finnCap stock price on the rise, but investors will have to bet on the party continuing.
Is the chart-break-out – followed by director buying – at finnCap (LSE:FCAP) worth taking action over?
On 26 February the AIM-listed shares in this corporate broker and market maker – to relatively small, listed companies – began rising from 23p, the level they had traded at since last July.
Last Friday, 5 March, they hit 31.5p after a 3 March update cited trading “materially” ahead of expectations in the second-half year to 31 March. After a brief drop to 30p, this morning the price is 31p.
October to December marked finnCap’s highest-ever quarter for deal fees, with good growth also in equity sales and trading revenue.
This period was quiet for merger and acquisition advice, but January to March has seen a strong uptick with various deals closing prior to the UK Budget.
You could therefore say this is as much a break-out on fundamentals as the chart, and top management has bought stock with a good sense of their pipeline of deals ahead.
On 5 March, the CEO bought £39,650 worth at 30.5p, taking her stake to 9.3% of the company. Also the chairman bought a maiden stake of £19,962 worth, also at 30.5p. Previously, the chief financial officer bought £21,600 worth at 22.65p after interim results were declared on 18 November.
Revenue for the latest financial year was projected at more than £43 million relative to consensus for just below. However, profits and the cash balance will be “well ahead” of the board’s expectations when they last updated with the 18 November interim results.
A feast-and-famine industry, embarking on a binge?
Assuming March 2021 earnings per share (EPS) of around 2.5p (there are a bulky 174 million shares issues, finnCap is on a forward price-to-earnings (PE) ratio of 12x. This compares to similar brokers Cenkos Securities (LSE:CNKS) with a colossal 470x due to published estimates of near-zilch profit, and Numis (LSE:NUM) on 14x.
All three have similar charts, of consolidation followed by break-out starting from last November, but accelerating since that point.
The market is saying such firms now face a bonanza. Corporate clients are set to take advantage of higher stock prices that have followed from monetary expansion, Covid-19 vaccines’ progress and now optimism about the UK economy opening up.
- These shares are back in favour as tech stocks dive
- Stockwatch: a good IT share for patient buyers
- Are you saving enough for retirement? Our calculator can help you find out
It is entirely possible that this scenario persists. An advantage with the business model of such firms – like asset managers – is that once fixed costs are covered, extra revenues swiftly boost earnings unless there is some partnership-type remuneration scheme to direct profit to employees.
But unlike asset managers, where fees tend to accumulate with client assets, brokers significantly have to keep doing deals – to earn fees beyond basic retainers.
This is liable to be a feast-to-famine industry. To buy into it, you must have medium-term confidence that stock values will remain supported. Likewise, confidence that ‘buy the drop’ will persist if markets get seriously hit any time in the next year or so. That confidence will remain in central banks to prop financial markets come what may.
If you are at all wary that something has to give, and that mean reversion in equity values must follow the current euphoria, then avoid corporate broking stocks. They are quite unlike retail brokers where market volatility has, in recent years, been as likely to bring private investors out to play, as others who sit on their hands.
A potential positive scenario after small cap re-ratings
The cost dynamic is key, as to whether shareholder value arises from medium-term revenue swings.
finnCap floated at the end of 2018, and its financial statements (see table) show net profit stuck around £2.3 million, then fell to £0.8 million in the March 2020 year. The reason was a 21% hike in administrative expenses to £24.5 million, relative to a 6% rise in turnover.
Note three of the 2020 accounts say this was due to a 45% jump in non-employee costs to £8.4 million.
This is down to extra costs from running Cavendish corporate finance, acquired for £14 million just prior to finnCap’s flotation, and costs of being an AIM-listed company, as well as an 11% rise in “employee benefit expense” to £16.1 million.
However, the average number of employees rose by 32% to 140, as if the employee cost was amply justified. Average staff costs fell 15% to £115,000.
In the interim results to 30 September, administrative expenses as a percentage of turnover had eased from 91% to 81% and note four showed the hike in non-employee costs easing to 13% at £4.5 million.
- 10 shares to give you a £10,000 annual income in 2021
- Shares for the future: a dozen good businesses
The “employee benefit expense” jumped 36% to £12 million however, despite total number of employees reducing by five to 135 since end-March 2020.
