Franklin Resources Stock: An Excellent Income Opportunity (NYSE:BEN)

Intro

Shares of Franklin Resources, Inc. (NYSE:BEN) at their present share price of just over $23 a share now find themselves down approximately 30% in value year to date. The collapse in one way is surprising given that Franklin Resources (including its recent second-quarter numbers) has now strung together 5 consecutive quarters of straight earnings beats. GAAP earnings of $0.68 in the company‘s recent second quarter beat the consensus estimate by $0.05 whereas the company‘s sales once more beat projections by a small margin.

In saying the above, consensus earnings revisions for upcoming quarters continue to get dialed down and this is worrying investors. At the end of January this year, for example, consensus was estimating that Franklin Resources would report approximately $0.92 per share for its fiscal third quarter. This number has already been dialed back to $0.83 per share and we, unfortunately, see a similar trend for the quarters to follow.

Recent volatility in equity markets and the Fed‘s accelerated tightening schedule could be construed as being temporary headwinds for Franklin Resources. Assets under management for example lose some of their value in a downturn and May witnessed a slight drop in assets under management in the company‘s fixed-income business as well as its overall equity segment. However, hasn‘t Franklin Resources seen this all before? Will not the company‘s much-improved specialization and expertise enable the firm not only to survive through increased volatility but also thrive?

Furthermore, Franklin Resources‘ improved capabilities with respect to its products remain a work in motion. We state this because, despite the large “Lexington Partners” acquisition which took place last April, Franklin Resources still has a war chest of almost $7 billion in cash & investments at its disposal.

This gives us confidence that the company has the wherewithal to pivot concerning upcoming investments if indeed the industry warrants such a move. Suffice it to say, based on the steep pullback in the share price of BEN, we remain very interested in BEN from the long side and would trade the stock in the following format.

Sell Near-Dated Put Options

Many times when researching individual stocks, investors get too caught up in thinking about the near-term direction of their plays and ignore the other profit-making possibilities. As we can see below in the implied volatility chart of BEN, IV has now surpassed 40% in the back month and is trading above the stock‘s historical volatility. This means current options prices are inflated which means we can collect above-average premiums for example when selling near-dated put options. The regular July out-of-the-money $22.50 put options for example are trading for close to $1 per contract which means the breakeven for this position would be $21.50 per put option (100 shares of stock). To minimize buying power, our strategy would be to roll these options out in time when tested (and preferable down) which would also reduce our breakeven in the position. Let‘s say though after a few months of rolling, we get assigned stock or can‘t roll near-term for a credit which means we end up holding a basket of shares of BEN with a cost basis of a hypothetical $20 per share. The question then becomes, why would we be happy owning shares at this price point?

Eventually, Get “PUT” Long Stock

BEN‘s valuation (GAAP earnings multiple of 6.22) is clearly cheap and would be an even more attractive proposition if shares actually went significantly lower. We state this because Franklin is healthily profitable as we can see from the free cash flow it is generating ($869 million over the past four quarters). Followers of our work will be aware that we believe growth rates are overrated in quality value plays. We state this because as long as Franklin can register enough sales to produce sustained earnings and cash flow, then this very same cash flow can be used to build the business through sound acquisitions over time. Free cash flow is the most important metric in finance and the driver of long-term growth. Suffice it to say, with a very attractive forward cash-flow multiple of 7.17, Franklin continues to have the ammunition to remain at the cutting edge of this ever-evolving industry.

Covered Calls

We then write covered calls on our long stock position to bring in additional income alongside the very generous dividend yield. Many see covered call writing as an opportunity loss (due to the potential to miss on substantial gains) but in stocks such as Franklin, we believe it is the prudent play. Why? Well, if one studies the long-term technical chart above, it is evident that shares have significant overhead resistance in play at present. This means it will be very difficult to envision a breakout happening here anytime soon. Suffice it to say, in trading conditions such as these, capping one‘s gains is a prudent move. Franklin‘s low valuation, strong profitability, and proven dividend all reduce downside risk in our option. On the contrary, upside potential (given the technicals) looks strained at this point which is fine by us as long as we stick to the above strategy. Suffice it to say, the objective is to keep on selling naked puts or covered calls in BEN to consistently reduce the cost of the respective basket of shares. A breakout in the share price or a collapse of Franklin‘s implied volatility would make us rethink our approach in due time.

Conclusion

Franklin Resources is a proven dividend aristocrat which has been suffering lately due to high inflation, rising interest rates and the ongoing war in Europe. Although we see the stock most likely going sideways over the near term, Franklin Resources remains an excellent income play when one takes into account the company‘s dividend and elevated implied volatility. We look forward to continued coverage.