Interactive Investor

Stockwatch: does this 8% yield and low rating offer compelling value?

24th June 2022 11:01

Edmond Jackson from interactive investor

Analyst Edmond Jackson takes a closer look at the investment case for this asset manager following a dramatic collapse in share price.

Since early last September, Liontrust Asset Management (LSE:LIO) shares have fallen over 60% from around 2,500p in nine months.

A current value of around 920p for the mid-cap shares represents just over 7x normalised earnings in the latest financial year to 31 March, and a near-8% dividend yield based on a 72p annual payout that is 1.8x covered by earnings, or 2.3x by free cash flow.  

That takes it into valuation terrain where the market is pricing for a sharp drop in performance. 

I have always made plain: asset manager equity is a geared play on markets where revenues vary according both to the value of assets under management (AUM) and inflows/outflows. Costs are far less variable, hence operational gearing works well in rising markets, but can conspire on the downside. 

Liontrust appealed at 112p in October 2012 when I thought quantitative easing persisting long past the 2008 crisis helped justify “buy”, as this manager reported a ninth successive quarter of positive inflows. 

The dilemma is the current realisation among central banks about how easy money policies have fanned inflation, and that tightening is vital. 

Showing how tricky cyclical stocks are currently 

Some context is useful to understand how one should trust one’s instincts.  

In January 2021, I re-examined Liontrust after a 43% rise in AUM to over £29 billion in just three months, or 83% since April 2020. I had not witnessed anything like such acceleration by an asset gatherer in nearly 40 years of following stocks. 

With the stock at around 1,300p, the City consensus was “buy”, anticipating a big uplift in net profit to £35 million and a forward price/earnings (PE) of 18x, easing to near 13x, with 36% earnings per share (EPS) growth to 97p projected for the March 2022 year. 

I questioned whether a cyclically-adjusted PE should apply given such momentum could prove top-cycle. “Unless stock markets are enduringly rigged and back-stopped by central banks then a more modest PE multiple is deserved.” 

I concluded: “Ultimately, Liontrust is a medium-term call on equities, so take profits if you believe inflation will rise later in 2021 as economies pick up; or if recent euphoria is due a reality check when government stimulus measures wind down.” 

Indeed, stocks rose further, justifying my wary “hold” stance – Liontrust soared nearly 90% close to 2,500p by early last September – but that now looks a classic blow-off. 

It then dropped to around 1,900p by early January and slumped to 1,160p with the Ukraine crisis. Despite an initial recovery to near 1,300p in April as inflationary fears gripped markets, it was already down to 930p before these results. 

Such volatility is an accentuated example of the dilemma with many cyclical stocks: should you wait to buy, or start to average in? And if holding, ride out volatility or respect a stop-loss? 

Near 60% advances in key variables but is the payout sustainable?  

Liontrust’s £59.2 million net profit is shy of consensus for £60.3 million, although adjusted diluted EPS up 59% near 128p has helped dividend per share up 53% to 72p. Assumptions about free cash flow can vary but the dividend looks at least twice covered. 

AUM rose 8.5% to £33.5 billion over the financial year, then the acquisition of Majedie Asset Management added £5.2 billion. However, falling sentiment took AUM down 12% to £34.2 billion over April to mid-June. 

A favourable aspect is fund holders increasingly following advice to ride out volatility than panic-sell. If anything, since the 2008 crisis, people have been more likely to “buy the drop” although central bank support has helped. The table shows 64% of funds held by “UK retail” yet they will not be leveraged like so many Americans were in 1929.  

As I explain in due course, however, a near 40% exposure to “sustainable investment” is a concern. 

The crux question is whether the resulting equilibrium for AUM (also its value) can generate cash flows for attractive dividends. Even a cut to 60p a share would represent a 6.7% yield which – intrinsically at least – constitutes support. 

Liontrust’s operating margin has advanced from 20% to over 32% in this latest financial year; hence, if costs are managed well then such a dividend base is possible. 

Obviously, we have seen tempting yields and resilient updates from house-builders, only for stocks to fall further. 