Whether bonuses are tempering shareholders’ profits is the dilemma, where key staff may not own significant equity like the CEO.
Another speculative aspect with such stocks is whether boards can satisfactorily balance the need to retain key people, versus earnings and dividends for shareholders.
At flotation, dividend policy was set as according to business performance; was cut in response to Covid-19. Then a 0.5p a share interim dividend was declared last November.
On the basis of 1p as projected for the latest financial year, a 3% yield has some significance but a corporate broker’s payout is potentially too variable to constitute “support”. The business’s assets are effectively people, although within £23.9 million net assets last September £15.2 million did constitute property/plant/equipment. Therefore, the crux for perception of value is earnings.
finnCap Group - financial summary
year end 31 Mar
|Turnover (£ million)||18.0||19.5||22.2||24.5||25.9|
|Operating margin (%)||16.1||14.6||13.6||12.9||4.6|
|Operating profit (£m)||2.9||2.8||3.0||3.2||1.2|
|Net profit (£m)||2.3||2.3||2.4||2.3||0.8|
|Reported EPS (p)||1.4||1.4||1.5||1.7||0.5|
|Normalised EPS (p)||1.4||1.4||1.5||2.2||0.5|
|Earnings per share growth (%)||-0.7||5.5||47.0||-76.0|
|Price/earnings multiple (x)||15.4|
|Operating cashflow/share (p)||2.6||0.6||0.1||2.0||1.0|
|Free cashflow/share (p)||2.4||0.4||0.0||1.8||0.8|
|Dividend per share (p)||0.0||0.0||0.0||1.4||0.8|
|Covered by earnings (x)||1.4||1.6|
|Net debt (£m)||-5.2||-6.0||-4.4||-5.8||-4.7|
|Net assets/share (p)||2.8||3.8||4.4||12||12|
Source: historic company REFS and company accounts
Take your view on prospects for small-cap values
The finnCap team is competent, hence calling this stock is effectively a macro one. Much rests on the UK economy and small-cap equity prices being sustained.
They have re-rated, often on a scale of 50% to 100% since last autumn, which in part is logical after a period of risk-aversion after Covid-19 struck a year ago.
The UK’s vaccine roll-out is manifestly superior to Europe, hence why sterling is strong, and on such logic small caps should continue to benefit given they are more domestic UK-oriented – certainly than FTSE 100 companies and some mid caps.
That assumes the consensus of economists, which has cautioned Brexit will have a net negative impact, is proven wrong. It also assumes that the chancellor does not hike taxes significantly, too soon, to start rebalancing public finances.
While I draw your attention to a risk of employee bonuses gnawing into shareholders’ profit if a benign scenario persists, an advantage with this kind of business model is low debt – unless a board embarks on serial acquisitions, which seems unlikely here.
At end-September, there was £1.7 million debt relative to £12.1 million cash, and the net finance charge was insignificant. Hence profit will not be checked this way if revenue expands.
- Take control of your retirement planning with our award-winning, low-cost Self-Invested Personal Pension (SIPP)
Such a business is also fundamentally cash generative, the interim statement showing a big jump in like-for-like net cash from operations from £875,000 to £7.8 million. Until recently, Cenkos Securities had been liberal with its payouts, hence offering very attractive yields but its stock declined from over 200p to around 50p, currently 70p.
If you are wary that stock market values must mean-revert before long then avoid this specialist sector. If you think the party can carry on at least a year – maybe two – then ‘buy’.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. 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.
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.
We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.
Please note that our article on this investment should not be considered to be a regular publication.
Details of all recommendations issued by ii during the previous 12-month period can be found here.
ii adheres to a strict code of conduct. Contributors may hold shares or have other interests in companies included in these portfolios, which could create a conflict of interests. Contributors intending to write about any financial instruments in which they have an interest are required to disclose such interest to ii and in the article itself. ii will at all times consider whether such interest impairs the objectivity of the recommendation.
In addition, individuals involved in the production of investment articles are subject to a personal account dealing restriction, which prevents them from placing a transaction in the specified instrument(s) for a period before and for five working days after such publication. This is to avoid personal interests conflicting with the interests of the recipients of those investment articles.