Is the 25% dividend yield from Magellan shares a trap or a gold mine?

Looking at Magellan Financial Group Ltd (ASX: MFG) shares, it appears to have a very high dividend yield.

In FY22, the funds management business paid an annual dividend per share of $1.79. Including the franking credits, that’s a grossed-up dividend yield of around 25%.

It would be a huge yield if it were repeated in FY23. But, what are the chances of that?

Profitability is reducing

Magellan manages many billions of dollars of investors’ money. However, it manages a lot less than it used to.

In November 2021, it was managing around $116 billion of funds under management (FUM). By December 2022, this had dropped to just $45.3 billion.

Magellan has seen an enormous amount of money flow out of the door. The fund manager said that it experienced net outflows of $2.6 billion during the month of December 2022, which included net retail outflows of $0.6 billion and net institutional outflows of $2 billion.

The company also recently admitted that performance fees for the six months ended 31 December 2022 “are not meaningful”.

Magellan informed the market that the average FUM for the six months ended 31 December 2022 was $53.8 billion, compared to $112.7 billion in the prior corresponding FUM.

On 29 July 2022, the run rate of average base management fees based on its closing FUM of $60.2 billion was 65 basis points. With the huge fall of FUM over the past year, this means that Magellan’s ongoing revenue and net profit after tax (NPAT) have dropped a lot.

While a company’s board decides the dividend, it is heavily influenced by a company’s current earnings generation ability.

Magellan’s dividend expectations

The funds management business’ dividend policy for its interim and final dividends is to pay 90% to 95% of net profit of its funds management business.

According to Commsec, Magellan is expected to generate earnings per share (EPS) of $1.02 and pay an annual dividend per share of 87 cents which would equate to a grossed-up dividend yield of around 12%.

The problem is, with the shrinking FUM, Magellan’s earnings are expected to fall in FY24 as well. The FY24 grossed-up dividend yield could be 9.1%.

So, not only is the 25% yield an illusion, the FY23 dividend yield of above 10% may not be sustainable either.

Can it turn things around?

The new leadership of Magellan believes that through the growth of its existing strategies as well as new products, it can get back to $100 billion of FUM after five years. The growth is aimed to be “more diversified” and be less dependent on global shares.

It’s going to take signals from clients on how to position. Magellan wants to grow its allocations with clients’ portfolios, and supported by industry tailwinds.

Magellan said it’s looking to invest to ensure it can bring its more diverse offerings to global institutions and “create value-added partnerships that sustain in a competitive environment.”

The post Is the 25% dividend yield from Magellan shares a trap or a gold mine? appeared first on The Motley Fool Australia.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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