Lazard’s Aggressive Buybacks And High Yield Are Interesting, But Risks Remain (NYSE:LAZ)

Lazard (NYSE:LAZ) is one of the several financial advisory companies we like to cover, and now it has become interesting again as we address it in this periodic review. The price is retreating pretty meaningfully from highs, and lies below pre-COVID levels. Yields are high and probably sustainable on a low volatility AM business and on financial advisory, which probably won’t get too much worse even if we have economic decline. We’d like the price to retrace a little further back to reflect the uncertainty in its markets, especially with macro risks still hovering above. But it has become interesting again and deserves discussion.

Q2 Results

Let’s start this time with shareholder payouts. The yield is annualizing at $2 per share and the buybacks are also pretty substantial, offering about 5% buyback yield just in the current quarter. The buybacks come at a reasonable time, with the stock price having been pretty low this quarter, especially around June when the markets crashed. At that price, LAZ was really interesting.

Recently prices have recovered by about 15%, and this comes in tandem with results where advisory declined about 20% YoY, not a surprise given 2021 was a monster year, and AUM in asset management declined by similar amounts on account of portfolio declines across the board, with a small net outflow effect amounting to about 2% of AUM. We should mention that a 20% decline in financial advisory is really not bad, and strength has come from Europe, which means that the big weakness in the American wallet share is probably from Tech. The European resilience was very diversified, but those same (non-tech) segments also performed well enough in the US. The bifurcation wasn’t accented much by management.

The asset management (AM) business is usually rather low in volatility, because clients often just reallocate from one strategy to another, and has already proven itself during the COVID-19 sell-off where outflows never exceeded 11%. Moreover, where there have been outflows it’s been in lower fee products, and any backflow involved in the netting of outflows has come into higher fee, actively managed funds. This has created resilience for LAZ. So the real questions surround financial advisory.

In 2021, sponsors were really important for activity. Indeed, even at the open of 2022, when other parts of the markets got antsy and the M&A boom started reversing, sponsors became an even more important client in the client mix. The problem is the sponsor market is being seriously affected by the state of credit markets, where the lack of credit availability, especially rather high yielding credit where leveraged finance markets are effectively closed, is making leveraged PE deals impossible. DCM might be picking up a bit of slack since private credit has become much more important lately.

There are also other pervasive issues. We have gone from a discussion of inflation to a discussion of recession. Actors haven’t been able to make much of the current situation yet, and the level of uncertainty clearly has a broad effect on markets, where ECM activity in particular has been majorly hit on account of resets in equity markets. Moreover, it takes time for sellers to accept the new market environment and the more conservative attitudes of buyers. Once expectations reset there should be some backflow into financial advisory as new turnover is created.

Conclusions

Lazard has a decent restructuring franchise. As far as distressed activity is going, some liability management engagement are picking up, and there are some punctuated deals in restructuring going on; Lazard is working on restructuring gas contracts for a German client. However, restructuring strictly speaking is still in this phase of ‘dialogue’ which means nothing concrete is happening. Naturally, when pressure gets put on balance sheets, this avenue will open up again and create some backstops.

However, we think that it is inevitable that in the event of further macro deterioration, there will be further declines in M&A activity. We also feel that it will very negatively affect the sponsor segment that could previously be relied upon for providing resilience. In particular, if we are met with further declines in consumer confidence on top of higher rates, discipline in credit markets will become a major bottleneck for leveraged deals, and Lazard isn’t exactly a mid-market advisor that could create deal flow for ‘value’ style PE like minority funds and others. Also as cash becomes more costly and the private sector deals with bloated debt in the 2020-2022 period, higher costs to outlaying cash could really dampen the environment.

Asset management is pretty resilient, and active funds are going to steal share. This is really good, and this segment accounts for about 33-40% of the business depending on what you consider a normalized level of revenue for financial advisory. Lazard is also demonstrating a healthy shareholder payout policy that currently exceeds 10%. The dividend is covered by the annualized net income by 2x. That is fine, but of course net income could continue to decline if the discussed issues affect the financial advisory business. There is probably enough margin of safety there for income investors. For value investors, I think it would be of low cost to just wait out the markets and see if the stock retraces further down to March 2020 lows. The baseline situation, since quite a few dividends have been paid out in the meantime, probably warrants a price only 5-10% above those lows. That would be an excellent, high conviction entry point. Otherwise, it is a question of whether you want its income. We think there are more prudent dividend stream out there though.