T. Rowe Upgraded to Outperform

We have upgraded our recommendation on T. Rowe Price Group Inc. (TROW) to Outperform from Neutral based on its above-average organic growth rate, strong debt-free balance sheet and robust earnings.

T. Rowe Price’s third quarter 2010 earnings came in at 64 cents per share, significantly up from 50 cents in the prior-year quarter. Results also outpaced the Zacks Consensus Estimate of 60 cents.

The results were primarily supported by better-than-expected top-line growth and increased assets under management (AUM). However, higher operating expenses as a result of high compensation and related costs were among the negatives.

T. Rowe Price remains debt free with substantial liquidity that includes cash and mutual fund investment holdings. It also maintains a sizeable internal equity and fixed income investment research capabilities. This has assisted in strengthening the company’s capital leverage and generating a return on earnings that is substantially higher than the industry average.

These growth drivers also pave the way for an industry-leading dividend yield, thereby creating ample investor confidence and scope for investment and growth opportunities in future.

In the long run, as markets rebound, the company is likely to benefit from the secular growth in domestic and global AUM, continued growth in retirement-related AUM and from its strong investment performance track record.

Despite the ongoing market volatility, T. Rowe Price continues to outpace its peers in AUM growth through its disciplined and risk-aware investment approach. AUM was up 12.4% at the end of third quarter of 2010 from $391.3 billion as of December 2009. Besides, the company’s lower cost fund structure and distribution methods help promote stability in mutual fund AUM throughout the market cycle.

While the resonance in the global markets will help in higher market valuations and increased income, the company will also be able to capitalize on the increasing savings and investment capacities of its customers.

However, the economic downturn has significantly hurt the company’s revenues and organic growth. Due to ongoing market volatility, we expect investment income to fluctuate in the near- to mid-term.

Also, T. Rowe Price operates in a highly competitive funds market. Most of the investment portfolios are available without sales or redemption fees, which may inspire investors to transfer assets to competing funds at any point.

Additionally, more than 30% of the company’s AUM business is exposed to third-party financial intermediaries, who are a vital source of net cash inflows but are not bound by any contractual obligations, thereby increasing the competitive risk of maintaining adequate and successful distribution relationships in the long term.

Furthermore, T. Rowe Price incurs significant expenditure to attract investment. These efforts often involve costs that precede any future revenues that may be recognized from an increase in AUM.

Though relative mutual fund performance remains a cause for concern, we believe that in the long run, the company’s financial stability has the potential to take advantage of the gaining traction in the economy and benefit from the growth opportunities in the domestic and global AUM.

T. Rowe Price currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. T. Rowe Price’s peers Legg Mason Inc. (LM) and The Blackstone Group (BX) also share the same rank.

T ROWE PRICE (TROW): Free Stock Analysis Report

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