Stockwatch: Rescuing others should boost this share

Despite uncertainty, companies like this one could see a big uptick in business over the next few years.

Following my key point on Tuesday, about how rates of new Covid-19 infections may well be the crux for stock market sentiment, more positive signs are appearing around this “lockdown Europe” – following China and South Korea’s lead.

Simultaneously, the US Senate has agreed a $2 trillion public support package. However, the new infections rate looks as much coincidental as causal of a stock market rebound underway. The European director or the World Health Organisation noted of Italy especially:

“encouraging signs…though it is still too early to say that the pandemic is peaking in that country.”

We can expect health officials to remain very cautious at declaring progress, although stocks are naturally twitchy after a 30%-plus fall.

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The big unknown is any exit strategy and upshot from global lockdown. If testing and isolation of people can rigorously sort those risky (or at risk) from those now immune to return to work, a steady grind to normalcy can commence. Other scenarios are for lockdowns being lifted only to result in higher infections, causing disruption to drag on for a year or more.

Mixed upshots to the government’s rescue plan

The government’s Covid-19 business interruption loans scheme aims to offer stressed firms up to £5 million interest-free for the first year, which would appear to support many – though it can do little for the demand side beyond mitigating the extent of unemployment and businesses failing generally, with its “helicopter money” drop.

It has already emerged in the small-print that business owners could be personally liable for government-backed debts – putting their assets at risk. It remains unclear where this leaves those owning limited liability companies. However, Royal Bank of Scotland (Natwest) has said it would not be requesting this for business interruption loans, which puts pressure on rival banks to do same.

Business recovery services are ideally positioned

It’s a vulture’s perspective, but insolvency services should benefit, probably over at least two years given more companies will need help to withstand and emerge from this crisis – assuming they can afford professional fees.

The context is UK corporate insolvencies having already risen by 7% to 17,196 in 2019.  he government’s financial assistance plan makes it tricky to predict exact amounts of stress, but they are going to rise. 

I’ve been positive on AIM-listed Begbies Traynor Group (LSE:BEG) from 63p in February 2018 when Brexit and credit stresses were taking a toll on corporate UK. This is a company on a circa 13% operating margin, weighted around 70% to business recovery services and 30% property services - including auctions and business sales – and run from a network of UK offices.

Its stock has since trended volatile-upwards, recently peaking at 90p at end-2019, falling back to 63p with the Covid-19 slide and is currently around 65p, capitalising it at £84 million.

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

A 3 March update in respect of Begbies’ third quarter to end-January had already cited “strong growth in revenue and profit compared to the prior year” hence and following a strong first half, annual results should be “at least in line with expectations.”

These are for a rise in net profit from £2.5 million to £7.3 million albeit benefiting from acquisitions, for a rise in normalised earnings per share (EPS) from 2.9p to 5.8p. This represents a price/earnings (PE) ratio of 11.4x.

Expectations for the dividend are checked however to a single-digit percentage rise to 2.8p a share, which would still represent a meaningful yield of 4.4%. The table shows a very strong trend in free cashflow per share to 7.8p in 2019, as if the group has a much lower risk of seeing its businesses compromised under Covid-19.

The dilemma for group earnings however is Begbies having diversified into property auctions and business sales, potentially slammed by the lockdown underway. Notice how the housing market is already being described as “frozen” for the foreseeable future because valuations as well as viewings have halted.

Segmental analysis in note 2 to Begbies’ interim results to end-October 2019, implied 68% of revenue and 69% of profit was derived from business recovery and financial advisory, the remainder from property advisory and transactional services. This makes valuation especially tricky for Begbies: it’s a guess as to what extent insolvency and related work can offset what looks an inevitable slide in property and transactions work.

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Eddisons’ chartered surveyors, acquired five years ago, still has online auctions underway for commercial property, but, given the residential market is suddenly being declared “frozen” in the news, with surveys cancelled, I assume commercial will be affected also in due course.

Statement re Covid-19 can’t clarify prospects

In line with a plethora of updates, on 24 March Begbies re-asserted having a “breadth of service lines with multiple sources of revenue,” also “a strong financial position including having significant headroom on its committed bank facilities.” It didn’t add anything about the upshot for trading though, especially its property services and business sales side. Most likely we will have to await a fourth-quarter/full-year trading update after the 30 April year-end.

Meanwhile, and in terms of liquidity, the end-October 2019 balance sheet had cash up 54% to £5.7 million, albeit swelled by a £7.8 million placing (for acquisitions) in July 2019. Net cash generated from operations rose 38% year-on-year to £4.6 million, though, bear in mind recent acquisitions are helping boost various numbers in context of total revenue growth up 21% versus 10% organic.

Financial risk looks contained for various scenarios

Crucially, in terms of debt and contingent liabilities for the new environment, Begbies has no short-term debt and its long-term debt was paid down by 20% to £8 million over 12 months to last October. There were also nearly £10 million of lease liabilities, mainly long-term. In respect of all this, finance costs took 20% of interim operating profit.

Amid a 1.4x ratio of current assets to current liabilities, the liquidity situation looks fair enough, should the group now divide in terms of cash flow from its main accounting side versus property/business sales. 

A worse-case scenario would be if some accounting operations get compromised by social distancing measures persisting; this sudden new environment being hard to predict for professional services. It’s quite different from the “counter-cyclical” theme Begbies tags itself with.  

Another “worse case” would be if the £36.1 million trade receivables (up 26%) lead in due course to some bad debts. They compare with £25.5 million trade payables.

Mind also in terms of the balance sheet, since this is a “people” business group having made acquisitions, intangibles comprise 93% of net assets. Yet, overall, it looks sound for the opportunities and challenges ahead.

Ideally, one would see acquirers update on contingent liabilities (the interim cashflow statement cited £1.9 million such payments alongside £4.4 million on acquisitions). However, earn-outs are now a moving feast given performance will vary.

Broadly, it’s a longer-term “buy” if uncertain just now

Overall, and on a two-year investing view, Begbies should be a net beneficiary of a likely rise in demand for business recovery services. In the short term, however, it’s quite possible the shine is taken off the current trend, as property and business sales potentially get hit straight away. 

Meanwhile, it takes a few months for demand for insolvency help and the like to reach anticipated potential. So, I think the market is right to cautiously de-rate Begbies from its high, pending clarification of this. The stock would appear to have better resilience of dividend however, where a base level historic yield now of 4% will be relatively attractive versus many payouts now at risk. 

It is appropriate, therefore, to flag Begbies as one to watch – as an emerging fresh “buy” – also for its Red Flag Alert Reports on the UK economy (released via the daily regulatory news service (RNS)) which on 27 January cited 494,000 UK businesses already in significant distress, the highest measured by its research.

I suspect its narrative will first get a bit messy overall, so, pending better visibility on group dynamics: Hold.

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