UBS on LPL: Sell

An analyst at UBS Investment Bank has taken a dour view of the growth prospects for LPL Financial Holdings LLC, downgrading the firm Friday to “sell,” from “neutral.” Prior to the downgrade, analyst Alex Kramm had a 12-month price target of $28 per share on LPL stock. That target now is $25 per share. In afternoon trading on Friday, the company's stock Ticker:(LPLA) was trading at $30.05. “While LPLA shares have already significantly underperformed the group following the company's [second-quarter] earnings report, we believe the combination of a challenging macro environment, continued margin pressure and increased scrutiny by investors could drive incremental downside,” Mr. Kramm wrote. “With the company posting virtually no earnings growth this year, we also believe the stock's valuation will increasingly be called into question.” LPL spokesman Michael Herley said that the company does not comment on sell-side research reports. Growth of the adviser force at the broker-dealer has been strong over the past few years — with LPL consistently adding more than 400 reps per year. But Mr. Kramm warned that recruitment at the firm could trail off, crimping long-term growth. “The volatile market environment prolongs the decision-making process for advisers looking to switch brokers, or become independent for the first time,” he wrote. “Moving platforms always represents a disruption to an adviser's business and the prospect of having to transfer accounts and explain to clients why the move is being made could lead advisers to re-evaluate their decisions.” He also warned that LPL's increasing focus on large advisers has eroded the B-D's margins. LPL is a big seller of variable annuities and nontraded real estate investment trusts. Mr. Kramm noted that those products are facing heightened scrutiny from investors as well as regulators. Variable annuities account for 45% of the company's commission revenue, while nontraded REITs could represent more than 75% of the company's commission revenue from alternative investments, which is expected to be $143 million on an annualized basis this year. “Variable annuities, which generate some of the highest commissions among all financial products, have come under fire by both investors and regulators in recent years,” Mr. Kramm wrote. “More recently, we have also fielded multiple investor inquires regarding [the company's] exposure to nontraded REITs. “While we do not expect nontraded REITs to disappear anytime soon, increased oversight and investor questioning could clearly lead to a slowdown in sales for a product that represents some 10% in earnings today.” In 2011, LPL posted total net revenue of $3.48 billion, with gross income of $1.03 billion and with earnings per share of $1.95. Mr. Kramm estimates that for 2012, the firm will have total net revenue of $3.63 billion, gross income of $1.1 billion and earnings per share of $1.92.