A Member of Pat McKeough’s Inner Circle recently asked for his advice on an asset management company involved primarily in institutional-level investment banking, asset management, and other financial services.

Pat notes the company’s revenue has increased 21.7% over the last five years, and that the shares yield a high 5.5%. However, he feels uncertain market conditions could hurt the company’s asset management business.

Pat comments that if the markets fall, the company could see significant fee revenue cuts over time and the current valuation at 8.7 times estimated 2019 earnings may not offer good value.

Q: Pat, I would like your opinion on Lazard (NYSE LAZ). Thanks for your help.

Lazard Limited, (Symbol LAZ on New York; www.lazard.com), is a financial advisory and asset management firm that engages in investment banking, asset management, and other financial services, primarily with institutional clients. Lazard is one of the world’s largest independent investment banks. It does business in 43 cities across 27 countries in North America, Europe, Asia, Australia, Central and South America. The firm’s principal offices are in New York City, Paris and London.

Lazard operates two business segments: Financial Advisory, in which it provides advice on mergers and acquisitions, strategy, capital structure, and corporate finance; and Asset Management, in which it provides investment advice and services to corporations, partnerships, institutions, governments, and individuals. The Financial Advisory business segment has accounted for just over 50% of total revenue for each of the past five years.

In 2018, Lazard provided advice on 61 corporate transactions (up from 50 in 2017) valued at more than $1 billion. These transactions include Aetna’s $78 billion sale to CVS Health; Express Scripts’ $67 billion sale to Cigna; Innogy’s 37.9 billion euro ($42.6 billion U.S.) takeover by E.ON; IBM’s $34 billion acquisition of Red Hat; the valuation of The Woodbridge Company’s Financial & Risk business; Sanofi’s $11.6 billion acquisition of Bioverativ; and AkzoNobel’s 10.1 billion euro sale of its Specialty Chemicals business to Carlyle and GIC.

Lazard has also been engaged in a broad range of restructuring deals for clients such as Breitburn Energy Partners, Claire’s Stores, Sears Holdings, Takata, Toshiba and Toys “R” Us.

In the Asset Management segment, total assets under management fell 6.2%, to $241 billion at the end of 2018 from $227 billion in 2017. This reflects the general contraction for global markets during that time. However, that decline also reflects a net outflow of $4.9 billion as clients withdrew their investments.

Over the past five years, Lazard’s total revenue has increased 21.7%, from $2.3 billion in 2014 to $2.8 billion in 2018. The Financial Advisory segment contributed almost all of that growth. Earnings increased 23.4%, from $427.3 million, or $3.20 a share, in 2014 to $527.1 million, or $4.06 a share, in 2018.

In the quarter ended December 31, 2018, revenue was up 1.2%, to $687.2 million from $678.8 the previous year. Excluding one-time items, earnings fell 19.6% to $119.0 million, or $0.94 a share, from $148.0 million, or $1.12. The decline was mostly due to escalating expenses. This included investments in technology, but also higher pension plan expenses mainly resulting from new accounting guidelines.

Inner Circle: 5.5% yield is supplemented by special cash dividends

The firm has raised its regular dividend every year since 2007 and Lazard currently pays a regular quarterly dividend of $0.47 for a high yield of 5.5%.

In addition, Lazard pays out special cash dividends. Since 2015, special dividends were declared as follows: $1.00 a share in 2015; $1.20 in 2016; $1.20 in 2017; $1.30 in 2018. In February 2019, Lazard declared a special dividend of $0.50 a share. The payout was lower than in 2018, mainly because the company took advantage of its lower share price in the fourth quarter to use some of its cash to buy back 6.4 million of its shares for $246.3 million.

Uncertain market conditions could hurt Lazard’s asset management business in the short term and the firm’s clients may pull more of their assets out from the company’s control or may cash out of the market. Lazard’s fee revenue would also be hurt if the markets do fall—that’s in addition to the continuing industry-wide move to lower asset management fees. Still, Lazard has been able to offset some of that by creating new products and expanding into non-traditional categories such as private equity and alternative assets.

Meanwhile, the company is a global leader in the field of corporate finance and has already invested heavily in technology, data analysis, and personnel in order to maintain that position. Lazard’s mix of activities across business segments, geographic regions, industries and investment strategies also helps to diversify and stabilize its revenue stream.

The stock trades at 8.7 times the estimated 2019 earnings per share of $3.93.

Recommendation in Pat’s Inner Circle: Lazard Ltd is a hold.