Does another bullish update from smaller companies fund manager Miton Group (MGR) imply its AIM-listed stock remains a ‘buy’, or is it an amber light how UK small-cap valuations are getting stretched?
Miton has declared that positive net inflows have continued such that assets under management at end-October were £3,635 million versus a 10-month average of £3,287million over 2017.
Between June 2015 to June 2016, AuM edged up from £2,225 million to £2,542 million, ending last year at £2,905 million, although it had started 2016 at £2,784 million.
AuM is a key benchmark for a mainstream fund manager (i.e. without hedge fund performance fees) which, to an extent, reflects capability besides public enthusiasm to invest in stocks.
Miton doesn’t distinguish any aspect of institutional money under management; its pitch is “building a distinct identity as a genuinely active fund manager” as if mainly in the private investor space.
The business could, therefore, be said to be exposed to shifts in sentiment, although a long-term trend is underway – freeing up pensions to enable individuals to take control, e.g. via the funds Miton offers.
Miton Group – financial summary year ended 31 Dec Consensus estimates 2012 2013 2014 2015 2016 2017 2018 Turnover (£ million) 22.3 28.0 27.0 22.0 24.1 IFRS3 pre-tax profit (£m) 0.9 0.7 -5.5 2.1 4.3 Normalised pre-tax profit (£m) 0.9 1.8 6.8 2.5 4.9 6.4 7.1 Operating margin (%) 4.0 6.1 24.9 11.0 20.1 IFRS3 earnings/share (p) 0.8 0.5 -3.0 0.8 1.9 Normalised earnings/share (p) 0.6 1.1 4.6 0.9 2.3 2.9 3.2 Earnings per share growth (%) -24.7 82.0 314.0 -80.0 147 26.0 13.3 Price/earnings multiple (x) 17.5 13.9 12.3 Historic annual average P/E (x) 54.8 37.2 5.5 29.4 16.8 Cash flow/share (p) 2.2 3.1 2.0 0.7 5.6 Capex/share (p) 0.0 0.2 0.1 0.0 0.0 Dividend per share (p) 0.40 0.45 0.54 0.60 0.67 1.10 1.35 Dividend yield (%) 1.7 2.8 3.4 Covered by earnings (x) 1.5 2.6 9.5 1.9 3.8 2.6 2.4 Net tangible assets per share (p) 5.9 1.8 8.3 9.4 11.1 Source: Company REFS
Achieving 2018 projected profits in 2017
Profits are declared ahead of expectations and Peel Hunt, Miton’s broker, has raised its 2017 profit forecasts by 17.6% to £6.35 million and earnings per share (EPS) by 19.2% to 2.86p, although the dividend is kept at 1.1p.
This effectively means achieving in 2017, what was guidance for 2018 when profits are now anticipated up 11.4% and EPS by 11.7%.
With the offer price around 40p, it puts the stock on a 12-month forward price/earnings (PE) multiple of 12.4 with a 3.4% yield. In context of the last five years, it shows quite some earnings variability (see table) and the chart in a circa 50p to 20p range.
Buyers ideally need a sense that the underlying dynamic is improving such that the 2018 projection is being kept conservative to avoid any profit warning if markets hit trouble.
Yet, other things being equal, the economics of a well-run smaller fund manager – Miton is capitalised at £72 million – imply scope to keep surprising on the upside.
Chief executive has added £110,025 worth of shares
On 30 October, chief executive David Barron bought 270,000 shares at an average price of 40.75p and, while fairly close to this bullish update, he’d need confidence that the business is well-placed for the longer term.
It’s paid off to follow the directors before, e.g. when I drew attention at 25p in January 2015 after directors had bought at 21p to 22p, my rationale being that low interest rates would continue to boost stocks with small caps likely to benefit as the bull market matured.
Last July, at 39p, I posited a long-term target of 70p based on achieving some £10 million annual pre-tax profit for earnings per share near 5p.
The 2016 results had shown operational gearing – i.e. revenue increases magnified at the profits line – with a 70% rise at the pre-tax level versus revenue up 9.5%, and yet revenues were still lower than 2013/2014 (see table).
The economics of a capable fund management operation are attractive: once fixed costs such as offices, IT and regulation are covered, growth in AuM means significantly higher profits unless managers exact greater compensation.
The economy offers scope for active fund managers
The macro context is panning out broadly as I indicated with UK small caps performing especially well lately: the Morgan Stanley UK small-cap index is up 24.4% over 12 months from end-October 2016.
Despite a Bank of England interest rate rise this only reverses the cut after the EU referendum.
Rates remain overall low and there’s political consensus for infrastructure spending and public sector wage rises creeping in – i.e. supporting economic demand despite retail sales pressured by inflation rising against static wages.
Yet online retail specialists are prospering, and UK manufacturing output is at a four-year high, helped by export orders under lower sterling.
These are times for genuinely active fund managers to prove their mettle.
Yet this stock remains about the same price as in July, implying investors are cautious the UK economy will falter and small caps with it.
Miton does, however, offer international funds such as US and European, and the launch of a global infrastructure fund income had attracted £17.3 million by end of last August.
The managers have built up some quite chunky holdings in UK small caps, which they would likely have to hold through a cyclical downturn, as dribbling out stock would undermine bid prices.
In fairness, Miton has not got a disclosed stake over 3% e.g. in Walker Greenbank (WGB), the luxury furnishings group clobbered lately after a profit warning.
Mind an aspect of partnership culture
A bugbear with this kind of “high value-added people business” – also affecting some other financial firms, property surveyors and head-hunters – is a partnership mentality where the costs of incentive schemes are spread subtly onto outside investors.
Wages/bonuses should appear as administrative costs above the profits line, though some firms rate even bonus schemes as exceptional costs to declare higher “normalised” profits.
Miton appears to have a fondness for share schemes, which doubtless are said to align managers’ interests with outside investors and counter key people being poached by rivals, but which impart dilution.
It explains a current share buyback exercise where Miton is offering to buy up to 8,546,063 shares at 39.75p from holders who notify Peel Hunt by end-of 5th December.
It’s presented as “ameliorating” dilution but is strictly net negative for value because £3.4 million spare cash could otherwise have been returned to shareholders – e.g. an equivalent 1.85p per share special dividend equivalent to a 4.6% return with the stock presently about 40p.
Miton would probably say there’s a positive upshot for employee motivation/loyalty that should be recognised in the value equation.
Stock is still largely a macro call
Effectively it’s a play on exacting higher returns from smaller companies in a mature bull market; in some ways better than a fund because you get keener operational gearing than when an investment trust borrows capital. The chief risk is when sentiment turns against small caps, though it’s already cautious in anticipation of this, given Miton is priced the same as in July despite a near 18% profits upgrade.
There’s also reason beyond the economic/market cycle, to favour capable fund managers – growth in ISAs and SIPPs helped by people contracting out of established pension schemes, such that capital is likely to be quite sticky as these investors will take a long-term view rather than try to time markets either way.
The chief executive accumulating over 555,000 shares in Miton is most likely because he judges the business – all-considered – capable of long-term capital growth. You can’t eliminate an aspect of speculation on the trend in small cap stocks, but if you recognise the risks then follow the CEO. Add.
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.