Stockwatch: A momentum play linked to industry rationalisation

Do bumper interims from this AIM-listed financial planner/wealth manager AFH Financial Group (AFHP) consolidating smaller advisory firms, imply further upside?

Or trading on 32 times earnings for its year to end-October 2017, with market price at 345p, is its stock rating now high-risk?

After listing four years ago, the price traded sideways at around 150p, then doubled in 2017 and hit 360p earlier this year. It dipped back near 300p but has strengthened again on latest results.

A dividend yield barely over 1% makes plain,”support” is all about growth numbers and narrative: optimists will see plenty more scope for a £130 million group to rationalise a fragmented industry of owner-managed firms, while pessimists be wary the growth rate will eventually ease or a general downturn hurt sentiment towards financial stocks.

But it looks fair to assume more years of expansion ahead, thus, for AFH to keep growing into its rating.

Source: interactive investor         Past performance is not a guide to future performance

Interim results reflect strong all-round progress

In the six months to end-April, acquisitions have helped boost pre-tax profit 132% to £4.3 million in the six months, where I add back depreciation/amortisation but not share-based payments (like the company does) as they are ultimately a cost.

Normalised earnings per share (EPS) thus rise 52.5% to 9p versus 62% to 10p as proclaimed in the results’ highlights.

Like enough smaller acquisitive plc’s, AFH doesn’t provide like-for-like figures, although under “trading results” in the narrative they cite”revenue from acquisitions reported during the current period totalled £2.6 million or 11% of total revenue”, while ongoing recurring fees increased 38% and represented 59% of total revenue, driven by new business in both our wealth management and protection broking operations.”

Combining also economies of scale, interim operating profit has jumped 161% to £3.3 million.

A still-low financial base helps percentage growth, but AFH’s momentum looks very good, and its sub-£100 million annual status together with just over £23 million cash reserves implies plenty of mileage.

The 21 May acquisition of client portfolios of Freeths, a national legal practice, shows how assets can expand from a variety of sources. Funds under management are up 45%, over £3.2 billion year-on-year.

Financial advice industry: ripe to rationalise

Its demand side continues to grow amid greater public awareness of the need for advice, also wealth polarisation in society.

A Financial Conduct Authority survey has shown a total 5,270 advice firms and 25,951 advisers recorded as of end-November 2017, up from 5,218 and 25,611 respectively at end-2016, with investment managers taking on more advisers and the number at banks and building societies continuing to decrease.

This should feed the pipeline of smaller firms eventually willing to sell out e.g. as owner-managers retire or seek to monetise intrinsic value within their firms – the net present value of long-term cash flows from satisfied private clients providing recurrent fee income.

Thus, the supply side of potential acquisitions for AFH is also bolstered, so long as a growing plc does not end up losing aspects of personal service which cause clients to leave.

They are said to benefit not just from”providing exceptional value and service to our clients”, but also “using our increased size to drive down platform and fund management charges aligned to an appropriate risk based investment model.”

AFH’s six months’ period saw six such acquisitions introduce £270 million of investment portfolios, taking total funds under management over £3.2 billion, a 45% increase year-on-year.

Its stock has doubled in a year as investors respect proof of the business model and its ongoing potential.

The Company REFS table doesn’t show forecasts, but EPS of 20p rising to 30p looks possible on a medium-term view given AFH’s track record of acquisitions and its modest size in overall industry context; hence a two-year forward price/earnings (PE) roughly in the high teens.

AFH Financial Group – financial summary             year ended 31 Oct 2012 2013 2014 2015 2016 2017               Turnover (£ million) 7.2 10.8 15.0 21.0 24.1 33.6 IFRS3 pre-tax profit (£m) 0.3 1.1 0.9 1.6 2.0 3.5 Normalised pre-tax profit (£m) 0.3 1.0 0.9 1.6 2.0 3.5 Operating margin (%) 4.1 9.9 6.0 8.4 9.3 11.1 IFRS3 earnings/share (p) 0.9 4.2 3.1 5.5 6.6 10.3 Normalised earnings/share (p) 0.9 4.1 3.1 5.5 7.2 11.2 Earnings per share growth (%) -57.6 375 -24.9 77.1 30.9 55.6 Price/earnings multiple (x)           30.8 Annual average historic P/E (x)     41.6 46.0 29.2 32.8 Cash flow/share (p) -1.0 4.1 8.5 9.7 11.5   Capex/share (p)     15.4 37.0 23.1   Ordinary dividend per share (p)   1.0 1.3 1.5 3.0 4.0 Dividend yield (%)           1.2 Covered by earnings (x)   4.1 2.4 3.7 2.4 2.8 Net tangible assets per share (p)     4.3 -41.1 -5.0 -14.9

Source: Company REFS            Past performance is not a guide to future performance

Charles Stanley: forward PE of 13, yielding over 3.5%

By way of comparison, non-index investment manager Charles Stanley (CAY) is capitalised at £175 million and after reaching 500p at end-2013 its stock has been in a volatile-sideways trend, as low as 240p in 2016, currently 344p.

You could say its PE and yield benchmarks are more appropriate long-run averages for the industry, subtracting the boost from acquisitions, and once the freshness of AFH’s story wears off then it too will get priced similarly.

Yet Charles Stanley’s financial record showed an earnings/dividend decline from 2013 to 2016, now recovering, and having a private client stockbroking arm identifies it with relatively more cyclical earnings.

Admittedly, there’s still some overlap with AFH’s focus on retirement/pension planning, inheritance tax and the like, even if revenues should not be anywhere near as cyclical as e.g. stockbrokers floating companies – a true”feast and famine” industry. Mind also, when these riskier brokers start to warn on their outlook it can cool sentiment more generally towards smaller financial stocks.

A read-across to Charles Stanley is still a useful reminder, AFH cannot afford to put a foot wrong with its development: the market is extending significant goodwill, there’s no margin of safety at 345p.

Good cash flow albeit equity fundings

Interim operating cash flow is up 135% to £3.5 million, although £5.4 million investment during the period reflects how equity financing has been deployed. Last November AFH raised £17.5 million at 250p per share, higher than the £15 million initially targeted, as investors responded keenly – and indeed it made sense to raise a war chest amid positive sentiment.

These institutions must be pleased with near 40% upside in barely six months, thus contributing to positive sentiment around AFH. Rather than lock in gains they are more likely to wait and let the business plan come to fruition, topping the group up again if required.

Interestingly, AFH has eschewed debt (beyond a small property mortgage) despite the current era of low interest rates, as if the board is cautious this can continue – and they want to avoid material gearing ahead of any downturn.

The last placing involved dilution of 23% and it followed a £10 million placing at 175p in March 2017, similarly for development.

Regarding contingent liabilities arising on acquisitions (i.e. deferred payments according to performance), these are shown as £4.9 million within note 7 to £12.1 million trade payables, i.e. amply manageable.

Not too late to get aboard?

The chief downside risk is a”black swan” event hitting markets, where financials and higher-rated stocks get hit most. Otherwise, AFH looks well-supported in terms of growth momentum and contented shareholders.

It’s possible to envisage the group at least doubling in size hence taking its stock over 400p even if its rating eases somewhat. For those who understand the risks: Buy.

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Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company’s or index name highlighted in the article.


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