Interactive Investor

Stockwatch: a small-cap share to put on your watchlist

22nd June 2021 10:09

Edmond Jackson from interactive investor

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These shares have doubled in value since our companies analyst tipped them. Is this a justified re-rating and what should you do now?

Small-cap stocks now exhibit plenty of charts that show a 2021 rally extending the wider one from last November when Covid vaccine success took equities by surprise. 

On one level, this follows a time-honoured pattern, where the most liquid stocks benefit first before the rally ripples out as confidence builds. Since small-cap is viewed as inherently riskier, investors typically wait until any new macro trend is intact, and they may also re-invest early profits into small cap – in the belief this sector will benefit better in the next phase. 
On another, it can blur company-specific change, in an easy assumption “everything just went up”. 

For example, Record (LSE:REC), a £190 million currency manager in the FTSE Fledgling index, has nearly trebled from a 30p range it appeared stuck in for two years before Covid vaccines kicked everything off. On a chart view, it fuels the theory that the market is in a speculative bubble. 

Yet the company does finally look poised to benefit from the attractive economics of asset managers, since I drew attention three years ago as a ‘buy’ at 47p. My basic rationale was that a near-5% dividend yield (based on a 2.3p a share annual pay-out from 2018) and 20%-plus return on capital, despite pedestrian earnings per share (EPS) growth. Once fixed costs are broadly covered, revenues from growth in assets managed drop quickly through to profits – hence special dividends are also paid occasionally. The chairman does own nearly 30% of the business, as if patience should be rewarded.  

37% surge in assets managed, are a specific driver 

Over the last nine months, asset inflows have been surprisingly strong. This is a currency manager which has grown steadily since 1983 by providing hedging services/funds for corporate/institutional clients, allowing them to better cope with currency volatility.  

Cynics of recent monetary policy might say that a 37% surge in assets managed over Record’s 31 March financial year, partly reflects the enormous expansion of liquidity – the so-called “cash on the sidelines”. Record would probably say they are benefiting from clients’ need to tackle volatility in the wake of the March 2020 shock to markets from Covid. Moreover, the company was positioned well to capitalise. 

Various strategies are involved, such as dynamic hedging which seeks to cut the negative hit from currency swings, but also benefit from positive moves, and passive hedging which aims to remove all volatility. Returns from currencies can also be targeted. 

Interim results to 30 September had shown 12% growth in assets managed in US dollar terms to $65.9 billion, and 8% growth in sterling terms to £51 billion. This was not yet affecting revenue dynamics - growth of only 4% to £11.8 million while pre-tax profit fell 19% to £2.6 million. Various growth initiatives were underway though, such as a new currency fund solution in the fashionable ESG space (environmental, social and governance), and an $8 billion new dynamic hedging mandate and new people hired in aid of fund distribution. 

Record said: “The extreme volatility we witnessed earlier in the year has served to underline the benefits of a specialist risk management offering.”  

Three directors and five senior managers did then buy meaningful amounts of equity at 39p, although that was linked to a profit share scheme which may bring additional benefit. 

Record’s third quarter to end-2020 saw 13% growth in assets to $74.6 billion - exceeding $70 billion for the first time in its history.   

A mid-April update then cited 7% growth in assets managed for the fourth quarter to over $80 billion, or up by 37% for the year to 31 March. Client wins accelerated this year, with 10 in the final quarter taking total clients up to 89.  

Encouragingly, $6.6 billion went into higher-margin “dynamic hedging” funds, versus $2.1 billion into passive hedging and $1 billion into multi-product. A new “sustainable finance” fund is being launched which ought to help further. 

With growth in assets already easing, it is hard to fathom what might be the ongoing rate after this response to March 2020. The chairman’s outlook statement at last Thursday’s annual results maintained a regular theme about “confidence we can deliver on opportunities” although balked at genuine guidance. 

