Description

Julius Baer is a pure-play private bank.  Headquartered in Switzerland, but with branches located across Europe, Asia, the Middle East, and Latin America, Julius Baer provides wealth management, financial planning and related services to high net worth individuals (HNWIs).

Clients of Julius Baer don’t wait in line, and they don’t go to bank tellers.  Instead, they call their Relationship Manager, who handles all aspects of the relationship.  In addition to providing traditional wealth management services, Relationship Managers also provide a number of concierge type services.  Need reservations at your city’s most popular restaurant?  Need a summer internship for your college-age son or daughter?  Need elephants for your daughter’s wedding?  Your Julius Baer Relationship Manager can probably help with that.

In exchange for all this, Julius Baer makes money primarily in three ways. 

1) Net commissions and fees: Mostly asset management fees (charged as a % of AUM), also some trading commissions too

2) Net interest and dividend income: Julius Baer's clients deposit their cash at Julius Baer; Julius Baer then invests these deposits conservatively in mortgages and Lombard loans (loans secured by financial assets), allowing Julius Baer to earn a spread

3) Net trading income: Primarily income from foreign currency trading resulting from Julius Baer hedging currency for its clients

Of this revenue, 45-50% is paid out as employee compensation (primarily to Relationship Managers), then another 20-25% goes to other operating expenses (G&A, D&A, etc.), resulting in ~30% pretax margins (excluding amortization of acquired intangibles).

Julius Baer as a stock tends to get comped with other European banks and asset managers.  As a result, it trades at an undemanding valuation:  13x consensus 2018 EPS and 12x consensus 2019 EPS.  I would argue that Julius Baer is a fundamentally better business than the banks and asset managers with which it is typically grouped.  Yes, it is a bank, but its balance sheet is extremely conservative; Julius Baer’s interest-earning assets are primarily mortgage loans and Lombard loans to their clients.  And yes, it’s also an asset manager in a way, but unlike traditional asset managers, Julius Baer’s net inflow rate is not determined by the ebbs and flows of relative performance.

In fact, Julius Baer has a terrific track record of consistently generating inflows across a range of environments (including net inflows during the Financial Crisis):

Julius Baer is still a relatively small player in the global wealth management industry (UBS and Credit Suisse are the biggest), but they are the largest independent pure-play private bank.  I think their independence is a competitive advantage.  Their independence means clients have access to products from other banks, and it reduces conflicts of interest (Julius Baer doesn’t have an incentive to stuff client portfolios with products from the rest of the organization).  As a result, Julius Baer’s inflow rate is typically a bit better than the wealth management segments at large peers like UBS and Credit Suisse.

Rather than a traditional bank or asset manager, Julius Baer is really more of an “asset gatherer.”  In that respect, I’d group it with companies like Charles Schwab, TD Ameritrade, E*Trade, BlackRock and Fineco Bank.  These companies all have a track record of consistent mid-to-high single digit inflows.  When compared to these companies, which trade at 15x-18x 2019 EPS, Julius Baer at 12x 2019 EPS looks cheap:
*As of 8/8/18 close

Part of the investment case for Julius Baer is multiple expansion.  But even without any multiple expansion, Julius Baer can generate above-market shareholder returns just from earnings growth.  Start with net inflows in the 4-6% range, and add to that net market appreciation of 3-5% on average (albeit with volatility on a year-to-year basis), and the AUM base upon which Julius Baer generates earnings should grow in the high-single/low-double digit range over time.

In recent years, the amount of net revenue that Julius Baer generates on AUM has been under some pressure:

Three factors have contributed to the declining revenue yield environment for Julius Baer:

1) Low interest rates have pressured Julius Baer’s net interest margins
2) Relatively depressed levels of Fx volatility have been a headwind to Net Trading Income (which is primarily generated when Julius Baer hedges currency exposure on behalf of its clients
3) “Regularization” (whereby Swiss banking clients have had to disclose their assets in Swiss bank accounts to their home country taxing authorities) has been a headwind to AUM growth in the Swiss banking industry in recent years as overseas clients have moved some of their assets home or withdrawn funds to pay taxes.  Moreover, cross-border clients tend to be higher-margin, so the incremental loss of these clients has pressured Julius Baer net revenue yields.

The good news is that these three headwinds are likely to abate.  Futures curves imply European interest rate increases starting sometime in 2019, Fx volatility could mean-revert from current low levels, and “regularization” is now largely complete after a global automatic exchange of information program was adopted by about 50 countries last year.

If I’m right about these headwinds abating, then revenue growth going forward should be at least as high as AUM growth (which again, should grow in the HSD/LDD range on average driven by 4-6% inflows and 3-5% market appreciation).

On the downside, there probably isn’t much operating leverage on personnel costs.  Relationship Managers are valuable employees for Julius Baer, and I would expect personnel costs to continue to run at 45-50% of revenues:

There is some operating leverage on non-personnel expenses however:

As a result, I’d expect pretax income and net income to grow faster than revenue.

On an LTM basis, Julius Baer’s adjusted EPS (excludes amortization of acquired intangibles and some integration/restructuring costs) is CHF 4.01; over the last 5 years, this has grown at a 12% CAGR.  Absent a major market downturn (which would lower Julius Baer’s AUM base), I think Julius Baer should continue to generate low double digit earnings growth going forward.  Add to this a 2-3% dividend yield, and it’s easy to see how Julius Baer can outperform even without multiple expansion.

Catalyst

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