Stockwatch: Kicking the tyres of broker's 55% upside target

by Edmond Jackson from interactive investor |

This share tip is profitable, but is a surge in price realistic? Our companies analyst gives his view.

A year on, is this ambitious rationaliser of UK financial planners living up to hopes?  I drew attention to AIM-listed AFH Financial Group (LSE:AFHP) last June after interim results, rating the shares a 'buy', despite an historic price earnings (PE) ratio of 32 times.

With the shares at 345p, I believed the £130 million company had plenty more scope in a fragmented sector.  

"It looks fair to assume more years of expansion thus possible to envisage AFH at least doubling in size, taking its stock to over 400p, even if its rating eases somewhat."

The price had risen to 415p by last September before retreating with the rest of the market, finding support variously at around 315p.  This year the shares have rebounded to a 380p range - currently at 365p - after another set of strong interims for the period ending April.

Despite steady exercising of options, there's no sign of management deciding to sell stock and AFH's broker reckons on a median upside target of 55%.

Competitive edges in financial planning

AFH describes itself as "a financial planning-led, wealth management firm", aiming to be the UK market leader by acquiring smaller IFA firms advising on pensions/retirement planning, tax and inheritance planning.  It's also involved in insurance, both for corporate and individual clients.

Financial planning being extolled as a necessary virtue irrespective what markets/economies are doing, with an ethic of personal responsibility, this ought to be an attractive area for the long term, and AFH's development means it can offer highly competitive platform/fund management charges. 

A cynical view would be that it's just a current example of finding a sector to ramp up acquisitive growth – hence short-term risks with integration of "people businesses" plus a highly-rated stock being sensitive to market falls.  Since the bar is raised for growth rates they will inevitably slow, at which point aggressive investors move on.

For example, Brewin Dolphin (LSE:BRW) reached a capitalisation of over £1.1 billion with its stock at over 400p, buying wealth management businesses.  It peaked at the end of 2017 on an historic PE of 22 and has since de-rated to 300p after a placing to continue acquisitions.  AFH is relatively smaller/specialist and says its operating margins can continue to expand, although Brewin’s reached over 20% which haven’t proved a prop lately.

So, while I feel it justified to draw attention to AFH again, say on a two-year view, investors should be mindful of risks with acquisitive growth.  They can simply be timing and market-related when a stock goes ex-favourite. 

Strong financial results during 2019

Recent half-year results affirm an acquisitions strategy, but mind how those struck in the latter part of 2018 and this year have bumped up reported results – four purchases contributed £3.2 million or 9% of interim revenue.  A £15 million placing last October at 370p helped facilitate them at the cost of 11% dilution.  However, management does admit that the number and size of acquisitions means regulatory approval and integration has taken longer than before.

The year to end-October 2018 had shown funds under management soaring 58% to £4.4 billion, helping pre-tax profit up 94% to £6 million on revenues up 51% to £50.7 million. Underlying earnings per share (EPS) rose 34% to 22.7p (excluding amortisation of intangibles and share based payments), although reported EPS rose 43% to 16p.

The dividend similarly jumped 50% to 6p per share.  Reported operating margin advanced from 11.1% to 15.7% and pre-amortisation/share payments the rise was 16.8% to 20.6%.

Protection advice delivers chief organic growth

AFH's narrative cites "increasing organic demand for financial planning led, wealth management services," although you had to read down the 21 January prelims to the chairman's report to see how organic revenue growth was £6.1 million, up 21% on 2017 with gross margins steady at 55%.

This was driven by the "protection" side which deals with income, life and critical illness cover.

Note 3 to the latest interim results shows protection constituting 20% of revenue and 36% of operating profit (before amortisation).  Just be aware how fund management can suffer an aspect of redemptions in a financial downturn: AFH's trailblazing approach to asset gathering looks fine while the going is good, although Brexit and general election risks are festering.

