Interactive Investor

Stockwatch: can the small-cap broker results bonanza continue?

23rd March 2021 12:15

Edmond Jackson from interactive investor

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Smaller listed companies are exploiting higher valuations, and this stock has gained as a result.

Does an apparent polarity between the stock market and economy mean something has to give?  

This week has started with news of how the UK lost output during Covid-19. This is allegedly running at £0.5 billion a day, with one retailer claiming “the economy is going to hell in a handcart”.  

Meanwhile, AIM-listed Cenkos Securities (LSE:CNKS) has reported bumper 2020 results as smaller listed companies exploit higher valuations to raise capital: a 23% advance in overall revenue to £31.9 million, driven chiefly by corporate finance fees up 28% to £22.3 million.

It follows similarly strong results from AIM-listed FinnCap (LSE:FCAP) nearly a fortnight ago, affirming a bonanza for small-cap brokers. 

A wider bullish, or potentially bearish indicator? 

From a macroeconomic view, this is pertinent. Potentially, such investment can bolster the bull market in small-cap stocks, as the (chiefly domestic-oriented) firms capitalise on the UK’s relative success with vaccinations and a steady opening up of the economy ahead.

Cenkos raised £900 million for its clients during 2020, with 29 equity placements and four flotations. Management says this momentum has continued into 2021, with a healthy pipeline ahead. 

Sceptics, however, would caution that all this can change very quickly – should the market slump, with small caps taking the brunt of a change in risk appetite. Small-cap broking fees are inherently feast-and-famine.  

The latter view is supported, for example, by a recent acceleration in the rise of Cenkos’ share price to 78p during February, after a steady climb from 45p last November.

This could be seen as a classic ‘blow-off’ top. But you could also regard the subsequent drift to 67p pre-results as showing traders still have the measure of things.  

The truly long-term chart offers hope

Cenkos is only at the second top of a bullish ‘saucer’ over the last two years or so – having slumped from a 235p high in October 2014. Previously, there was a similar roller coaster from 265p in July 2007 down to 50p in August 2012.  

I drew attention to it as a ‘buy’ at 47.5p in October 2019 with the idea a victory for Boris Johnson at the impending general election would finally ‘get Brexit done’ and lift uncertainty holding back flotations.

Non-executive directors were buying, likewise the employee benefit trust, as if the board perceived value. The stock rose to 65p after the general election, falling to 33p a year ago with the Covid-19 sell-off, stabilising at around 45p to 50p until vaccines’ progress triggered a rally. 

Once again, non-execs are buying: the chairman has purchased 100,000 shares at 73p after the results, which is a maiden purchase since their appointment in June 2020. Another non-exec has bought 20,000 shares at an average 72.5p, taking his stake to 108,152 shares.  

Despite more client activity in capital-raising, the actual client base has not changed drastically in the last decade – having risen from 111 in 2011 to 130 in 2014, then progressively declined. You could say this is no special guide to revenue dynamics, given 2020 saw a fall from 100 to 94 clients. 

Operational gearing boosts the price/earnings multiple to 22x 

The results have pushed the price up to 71p, or 22x latest earnings per share of 3.3p. This could be seen as fair value if the positive mood among small caps persists, sustaining a pipeline of fees. Alternatively, it is an exposed valuation if you take the bearish view of famous British investor Jeremy Grantham, namely that the wider bull market will fairly soon break. In that case corporate finance fees would dry up.  

I find it impossible to make serious financial projections here given so much is hostage to wider market sentiment. Yet Cenkos professes a turnaround strategy “to deliver sustainable growth over the next three years”, so if markets are reasonably supportive then potentially company developments can tally with the bullish saucer on the chart.  

The table shows how operating margins have slumped from 30% to 7%, or nothing at all in 2019, which quite reflects the operational gearing of this kind of business. Its chief asset is human talent, which requires recruiting and keeping in place So, once this cost is broadly covered, revenue rises can drop swiftly to the bottom line.  

