Interactive Investor

Stockwatch: a fast-growing small-cap to buy or cheap for a reason?

4th October 2022 11:12

Edmond Jackson from interactive investor

Currencies are a hot topic right now and this company is making good money from them. Its share price is making headlines too. Analyst Edmond Jackson considers whether this stock is one for your ‘buy list’.

A bumper update from foreign exchange trader Argentex Group (LSE:AGFX) has cited 75% revenue growth in respect of its six months to 30 September, to £27.4 million. 

While a low arithmetic base aids growth, costs are said to be controlled – in a context of operating margins among the strongest you will find (see table). As a capital-light, people/technology business, returns on capital are also very high. 

It implies an upgrade to the consensus forecast of £11 million net profit in the 12 months to March 2023, where the forward price/earning (PE) is a modest 11 times, easing to near 9x for the next year - with the stock currently at 102p.  

The price/earnings to underlying growth, or PEG ratio is already less than 0.5, when ideally you are looking for sub-1.0. 

There is also a circa 3.5% yield covered at least thrice by the earnings scenario, a rarity among early stage growth stocks. Argentex was founded in 2011, listed in 2019 and hopes to leverage scale internationally. 

Mind, the financial year-end is changing to 31 December, but to illustrate the scenario comparably I stay with 31 March. 

Argentex - financial summary
Year-end 31 Mar

Turnover (£ million)10.613.221.929.028.134.5
Operating margin (%)51.547.010.335.427.830.1
Operating profit (£m)
Net profit (£m)
Reported EPS (p)
Normalised EPS (p)
Earnings per share growth (%) 13.977.5-10.2-34.419
Return on total capital (%)69.273.862.134.521.325.1
Operating cashflow/share (p)6.5-0.43.523.99.515.2
Capex/share (p)
Free cashflow/share (p)6.0-
Dividend per share (p)
Covered by earnings (x)    1.33.3
Cash (£m)14.512.713.622.726.837.9
Net debt (£m)-13.6-12.1-11.2-22.7-19.9-31.3
Net assets (£m)
Net assets/share (p)

Source: prospectus and company accounts

The March 2022 balance sheet had no debt, while cash had soared 41% to near £38 million. A fair portion of that will be a regulatory buffer as the business grows rather than cash to pay out. But it reflected a 59% annual advance in cash generated by operations to over £17 million. 

Why then, does the stock remain below its 106p listing price? This is despite spiking nearly 30% from an 80p level since mid-September. 

Capitalising on banks’ lack of effective FX capabilities 

Various operators have flourished in the foreign exchange space. Indeed, Argentex was formed after Carl Jani – a previous co-CEO, now retired by the age of 40 – had been senior trader at Schneider Foreign Exchange.   

Tokyo-based Monex Group acquired Schneider FX for around $100 million in 2012 to become a leading UK commercial foreign exchange provider. That hints at long-term takeover potential here. 

Versus Argentex's £115 million market value, in the listed space there is Alpha FX Group (LSE:AFX), which around 1,660p currently is capitalised at £720 million and describes itself as “providing strategies and technologies to help firms manage currency”. 

Despite a strong record of financial growth and its stock rising from around 800p mid-2020 to over 2,300p early last January, the market price has trended volatile-sideways – I suspect, as rising interest rates have weighed on growth stock ratings. 

Even at 1,660p AlphaFX’s 12-month forward PE is around 25x and the yield, sub-1.0%. The PEG ratio is a decidedly pricy 3.0x. 

On the face of it then, you cannot go seriously wrong buying into Argentex as a tuck-away.  

How relevant are risk factors detailed in 2019 prospectus? 

If you were to fully take on board risk factors raised in a prospectus, you would never back an innovative company. Yet they offer a flavour of potential downside and I pick out several. 

Argentex describes itself as a “riskless principal” matching client trades with an institutional counterparty. Back in 2019, it was 90% reliant on Barclays Bank for this; quite what it could be now, but Barclays terminating the arrangement was cited as a chief risk factor.  

