Stockwatch: Upside potential and meaningful yield

Does a 31.6% hike in assets under management to £3.8 billion improve prospects for fund manager Miton (MGR), or perhaps reflect a late-stage bull market given its small-cap equity orientation?

The latter could be liable to destabilise as demand outweighs quality opportunities, leading to riskier investing and inevitable disappointments – hence a positive cycle eventually turning warier.

I drew attention to AIM-listed Miton initially at 25p in January 2015 as a recovery play; its price having dropped from a 2014 high of 50p as low as 19p after the group lost a third of its assets due to a business sale. The retirement of a key fund manager also provoked the loss of an institutional mandate.

• Stockwatch: A geared play to follow

The chairman and another non-executive director had bought a total of 190,000 shares at 21-22p and a trading update cited “major improvement in performance that has gradually reversed the trend in redemptions and will bring renewed inflows in time.”

Operational gearing from asset growth

At this point, assets under management were £2.1 billion hence the latest update implies 38% growth over two years. It’s a lynchpin for value because once a fund management group has got established and covered people/IT costs, revenue growth ought to drop through quite easily into profits.

This is not a business requiring much ongoing capital expenditure; the chief risk for costs (likewise with surveyor/recruiter plc’s) is management convincing boards they need remuneration schemes that cream off shareholders’ profits, or else they may leave for private partnerships.

Miton’s administrative expenses clip over two-thirds from net revenue, this percentage easing from 69.1% to 66.2% last year, and an additional share payments’ expense was down 25.8% to £548,000. Within a 10% rise in admin costs, however, fixed cost of staff rose 5% to £6.7 million and the variable element by £0.8 million to £3.0 million.

It would appear better if the bonus element was more directly related to fund performance than “net revenues generated by the group and underlying profitability”, as this can follow from bullish sentiment than specific talent; though Miton could say brand confidence also drives revenue gain.

Anyway, it’s not a hedge fund pay scheme and pre-tax profit has risen 33% to £6.8 million versus revenue up 15.5% to £27.8 million. Shareholders are enjoying the benefits of operational gearing as shown also by Miton even beating a 2018 earnings per share (EPS) forecast of 3.2p.

Fund assets rise over £4 billion yet rating is modest

Miton, therefore, merits renewed attention, for unless markets slump in a major switch to “risk-off”, then it’s likely to continue beating forecasts. Management cites momentum in the business continuing, with sufficient infrastructure to support growth.

I’d be inclined to pencil in EPS of around 4p or better for 2018, versus the company broker’s upgrade to 3.8p, implying a prospective price/earnings (PE) of about 10 times. Yet the market is clearly cautious, Miton shares rising only from 39p to 42p after the results, most likely due to caution the equities bull market could peak with rising interest rates, which also increase the chance (finally) of cyclical recession – so far averted by monetary stimulus.

A recession is typically when small caps suffer most, although perception of Miton as a specialist in this area needs updating. Yes, it has had such an historic bias due to founder Gervais Williams’ career focus, but the group has diversified also to offer themes such as global infrastructure income, US/European opportunities and multi cap income.

Management says 2017 positive net inflows of £494 million are across a range of strategies, and positive net inflows of £190 million in the first two months of 2018 have been helped by the launch of a balanced multi asset fund in January, and a US smaller companies fund in March, taking assets under management past £4 billion.

Miton Group – financial summary               year ended 31 Dec             Estimates   2012 2013 2014 2015 2016 2017 2018 Turnover (£ million) 22.3 28.0 27.0 22.0 24.1 27.8   IFRS3 pre-tax profit (£m) 0.9 0.7 -5.5 2.1 4.3 6.2   Normalised pre-tax profit (£m) 0.9 1.8 6.8 2.5 4.9   7.7 Operating margin (%) 4.0 6.1 24.9 11.0 20.1 22.3   IFRS3 earnings/share (p) 0.8 0.5 -3.0 0.8 1.9 3.1   Normalised earnings/share (p) 0.6 1.1 4.6 0.9 2.3 3.4 3.8 Earnings per share growth (%) -24.7 82.0 314.0 -80.0 147 47.8 11.8 Price/earnings multiple (x)           12.4 11.1 Historic annual average P/E (x)   54.8 37.2 5.5 29.4 16.8 13.9 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 1.4 1.7 Dividend yield (%)           3.3 3.4 Covered by earnings (x) 1.5 2.6 9.5 1.9 3.8 2.2 2.4 Net tangible assets per share (p) 5.9 1.8 8.3 9.4 11.1 10.3  

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

40% dividend hike underlines a fundamentals’ re-rating

This reflects boardroom confidence about how earnings progress is no flash in the pan, and, at 1.4p per share, is covered 2.4 times by underlying diluted earnings – representing an historic yield of 3.3%, or about 4% according to the company broker now projecting a 20% advance to 1.7p.

The 2017 cash flow statement shows dividend costs up from £1 million to £1.5 million versus £19.9 million year-end cash on the balance sheet, quite similar to £21.3 million at end-2016.

Neither the results’ financial review nor note 5 to the balance sheet clarify – like they should -whether/what extent this surplus cash is a regulatory requirement. Anyway, the board seems unlikely to re-rate dividends more substantially in case markets turn down and redemptions follow.

There is no debt (service costs), the balance sheet effectively comprises £41.6 million goodwill/intangibles and the cash element, within net assets of £59.4 million. Altogether, the business looks long-term capable of dividend growth, also acting as a prop for its shares, given a business model conducive to cash returns.

13 of 15 funds in the first or second quartiles

This conveys relatively sound overall skills, and hopefully the multi-asset funds will mitigate future volatility from single-strategy equity. A current difficulty assessing fund managers’ performance though, is not knowing whether skills that have done well say to end-2017 – in a risk-taking environment that followed from low interest rates and QE – will prove themselves from 2018 onwards or may at least need adjusting.

This year has already seen a sudden 10% drop in the US stockmarket and a moment of truth for indebted small caps, as AIM-listed Conviviality (CVR) has crashed into suspension. Amid news this drinks wholesaler seeks £125 million emergency equity to recapitalise, it’s not good to see Miton on the share register with 7,507,144 or 4.35% as of end-June 2017.

Trawling through the Holdings RNS doesn’t reveal a reduction this stake, but Company REFS does currently cite 3.22%, as if Miton did reduce so far as it could. Yet Conviviality exemplifies how fund managers have relaxed discipline in a bull market, to back an inherently high-risk set-up making rapid acquisitions of low-margin businesses with cheap debt (for so long as interest rates remained low).

Street-wise small cap investors know the history of big losses most frequently involves acquisitive over-stretch, loss of controls and excess debt. So, if it was to get involved at all, Miton should have been more keenly alert to lock in gains and not be left even with 3.22% when the music stopped. Perhaps Conviviality will be small in Miton’s overall portfolio context, and even a modest reputational issue be overcome by other successes.

I’m left wondering, though, if this oversight reflects the chief executive – Gervais Williams, a well-seasoned small caps fund manager – having other plc development issues weighing on his time and mind, as Miton grows, than being critically focused.

Whether that amounts to a tell-tale sign, the main variable is investors’ confidence in financial assets holding up, especially if more small caps hit challenges. Barring a market slump, I think Miton will continue capitalising on demand for specialist, actively managed funds, and regain its 50p high in 2014 and trade higher still, backed by meaningful yield. Add.

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