rates. Management expects the first four rate hikes to generate c. $310 million in annual gross profit, and each subsequent rate hike will produce another c. $50 million annual gross profit (with 25% deposit beta). In light of the rate of growth in client assets and the relatively low percentage of cash on hand, I suspect the benefit could be even greater due to the magnitude of client balances being redeployed into the ICA program (“cash account assured”) with higher returns in the future.
Notably, the ICA portfolio is gaining momentum – LPLA has added a new three-year $500 million fixed contract at attractive rates and will roll over a $1 billion fixed contract expiring in the first quarter of 2022 into a new contract at a four-year fixed rate at c. 140 bps (previously about 325 bps). With rate increases looming, LPLA will likely want to keep these contracts relatively shorter initially, so it will have the flexibility to build them into future increases. Throughout fiscal year 2022/2023, expect more fixed rate contracts to be locked in amid increased market demand for ICA balances at higher yields, which will likely drive the proportion of fixed rate contracts at over 70% over time.
A robust pipeline underpins the strategic growth strategy
In addition to organic growth investments, LPLA’s capital management strategy will also focus on inorganic opportunities (similar to the recently completed acquisition of Waddell & Reed (WDR)). So far, LPLA has been successful here, recruiting c. $2 billion in assets in its most recent quarter as management moves towards strong organic growth on growing demand and expanding pipelines across many channels. Encouragingly, much of the growth strategy will be focused on large financial institutions following the addition of BMO Harris (BMO) and M&T (MTB), with CUNA Brokerage also due to close soon. With large financial institutions increasingly becoming a more accessible market opportunity for LPLA, I see a clear path to sustainable organic growth.
Meanwhile, the integration of WDR is progressing well – its final asset retention and EBITDA rate is well above c. $50 million, with EBITDA guidance revised up to over $90 million. While the timing of the deal likely played a role in keeping expectations low, I think management should be commended for the strong retention of advisors and clients throughout the recent turmoil caused by COVID-19. And as LPLA unlocks new platform synergies, I see a lot of benefits for WDR’s wealth management client assets (now at around $77 billion) over time.
Overall, I think investors will walk away from earnings with even greater conviction in the longer-term bullish LPLA case, as the centuries-old shift to independent advice and the consolidation of advisor networks continues. In addition, management offered encouraging clarity around key areas such as core G&A/promotional spend execution rate as well as increased disclosure on the higher revenue stream of multiple business solutions. As we approach the next few quarters, I also see added benefit in the cautious rate sensitivity forecast, particularly with the expected remixing of money market balances in the ICA and the execution of the upcoming fixed rate extensions. As such, I see a clear path to a valuation reassessment towards a higher P/E multiple in the teens, which seems warranted for a secular growth story positioned to benefit from an interest rate backdrop. higher.