After breaking even around the pre- and post-tax levels in 2019, last year £1.8 million net profit was achieved. Cenkos also presents an advance in underlying profit from £1.4 million to £4 million, which is before restructuring costs and charges to a near-term incentive plan.

In a people business context, however, it means payoffs and bonuses, which on a conservative view is nothing ‘exceptional’: they are running costs, and bonuses are a choice by the board. 

Cenkos Securities - financial summary
Year end 31 Dec

  2014 2015 2016 2017 2018 2019 2020
Turnover (£ million) 88.5 76.5 43.7 59.5 45.0 25.9 31.9
Operating margin (%) 30.3 25.8 11.4 16.8 7.0 0.4 7.5
Operating profit (£m) 26.8 19.8 5.0 10.0 3.1 0.1 2.4
Net profit (£m) 21.3 15.4 2.5 7.2 2.4 0.0 1.8
Reported earnings/share (p) 32.0 25.9 5.8 15.0 4.5 0.1 3.3
Normalised earnings/share (p) 32.0 25.9 5.8 16.0 6.5 1.6 3.3
Price/earnings multiple (x)             21.5
Operating cashflow/share (p) 18.0 45.0 -8.0 34.9 5.6 -20.4 30.2
Capital expenditure/share (p) 0.6 0.3 0.5 0.7 0.5 0.4 0.0
Free cashflow/share (p) 17.4 44.7 -8.5 34.2 5.1 -20.8 30.2
Dividend/share (p) 17.0 13.0 2.0 9.5 6.5 3.0 3.5
Yield (%)             4.9
Covered by earnings (x) 1.9 2.0 2.9 1.6 0.7 0.0 0.9
Cash (£m) 42.8 46.3 38.1 47.5 45.5 18.3 32.7
Net assets per share (p) 62.1 50.4 47.9 52.3 48.7 43.5 45.1

Source: historic company REFS and company accounts

A 35% rise in staff costs to £21.3 million despite an 18% fall in headcount 

Page 13 of the annual report cites this as due to an increase in variable remuneration accrued for staff, partially offset by a reduction in their number from 111 to 91. But it affirms my wariness towards agency-type, public listed companies.

If they maintain an extent of ‘private partnership’ mentality, then the lion’s share of benefit from revenue advances and operational gearing is likely to end up with employees. 

Net profit has increased by £1.76 million, staff costs by £5.5 million. Very high payout ratios aid the dividend yield, but the cash flow statement shows £1 million as dividends for outsiders. In fairness, Cenkos has distributed £115 million to shareholders since floating in 2006, equivalent to 178p a share. 

The obvious response would be that the board has no choice if it wants to retain quality people, otherwise they would go elsewhere. But it is a factor to keep in mind, also for the stock rating.

Is a ‘growth’ type rating appropriate here, if profits are materially creamed off in good times, then shareholders have also to bear the risk of a sudden downturn? 

Near-term trade payables have soared to £24.5 million

This pops out of the balance sheet to me, as I am sensitive to trade payables boosting profit (if a timing delay is involved).

Receivables have eased 3% to £13 million, and non-current trade payables similarly to £5.1 million.

However, near-term trade payables have jumped a whopping 67% to £24.5 million. Note 19 partially explains this as a near £2 million increase - equivalent to annual net profit - in trade creditors to £9.4 million and accruals up 115% near £13 million. Further clarification would have helped, in note 19.  

It means net assets have risen only 4% to £25.6 million, despite year-end cash jumping 79% to £32.7 million. Mind that due to Pillar One regulatory needs, the real position is less than half of this. Yet it bodes well for pay-outs in the future, hence Cenkos’ prospective yield looks to be over 5%.   

I suspect retailers are squealing loudest after a year of lockdown. I also think we are going to see some adept smaller companies prosper, while others remain challenged. Last year does, however, look to be an exceptional year for corporate finance, and my base case for this stock is consolidation supported by a useful yield. ‘Hold’. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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