Stockwatch: Sweet spot play on pensions advice

Are Independent Financial Advisers (IFAs) on a roll, amid the growth and liberalisation of pensions? Changes in law have fuelled demand for advice like whether to leave final salary schemes, and a new market is evolving in auto enrolment schemes linked to asset management.

Lighthouse Group (LGT) – a £25 million AIM-listed company – provides a range of solutions, including wealth management advice to higher net worth clients and regulatory/authorisation services to IFA firms. Branding itself “the national financial adviser of choice for Middle Britain” Lighthouse is effectively a play on growth in financial advice as people and organisations take more responsibility for themselves outside the state.

It’s not easy to get investment exposure to this aspect of pensions and investments: the other route being £200 million AIM-listed Mattioli Woods (MTW), which trades on a 2% yield, like Lighthouse.

Mattioli, however, enjoys a 12-month forward price/earnings (PE) ratio of just under 20 times, given a more substantive financial growth profile. Lighthouse is on a forward PE of 13, at about 19.5p in the market.

I have drawn attention to both stocks: Mattioli Woods at 450p in July 2014 which then soared to 860p, triggering profit-taking to 770p. I covered Lighthouse at 14.5p last April when the finance director was buying, in context of a drive for higher-margin revenues and cost cutting to revitalise profits.

I also mooted an improvement in the stock rating, given Lighthouse is attuned to growth sectors of advice across individuals and firms. It’s also overcoming setbacks such as a £2.2 million loss amid restructuring in 2011 then over 100 advisers leaving in 2012.

Pensions/investments drive demand for advice

New business revenues are being helped by contracts with “affinity” marketing groups on behalf of organisations such as trade unions and public sector pension schemes, whose revenues have risen from 14% to 18% of group total over the last year or so.

They are also fuelled by all employers required to offer a workplace pension scheme: Lighthouse has staged over 400 auto-enrolment compliant schemes in a context of some 600,000 firms yet to establish one that’s appropriate. On an individual level, there’s also strong demand for advice/action by people who want to free-up their pension by leaving final salary schemes – it’s the most frequent issue I hear from middle-aged employed people.

In a similar vein is “wealth advice” for life savings or a lump sum, now that zilch interest rates have destroyed any risk-free rate of return on capital. I respect that a majority of people don’t have the inclination to follow and invest in stocks directly, thus are inclined toward funds, where IFA’s can help according to their analysis and risk assessment.

Interest in financial assets partly follows from faded memories of the 2008 crisis, but there is an educated sense to ride out market volatility or use it to “buy the dips” where history is on the side of long-term investors.

While capital gains and dividend taxation are likely to rise under a radical-left Labour government, it would be far less likely to tamper with established tax-free wrappers such as ISAs and SIPPs.

Higher introducer payments also helping revenue

Interim results to end-June showed a group revenue rise of 8% to £25.7 million, driven by a 29% hike in income from affinity partnerships to £4.3 million. Mind that higher introducer payments have contributed to the gross margin easing from 30% to 27%, with gross profit trimmed from £7.14 million to £6.99 million. There is also sustained demand for pensions advice.

Thus, a 34% rise in operating profit to £1.13 million was achieved by cutting “other operating expenses” by 6.6% to £5.73 million; which can only go so far. More positively, productivity has improved by way of a 22% rise in average annualised revenue per adviser to £117,000.

The end of September saw a three-year contract renewed with a 240,000-member, civil service and public sector affinity marketing group, also a new contract with the UK’s largest civil service union – 180,000 members, for mortgage advice – putting the total number of affinity agreements at 20 organisations, representing about 6.2 million people.

Wealth advice and funds aid the recurring element

Interim revenues from high net worth clients via employed and self-employed advisers rose 12% to £4.7 million. In drawing attention to the stock last April, I noted the group’s September 2016 launch of Luceo Asset Management, which has done well so far – assets under management increased from £5 million to £20 million over the six months to end-June. The funds are actively managed by Octopus investments, with two new launches last February to meet risk objectives.

Luceo is diversifying to offer cost-effective passive funds “that should augment further the regular investment flows.” Presumably, the covert objective is to make hay while the sun shines; pulling in money while confidence in financial assets is high. There isn’t a specific breakdown, but funds growth in particular should help explain group recurring revenue up from 44% to 49%.

Attractive cash flow/balance sheet profile

An advantage of a cash-generative “people business” like this is needing no debt: cash-at-bank has risen 7.4% to £8.5 million, the interim cash flow statement showing a £270,000 net cash inflow from operations due to the profit improvement.

It’s unclear, though, what extent of cash may be required by financial regulators as a buffer, than being available for corporate development. Intangibles constitute a moderate 52.2% of net assets considering a track record of acquisitions in “people businesses”.

The ratio of trade receivables versus trade payables has reduced from 1.13 to 0.97, although trade payables anyway are down 18.6% to £8.4 million, so profit should not have been enhanced by tougher/longer settlement days to creditors, reflecting a “continued drive for operational efficiencies.”

Lighthouse Group – financial summary           Broker estimates year ended 31 Dec 2012 2013 2014 2015 2016 2017 2018                 Turnover (£ million) 55.0 47.9 46.8 48.9 47.9     IFRS3 pre-tax profit (£m) -4.6 -1.7 0.6 0.9 1.9     Normalised pre-tax profit (£m) 0.7 -0.4 0.7 0.9 1.9 2.3 2.5 Operating margin (%) 1.4 -0.6 1.7 2.2 4.0     IFRS3 earnings/share (p) -2.8 -1.3 0.4 0.7 2.0     Normalised earnings/share (p) 1.4 -0.3 0.5 0.7 2.0 1.4 1.5 Earnings per share growth (%) 94.4     33.3 190 -28.9 7.1 Price/earnings multiple (x)         10.0 14.1 13.2 Historic annual average P/E (x)   2.6   13.6 16.6 7.8   Cash flow/share (p) 0.4 -1.5 -0.3 0.8 0.5     Capex/share (p) 0.5 1.0 0.1 0.2 0.2     Dividend per share (p) 0.3   0.1 0.2 0.3 0.4 0.4 Dividend yield (%)         1.3 2.0 2 Covered by earnings (x) 5.2   8.5 3.4 8.3 3.5 3.8 Net tangible assets per share (p) 0.6 -0.3 0.3 1.0 2.9                     Source: Company REFS               Earnings growth and rating improvement due

So, the industry context is benign and should not be seriously affected if markets turn volatile: Lighthouse is capitalising on relatively new and firm trends in pensions and financial advice, well-insulated from political risk.

Management continues to develop its own products for the asset management and workplace solutions markets, with an emphasis on higher margins. Thus, a fair expectation is that the track record should continue to improve and, with better progress at the top line, rewarding investors who tuck the stock away. Patience is also required for trading given a normal market size of 7,500 shares. Accumulate.

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.