Interactive Investor

Stockwatch: this small-cap share may have reached an inflection point

31st January 2023 11:56

by Edmond Jackson from interactive investor

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An attractive risk-reward profile and potential to lock in a serious dividend yield have got analyst Edmond Jackson interested. Here’s why he’s positive on this small company. 

Upside for this share 600

After a seven-year decline from 600p to a 19-year low of 180p last December, shares in Personal Group Holdings (LSE:PGH) have crept up to 210p. This is being helped by yesterday’s pre-close update for the employee benefits and insurance provider, which affirms market expectations and declares confidence versus “another difficult year for the economy and wider macro environment”. 

The CEO said: “2022 was a pivotal year for Personal Group, as we put the pandemic behind us and re-built our business strongly, delivering underlying double-digit growth in many areas of our recurring revenue.”  

With the stock remaining low against its all-time range, if operations are improving sustainably after Covid disruption then it suggests an inflection point.  

A superficially attractive risk-reward profile 

Consensus is for £2.8 million net profit in respect of 2022, for normalised earnings per share (EPS) near 11p – a circa 6% slip on last year, with the second half-year picking up after cost rises in the first.  

While the implied price/earnings (PE) multiple tests 20 times, it drops below 14 times if £4.2 million profit is achieved as projected this year – which would still be around half what the company was making pre-Covid. 

With strong conversion of profit to cash and no debt, the dividend record shows it has only required covering around 1.2 times by earnings. Yes, investment has been made in insurance sales and year-end cash declined from £23 million to £18 million, but a 10.6p flat dividend in respect of 2022 would cost £3.3 million. It would be £4.4 million if 14.0p is paid out in line with consensus for this year, implying a circa 6.5% yield. 

Should the company eventually restore dividends to over 20p, then buying now locks in a 10%-plus prospective yield. 

Personal Group Holdings - financial summary
Year-end 31 Dec

201620172018201920202021
Turnover (£ million)53.645.255.570.971.574.5
Operating margin (%)19.621.018.715.012.15.9
Operating profit (£m)10.59.510.410.68.64.4
Net profit (£m)7.38.38.48.86.93.6
EPS - reported (p)29.025.727.228.422.111.5
EPS - normalised (p)29.025.727.228.422.111.5
Operating cashflow/share (p)20.531.727.027.926.024.3
Capital expenditure/share (p)4.71.03.93.22.53.9
Free cashflow/share (p)15.830.723.124.723.520.4
Dividends per share (p)22.022.723.023.318.410.6
Covered by earnings (x)1.31.11.21.21.21.1
Return on total capital (%)19.819.219.818.814.67.6
Cash (£m)7.212.615.114.517.620.3
Net debt (£m)-7.2-12.6-15.1-14.0-16.9-19.8
Net assets (£m)32.333.835.338.040.841.3
Net assets per share (p)105110114122131132

Source: historic company REFS and accounts.

Mind that a near-£67 million stock is going to be priced modestly – respecting tighter liquidity – unless economic prospects are strong. Today, the International Monetary Fund (IMF) is in the news predicting a 0.6% contraction in the UK economy this year – hardly a disaster – but no one really knows how deep or long any downturn will prove. 

Unless this industry faces tough times, with firms and employees unwilling to commit to new schemes, a reasonably competent management should get some way at least to restoring pre-Covid earning power. 

Mind also, this business has been listed for over 20 years, so what might that imply about its growth credentials if valued well-below £100 million?  

The market therefore prices to ensure a useful yield if growth seems less than assured.  

In terms of CEO calibre, Deborah Frost assumed the role three years ago with a strong and diverse management background, this being her first listed company top job. It was also achieved via becoming a non-executive director in 2015 when strictly such roles are not meant to exchange. To be fair, Covid has disrupted the business during her tenure, hence it remains too early to judge. 

Bulk of profits still derived from health insurance 

The stock is classed as an insurer and this side contributed over 70% of first half 2022 operating profit, the employee benefits side accounting for 23% and the remainder from pay and reward schemes. 

Customer reviews appear broadly positive, at least from individuals pursuing insurance claims, inevitably with a few complaints – hence a 4 out of 5 rating from 38 Google reviews. Employee ratings on what it is like to work there average 3.5 to 3.7 out of 5.0 on Indeed and Glassdoor. It all looks fair enough considering any grievances tend to gravitate online. 

This latest trading update cites “affordable insurance” momentum continuing in the second half of 2022 with record new business sales in its best month. Given one client is Royal Mail, strikes appear to have been a latest form of disruption, but there is, as the company says, “a solid foundation from which to grow further in 2023, when the full benefit of the sales achieved in 2022 are expected to be seen”. 

Durability of revenues remains broadly questionable after the slide in profits during Covid was explained as frustrated ability to conduct new insurance policy sales. Investment in sales has benefited second-half adjusted EBITDA which came in at around £4.5 million, up from £1.5 million in the first half. “A rising element of recurring revenues offers visibility for 2023,” we’re told. 

Annualised premium income for insurance is up around 15% to £28 million; annual recurring revenue for the benefits platform by 56% to £5 million; and for pay and reward by 25% to £0.5 million. Mind, it is easier to post growth from a relatively smaller base.

Management proclaims “strong retention levels across all areas” which reinforces the sense of a turning point unless the economy takes a serious step down. My sense is the services are not exactly essential hence a recession could compromise new business. It is not easy to check 2009 performance – online accounts go back 10 years – although the stock gradually rose after the 2008 crisis, re-rating from early 2012. 

How well contained are cost rises? 

The interim results had shown insurance operating expenses up 71% to £3.2 million, albeit with investment in sales capability then benefiting the second half and potentially the medium term too.  

Unfortunately, insurance claims also jumped 35% to £3.7 million; and on the benefits side, voucher resale expenses rose 14% to £13.9 million versus a 15% rise in income to £13.8 million, hardly value accretive. 

There should have been more by way of explanation about how a 15% rise in overall interim expenses to £33.9 million might be contained if not reduced. It meant that despite a near 6% rise in revenue to £34.7 million, operating profit fell from £3.3 million to £0.7 million. 

A 2% interim operating margin compares with 20% annually, six or seven years ago which declined to around 12% in 2020 and 6% in 2021. This impacted return on capital quite similarly, hence is an issue for the stock rating. 

Unless and until it is possible to see cost-cutting, I suspect the market is likely to price the shares to ensure a yield perceived as adequate for this group’s operating risks, besides low stock liquidity. 

More positively, if the CEO can address this and the UK economy improves from 2024, the PE multiple may rise along with profits. There is a case to start averaging in. 

Last material purchase by a director was at 275p in June  

Previous director share buying has both positive and negative upshots. The chairman recognised long-term value to spend nearly £50k at a price almost 30% higher than currently, although they might also have misjudged the situation, and any director buying lately has been scant, linked only to an Employee Share Ownership Plan. 

At least there has been no change in institutional shareholdings since Royal London Asset Management appeared with a 5% stake nearly a year ago. The stock’s de-rating reflects concerns on the economy plus a fall in interim net profit from £2.6 million to £0.5 million. 

The net trend in UK company pre-close updates so far broadly affirms market expectations, hence is encouraging “risk-on” trading as enough investors try to position in modestly rated equities, hopefully to bank a useful yield while deferring capital upside. 

Personal Group meets such criteria assuming the CEO tackles costs and the economy does not stall. Buy. 

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

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