Interim results maintain the growth story

Pre-tax profit is up 85% near £6 million on revenue up 61% to £36.6 million, with underlying EPS up 49% to 14.9p and by 56% to 10.7p on a reported basis. Protection generated 87% of like-for-like growth, although recurring fees are said to represent 55% of group income. 

Mind that cash generated from operations fell from £3.5 million to £765,000, yet £2.2 million of debt was repaid and £850,000 went out on dividends.  It's a snapshot context, though would have been better to see operational cash flow at least cover the dividend. After £1.3 million tax it was £564,000 negative - an outflow.

Ongoing investment continues in technology and digital marketing campaigns, the interim cash flow statement showing spend on property/plant/equipment up from £151,000 to £434,000.  However, nearly £8 million went on "intangible assets" - principally acquisitions - and a further £1.6 million on deferred considerations.

So, the year-on-year fall in end April cash from £23.7 million to £8.8 million doesn’t wholly represent investment/ acquisitions, but also taxation and dividends.

Contingent liabilities and their impact on cash demands need watching at acquisitive groups.  Despite only £1.1 million of borrowings, within AFH's £25.1 million trade payables there's a £17.3 million contingent consideration and a similar non-current liability of £22.3 million i.e. near £40 million in all.  That's a form of gearing, and I speculate that unless AFH's cash flow profile improves, then resorting to debt or another share placing will be needed to maintain growth objectives.

AFH Financial Group - financial summary            
year ended 31 Oct 2013 2014 2015 2016 2017 2018
Turnover (£ million) 10.8 15.0 21.0 24.1 33.6 50.7
IFRS3 pre-tax profit (£m) 1.1 0.9 1.6 2.0 3.5 7.8
Normalised pre-tax profit (£m) 1.0 0.9 1.6 2.0 3.5 7.8
Operating margin (%) 9.9 6.0 8.4 9.3 11.1 15.7
IFRS3 earnings/share (p) 4.2 3.1 5.5 6.6 10.3 6.6
Normalised earnings/share (p) 4.1 3.1 5.5 7.2 11.2 14.6
Earnings per share growth (%) 375 -24.9 77.1 30.9 55.6 30.4
Price/earnings multiple (x)           25.0
Annual average historic P/E (x)   41.6 46.0 29.2 32.8 46.5
Cash flow/share (p) 4.1 8.5 9.7 11.5 14.1 8.6
Capex/share (p)   15.4 37.0 23.1 30.3 68.7
Ordinary dividend per share (p) 1.0 1.3 1.5 3.0 4.0 6.0
Dividend yield (%)           1.7
Covered by earnings (x) 4.1 2.4 3.7 2.4 2.8 2.4
Net tangible assets per share (p)   4.3 -41.1 -5.0 -14.9 -45.2
Source: Company REFS            

Company broker projects 55% median upside

In the next three-to-five years AFH aims to increase funds under management from £5.4 billion last April to £10 billion and earn £140 million revenue with an operating margin of 25%.  That implies EBITDA operating profit of around £35 million. That's fine so long as quality doesn't start to get diluted buying companies, and there's no wider crisis of investor confidence.

Shore Capital (joint broker to AFH with Liberum which is also Nominated Adviser) posits that if AFH achieves such targets then compound annual EPS growth of 25% is possible.  It estimates a fair value range for the share price of 490p to 650p (mid-price 570p) on a 12-month forward view, assuming EPS of 32.7p to 2020 and multiples of 15x to 20x.

Shore reckons that as contingent liabilities for acquisitions are paid down with cash flow over 2-3 years, the earnings multiple will drop into single figures.  However, this assumes no further share issuance, with future acquisitions relying on cash generation once deferred considerations have been paid. 

Buy the dips, mindful of long-term risks

Market jitters anytime are liable to hit AFH just like they would any relatively small financial stock. But, all-considered, I suggest buying such dips.  Financial planning looks a relatively dependable sector with good margins, and clients may prove stickier to their funds than is my fear in a downturn, although do remember that asset manager revenues link to a fund’s underlying value.  Add.

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

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