It would however be a drastic measure implying serious misconduct by Argentex, as this area may be fruitful for banks to co-operate on.  

I also notice some inconsistency as regards what drives Argentex's customer trades. It derives revenue from the difference in exchange rates at which it buys and sells currency. At flotation it described client transactions as for genuine business needs not speculation. But in the latest update the CEO says:  “While current market dynamics, specifically the historic lows in sterling, present exceptional short-term trading conditions, our long-term growth strategy and outlook remain unchanged.” 

Perhaps that relates to high-net-worth individuals, yet the declared business model was to avoid speculators. It seems liable at least to imply some volatility to the business, say if a financial crisis strikes.  

A key risk factor I pick out, however, is: “Macro-economic conditions that reduce demand for foreign currency are likely to impact the group. International trade is a key driver of demand for foreign exchange services...a slowdown in international trade could adversely impact turnover hence a material impact on income, earnings and growth.” 

That implies a global recession could be a serious headwind – assuming the business serves commercial rather than speculative trading. Argentex did not exist during the 2008 crisis, so there is no benchmark. Likewise AlphaFX, which goes back only to 2017. 

Another aspect is that while the total number of corporate clients nears 1,400, the top 20 have been cited as constituting 40% of revenue. Long-term contracts are not involved.  

If global conditions lead to a stagflationary debt crisis, Argentex might not sail merrily through. 

Founder shareholders sold £32 million in the 2019 listing 

Despite selling at IPO, the two co-founders retained 12.2%, and other managers 7.7% - an incentive for further capital growth, if also hedging their exposure.  

It compared with a net £12.5 million raised, chiefly to raise trading capacity. Argentex had reached a stage where client demands for forward contracts occasionally outstripped its ability to supply them.  

Seven months later, the stock had nearly doubled to 205p, after interim results to September 2019 showed £4.3 million underlying operating profit on £9.3 million revenue. 

The price slumped briefly below 100p in March 2020 as Covid fears overcame markets, regaining 170p that August. 

In terms of potential cyclicality, an October 2020 update cited a near-15% decline in revenue for the next six months, “primarily driven by a reduction in client activity, as the continued macro-economic uncertainty and the effects of Covid-19 led some clients to defer their trading activity”. 

Revenue profile may be lumpy and affect profit

Argentex is second-half-year weighted for revenue, yet its March 2021 year saw underlying operating profit down 30% to £8.7 million, on revenue 3% easier at £28.1 million. A 2p final dividend was maintained, with 3x underlying earnings cover.  

Quite ironically, the stock plunged from 145p to 100p that October, after a trading update affirmed a positive outlook at the July prelims – citing a 33% increase in revenues. It continued to fall, briefly below 70p last March. 

Such weakness has reflected de-risking from AIM stocks, whereas last April Argentex cited 23% annual revenue growth with the underlying operating margin sustained around 31%. 

The growth story was positive: Argentex’s team strengthened, it opened a new Dutch office as a potential European hub, and it planned entry into the Australian market. A new trading and service platform enables clients to tailor what they need. 

This now extends to being confident of beating market expectations, albeit note this applies for the period ended 31 December. It may be a convenient change of financial year-end if visibility is quite short-term. 

Outcome hinges on whether global recession is averted 

Avoiding recession is the short to medium-term crux. Both the listed foreign exchange brokers are on AIM and there is macro besides company-specific risks. Currency volatility may have driven an aspect of exceptional demand lately, but prospects for international trade seem key. 

Argentex’s overseas expansion can achieve long-term growth overall, despite potential setbacks, so be aware this also raises risks for a smaller company. 

If you are bearish on the global economy, wait for the numbers and narrative to get disrupted. On a long-term view, for those who grasp the risks: Buy.    

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

Head of ii Editorial Lee Wild owns Argentex shares


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