The chief risk I see is several years of stagflation, with central banks unable to raise interest rates enough to curb inflation without causing a debt bust. Only the most astute and focused stock pickers may thrive than having money in diversified funds. 

Liontrust Asset Management - financial summary
Year end 31 Mar

  2015 2016 2017 2018 2019 2020 2021 2022
Turnover (£ million) 36.8 45.0 51.5 85.8 97.6 113 175 246
Net profit (£ million) 6.2 7.3 6.8 8.7 20.1 13.2 27.7 59.2
Operating margin (%) 19.7 20.9 17.7 14.3 22.7 14.7 20.0 32.3
Reported earnings/share (p) 13.6 16.1 14.8 16.8 38.6 24.3 46.3 97.6
Normalised earnings/share (p) 16.8 19.3 17.2 26.7 40.2 38.4 80.1 128
Price/earnings ratio (x)               7.2
Operational cashflow/share (p) 9.5 17.3 23.6 47.3 33.5 37.1 72.9 163
Capital expenditure/share (p) 1.7 0.7 0.4 0.3 1.2 0.3 0.4 0.8
Free cashflow/share (p) 7.8 16.6 23.2 47.0 32.3 36.8 72.5 162
Dividend per share (p) 8.0 12.0 15.0 21.0 27.0 33.0 47.0 72.0
Covered by earnings (x) 1.7 1.3 1.0 0.8 1.4 0.7 1.7 1.8
Yield (%)               7.8
Cash (£m) 16.6 19.1 18.4 32.9 38.7 43.1 71.9 121
Net debt (£m) -16.6 -19.1 -18.4 -32.9 -38.7 -35.5 -68.5 118
Net assets (£m) 23.7 26.2 26.6 48.4 55.6 90.0 163 184
Net assets per share (p) 52.2 57.6 58.4 97.6 163 162 251 284

Source: historic company REFS and company accounts. Past performance is not a guide to future performance.

Strong UK market position, but will different skills be needed? 

In 2021, Liontrust enjoyed the second-highest net retail sales in the UK and the fifth-highest gross retail sales. Over five years to March 2022, 99% of its UK-domiciled funds were in the first or second quartile of their sectors, or 98% over three years.  

Yet past performance may be no guide when the financial environment changes radically.  

These are extreme comparisons, but to illustrate: years ago, I recall several wheels came off Jupiter Fund Management (LSE:JUP) when it was over-exposed to growth stocks that plummeted. Poor performance led to in-fighting and departures. Similarly in the US, Cathie Wood’s flagship ARK fund is down nearly 70% this year after soaring 150% in 2020.    

I also remember Liontrust having its own crisis of sorts, going back around 20 years, resolved at the time by several (possibly founder) managers leaving.  

A typical issue is strategies that led to out-performance and successful funds’ marketing suddenly hitting a wall. 

In Wood’s case, she has doubled down on “growth” which led to some investors selling out of her fund. 

Sometimes, however, change is necessary which in fund management groups can lead to strife.  

I have avoided “sustainable” type equities that score well on environmental, social and governance (ESG) criteria because they typically have not met my own - for established value. Their best source has been the US market which I continue to regard as overvalued. 

Liontrust may therefore be headed for an extent of identity crisis, where the CEO appears in denial saying: 

“While there will always be periods when the investment teams’ funds will underperform indices and peer groups, we have full confidence in the investment processes at Liontrust…”     

Yet two of Liontrust’s sustainable funds are down 24% and 27% this year and another having underperformed a global benchmark since launch over 20 years ago.  

Investors may get disillusioned with this strategy if losses persist. 

Risk/reward profile is a moving feast 

It is possible to define a “hold” case because Liontrust has achieved substance enough to sustain fee income – barring a market collapse – in support of dividends that should prop the stock from 900p. 

Unless economies get chronically mired, equities should start to rise in anticipation of recovery, possibly later this year. On such a rationale you might begin to average into Liontrust now. 

But with a recession looking more likely by the day, it may be premature to step into such a sensitive play. Hold. 

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

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