Record -   financial summary
Year end 31 Mar 2016 2017 2018 2019 2020 2021
Turnover (£ million) 21.1 23.0 23.8 25.0 25.6 25.4
Operating margin (%) 32.1 33.7 30.5 31.5 29.9 24.1
Operating profit (£m) 6.8 7.7 7.3 7.9 7.7 6.1
Net profit (£m) 5.5 6.3 6.2 6.4 6.4 5.4
Return on cap employed (%) 18.0 21.0 27.4 28.7 26.3 22.5
Reported earnings/share (p) 2.5 2.9 3.0 3.3 3.3 2.7
Normalised earnings/share (p) 2.5 2.9 3.0 3.3 3.3 2.7
Operating cashflow/share (p) 2.5 3.3 1.3 3.6 3.3 3.5
Capital expenditure/share (p) 0.0 0.5 0.2 0.1 0.3 0.2
Free cashflow/share (p) 2.5 2.8 1.1 3.5 3.0 3.3
Ordinary dividend/share (p) 1.7 2.0 2.3 2.3 2.3 2.3
Covered by earnings (x) 1.5 1.5 1.3 1.4 1.4 1.2
Net Debt (£m) -34.7 -32.4 -20.2 -21.1 -21.1 -19.1
Net assets per share (p) 15.2 16.6 13.3 13.7 14.1 13.5
Source: historic Company REFS   and company accounts            

Directors and senior managers buy stock again after results 

Yesterday, the chief executive and chief financial officer bought £73,422 and £7,025 worth of shares respectively, at 89p. Four senior managers also bought £44,834 shares also at 89p. It was all under the group’s profit share scheme but does show them putting substance behind Record’s rally – even if words as to a confident outlook are missing.  

What’s more, the special dividend has risen from 0.41p to 0.45p which, additional to the regular 2.3p ordinary dividend, takes the total annual pay-out to 2.75p – or 3% with the stock still at 89p, just off its 95p recent high around results time. In a long-term chart context, this takes it back to mid-2009 levels albeit still down on 150p in 2007 – for what long-term technical comparisons are worth. 

Mind, differentiating ordinary and special dividends like this is inferior to a business/board that has confidence to commit to a genuine dividend growth policy. If the business was then to hit unexpected trouble, they can simply omit the special pay-out and preserve an image of consistency – data tables are skewed because they tend not to include special dividends. 

“A strong platform for growth”

Investing for growth has come at the cost of a 20% fall in pre-tax profit to £6.2 million, although revenue was flat around £25.5 million and performance fees slumped from £1.8 million to £0.1 million. 

However, it is said tat this was in line with expectations, with strategy adopted since a change in CEO back in February 2020, in order to deliver on growth opportunities. 

I feel Record’s share price advance is in anticipation of this strategy bearing fruit, and also reflects bullish sentiment generally. In more ordinary times, the market would wait to see better evidence that growth in assets can translate into sustainable returns. That is the real attraction of holding shares in a successful asset manager: consistent revenue with profit topped up by performance fees, and clients less likely to churn.    

Yes, a 37% rise in assets managed justifies a re-rating, although a circa 3% yield is only modest support. From what I can see of market forecasts, net profit of £8.6 million is posited for the current year to March 2022, which for this size of company probably reflects guidance to Record’s broker. That looks plenty fair and EPS of about 4.5p implies a classic 20x growth rating by way of PE. 

Given many growth stocks are nowadays over-priced, and Record occupies a well-constructed niche – serving an essential need for companies/institutions – this rating is arguably deserved.  

The company needs to show it can deliver financially on this “platform for growth” and I suggest tuning in to a live investor presentation (details in a 21 June RNS from Record) from 5pm on 30 June. This is open to all existing and current shareholders and questions can be pre-submitted before the event. If people feel bullish as a result, this event could end up being price sensitive. 

I temper my stance to ‘hold’ as growth looks fairly priced. Yet insight may evolve to justify ‘buy’, so I suggest having Record on a watch list. 

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