Stockwatch: Growth at a fair price

by Edmond Jackson from interactive investor |

Results are strong and the company offers further upside from regulatory needs, argues our analyst.

At the end of 2018 I noted how smaller UK financial stocks were hit especially hard by autumn's market rout, but that, while hot air needed to escape from exotic ratings, there was broadly scope for recovery.

Among examples I favour, AIM-listed pawnbroker H&T Group (LSE:HAT) is up 33% to 320p while AIM-listed small cap fund manager Miton Group (LSE:MGR) rebounded 30% from 47p to 61p. Admittedly, the latter, remains substantially a play on equities, has eased to 51p as market jitters return.

Somewhere in between these two is AIM-listed Tatton Asset Management (LSE:TAM) which dials into the expansion of Independent Financial Adviser (IFA) firms, assisting them not only with investments but also regulatory needs and even mortgage services.

Significantly geared to funds investment

Despite US equities fretting over China/Mexico trade and Brexit fog continuing for who knows how long, Tatton's management asserts a growth narrative helped by regulatory demands on IFA firms – such as to regularly report all costs and demonstrate value added for their clients.

Latest full-year results to end-March show pre-tax profit after exceptionals and share-based payments up 69.4% to £6.1 million on revenue up 12.9% to £17.5 million – that's a 33.8% operating margin.  Assets under management soared 24.5% to £6.1 billion.

Investments are the chief £4.6 million contributor to operating profit, while mortgages accounted for £1.6 million and consulting is down from £3.8 million to £3 million, as both revenue and margin slipped despite a 6% rise in IFA clients to 390.

Tatton's finance director puts this down to "average revenue pressured by lower levels of additional consultancy and reduced flows on a wrap platform."

Source: TradingView Past performance is not a guide to future performance

To an extent, Tatton benefits from the structure of the IFA industry – lots of smaller firms - making it vital to outsource investment management. However, I also feel that, quite like with Miton, a growth profile rests too on British people's willingness to continue investing.  More likely they will, given the culture is to take more personal initiative nowadays, though if Brexit leads to serious economic harm, then demand for funds could stall a while. 

Basic earnings per share (EPS) more than doubled to 8.7p, although adjusted, fully-diluted EPS rose 9.9% to 10p.  That's some differential for considering what an appropriate price/earnings (PE) ratio might be.  Note 9 to the accounts puts the difference down to £0.9 million share-based payments and £0.5 million exceptional costs of new fund/project set-up. It's fair to use like-for-like underlying performance, but these are still genuine costs.

With the stock currently at 210p, the historic PE is in the low 20's but could easily drop to the high teens as progress continues. That's a fair growth rating.  Return on capital employed (ROCE) continues at around 48%, reflecting an ability to generate strong returns on low capital needs.

Tatton Asset Management - financial summary          
year ended 31 Mar 2015 2016 2017 2018 2019
Turnover (£ million) 8.5 9.2 11.9 15.5 17.5
IFRS3 pre-tax profit (£m)     2.0 3.6 6.1
Operating margin (%)       23.1 33.8
IFRS3 earnings/share (p)       3.9 7.9
Normalised earnings/share (p)     6.5 9.1 10.0
Earnings per share growth (%)       40.0 9.9
Price/earnings multiple (x)       23.1 21.0
Historic annual average P/E (x)     53.0 43.0 26.0
Cash flow/share (p) 4.1 6.1 11.3 3.9  
Dividend per share (p)       6.6 8.4
Dividend yield (%)       3.1 4.0
Covered by earnings (x)       1.4 1.2
Net tangible assets per share (p)       15.6 18.2
Source: Company REFS          

Results further sweetened by new contracts

An initial three-year contract has been declared with Ascencia Investment Management to run their discretionary portfolios, similarly Tenet Group which is one of the UK's largest financial adviser.

Tatton's chief executive says: "IFA firms of all sizes are recognising the benefits of outsourcing their investment management because of the difficulties in researching and maintaining investment portfolios themselves."  And the chief investment officer adds: "Our managed portfolio service offers very competitive charges without any reduction in standards are highly scalable... low cost and risk-managed long-term returns are a highly compelling combination..."

So, despite my concern about Brexit potentially weighing on British investor sentiment, if Tatton can continue rolling out its services to meet IFA needs, then with revenue as yet sub-£20 million there's scope to deliver attractive returns say on a 3-to-5-year view.  Tatton was founded in 2012 and is embarking on its third year of an AIM listing, whereas a purer fund management stock is possibly late-cycle after a decade of economic expansion and monetary stimulus.

Supported also by a near-5% dividend yield

Tatton's high rate of conversion of operating profit to cash means it can sustain what may seem like a tight earnings cover of 1.2 times.  From another angle, the board has declared a targeted payout ratio of 70% of annual adjusted earnings per share over the medium term.

The cash flow statement shows net cash from operations (i.e. post tax and exceptional costs) up 165% to £6.1 million, then just £0.6 million spent on investment. At the end of March, the balance sheet had cash up 19.7% to £12.2 million.  There's no debt, with liabilities constituting just trade payables and tax, hence a 27.3% rise in the ordinary dividend to 8.4p is amply possible – at a cost of £4.7 million.

I'd be surprised if a 10p, or better, dividend isn't achieved within the next two years unless a recession slams UK financial services. So, with the stock at around 210p, a prospective yield around 4.75% and growing.  Management says that with balance sheet cash rising, it is also alert for acquisitions, though with strict criteria has declined some.

When Tatton floated at 156p two years ago, one of its three "chief investment officers" actually bought 65,614 shares in the placing to own 463,419 overall.  The stock broadly rose to 294p by late last summer, but there wasn't any director selling.  During the market rout, he price twice tested 190p last December and January, then in March a director bought 24,500 shares at 202p and 25,000 shares at 203p later that month.

"Growth at fair price"

Now, the PE is no longer stretched near to 30 times like it was last summer.  The yield is meaningful and the business model financially attractive.  The chief uncertainties are whether any UK slowdown can dampen demand for Tatton's services, although a fragmented IFA industry plays to its advantage.

Management proclaims: "a simple lean operating model that gives the IFA and their clients the best investment management products at a sector leading price point" and on a multi-year view there looks decent mileage ahead.  Liberation of pensions and more self-employed people has spawned an extensive industry of smaller advice firms, requiring their own support services.

The context can thus appear quite a "double-edged sword" with near-term risks – sentiment surrounding financial stocks and the economic effects of Brexit – albeit offering a promising medium-term scenario.

A relatively tight market in the shares of this £117 million company could contribute to volatility.  Yet Tatton's progress and prospects make it worth averaging into its stock.  Accumulate.

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

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