U.K.-based fund manager Henderson Group reported an impressive underlying profit before tax of GBP 101 million for first-half 2013, up 22% on first half 2012 and in line with our expectations and guidance. Diluted earnings per share of 8 pence per share increased 14% on 7 pence in first-half 2012. Assets under management increased 3.5% from GBP 66 billion at December 2012 to GBP 68 billion at June 2013. Strong cashflow conversion enhanced the company’s financial health with GBP 16.7 million in net cash at 30 June and interest cover expanding to a healthy 19.2 times. The solid result supported the 2% increase in dividend to GBP 2.15 unfranked. Good financial discipline enabled further improvement in productivity, with the operating margin improving from 36% in first-half 2012 to 39% in first-half 2013.

Pleasingly, strong fund investment outperformance stood out, largely responsible for the uplift in profit. Performance fees of GBP 57 million more than doubled, from the GBP 22 million in first-half 2012. Investment performance is determined at 30 June each year for the bulk of Henderson’s funds subject to performance fees. The impressive overall earnings performance supports a positive investment view and near-term earnings forecasts remain unchanged at GBP 99 million (AUD 227 million). Our AUD 3.60 (GBX 230) fair value estimate is intact and, at current Australian dollar prices, the stock is trading at 16% discount to our valuation. In our opinion, Henderson is currently undervalued, trading at an undemanding 14.3 forward price to earnings multiple.

Overall fund investment performance is positive, with the number of funds outperforming benchmarks in one year remaining strong, at 77% at June 2013. Henderson’s assets under management are split 49% retail and 51% institutional with retail generating average management fees around 73 basis points and institutional around 35 basis points. Thus, the ‘stickiness’ retail client assets under management is a definite competitive advantage in the long term. Strong investment performance is one of the key factors in attracting additional flows and improved brand awareness.

Group assets under management benefited from positive market revaluations (GBP 3.8 billion), but disappointingly there were still net outflows (GBP 1.5 billion). However, all the outflows came from lower-margin institutional clients, particularly in first-quarter 2013. Encouragingly, retail quarter-on-quarter flows continued to demonstrate a positive trend, with GBP 590 million of inflows. Henderson needs to improve institutional flow performance by building stronger distribution capabilities within the United States, United Kingdom, Europe and Asia Pacific. Recently, Henderson expanded its distribution capability in Australia with the acquisition of specialist commodities fund manager ’90 West’. The improved retail flow performance is partly due to improved momentum in investor sentiment as well as the impressive performance of the funds. Management fee margins increased due to strong inflows into the highermargin retail products.

Analysts were particularly impressed with the sharp reduction in other operating expenses (excluding staff costs) due to continued tight cost discipline. As expected, staff costs increased significantly due to higher bonus payments flowing from the significant increase in performance fees. The variable cost base is boosting the outlook for operating margins. A 40% operating margin would be an impressive performance and supports our positive medium-term view. The 13% effective tax rate was lower than expected and we retain our 17% full-year 2013 forecast. Our average exchange rate for 2013 is 63 pence per Australian dollar.