Stockwatch: a speculative buy for 7% dividend yield

by Edmond Jackson from interactive investor |

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The CEO has raised his shareholding in this fund manager by over 50% in 2020. Should you follow? 

The case surrounding £1.1 billion Jupiter Fund Management (LSE:JUP) is compelling; a 7%-plus yield ostensibly being attractive due to the cash generative set-up of asset managers, and a modest price/earnings (PE) ratio of 8x to 11x, albeit in a near-term declining earnings scenario.

If forecasts are fair, then 2020 is expected to see an earnings per share (EPS) decline from 28.9p to 21p, then a recovery to 22.7p in 2021. The snag is this depends significantly on this year’s £370 million acquisition of Merian Global Investors working well, and success in turning around both managers' rather despairing net outflows of client funds. 

At about 230p currently, the stock is at a tipping point between this integration proving OK and its overall funds position at least stabilising, or, as can notoriously happen with “people businesses”, frictions arise and the true assets walk away. It’s also unclear whether central banks will sustain confidence in financial assets, while the global economy could be impaired for a few years by Covid. 

On a glass half-full view there is no alternative to holding a strong element of financial assets while interest rates are zilch - negative even - hence equities will win through. Moreover, Jupiter’s CEO raising his equity stake over 50% this year implies a favourable chance that the group's underlying dynamics can improve. 

Asset inflows/outflows have been in focus

Given a focus on asset inflows and outflows, I am interested to note that Jupiter’s latest trading update in respect of the three months to end-September, which cites £1 billion net outflows substantially offset by £0.8 billion of market returns. A dilemma with interpreting 2020 quarterly fund-flow numbers is there having been huge shifts in clients’ risk preferences: at the end of the first quarter, enough people probably might have dumped assets in horror; then, since central banks and governments threw money around like confetti, there has been an equally dramatic shift to embrace risk. 

In this way, Jupiter lost £2.3 billion to client behaviour in the first quarter of 2020, although its assets under management plunged £7.8 billion, or 18%, due to the February-March turmoil – for an astonishing 30% first quarter total decline in assets under management (AUM as stated on releases). Particularly worrying was the acquisition of Merian Global Investors, underway from last February, where this manager had £2.6 billion net outflows. Possibly the sale to Jupiter prompted some investors to jump ship.   

A 15 April update continued: “the Jupiter board believes this acquisition will enhance the group’s position as a leading UK asset manager, providing increased scale and diversification into attractive new product areas and creating stronger future growth prospects…” Mind, how asset management remains highly competitive and its prosperity relates largely to the macro/market environment. 

An early positive sign of turnaround in early 2020 was of relative investment performance improving, such that 80% of Jupiter’s assets under management were above industry median performance, and 75% in the top quartile. This had improved from 72% above median over three years. This does look good, although I’d question whether the risk profile of the bulk of assets managed was opportune for whatever the market trend at the time. It remains a short timeframe to cast judgement: “one swallow doesn’t mean summer”. It does at least show why Jupiter merits following. 

Otherwise, the numbers had been despairing: in 2018 Jupiter's net outflows were £4.6 billion, and sustained at £4.5 billion in 2019. A cynic might say this is why it lurched towards Merian in order to substitute asset losses. A conservative view would be this move is reckless because underlying commercial weakness is not resolved by embracing the inherent risk of a major acquisition. 

The latest update comes across as relatively benign: £55.7 billion assets under management, albeit re-rated by £16.6 billion from Merian. Not to be unduly critical, but the “active” asset management industry is going through a period of consolidation due to funds being lost to lower-cost passive managers. It partly explains attrition both of Jupiter and Merian’s assets, and the question here is whether a merger helps a fight back. On a balanced view, there definitely is scope for consolidating asset managers that are cornered by funds loss. 

Dividend yield also key to the investment case 

The last six years’ performance in the table suggests radical change is indeed necessary. Jupiter's revenues have progressed modestly between 2014 and 2017, and the operating margin was then highly attractive at around 40%. The margin has dipped, though remains attractive, as is a high conversion of operating profit to cash. See how a fund manager's capital expenditure needs are negligible (once fixed costs such as IT are covered) and free cash flow per share is consistently ahead of earnings per share. Even having modestly declined, free cash flow covered last year’s payout by 1.9x. 

Jupiter Fund Management - financial summary            
year end 31 Dec            
  2014 2015 2016 2017 2018 2019
Turnover (£ million) 388 404 402 460 461 419
Net profit (£ million) 126 132 136 155 143 123
Operating margin (%) 41.1 40.7 42.6 41.9 38.9 36.5
Reported earnings/share (p) 27.2 28.5 29.6 33.7 31.1 26.8
Normalised earnings/share (p) 22.8 28.6 29.7 33.8 31.5 28.9
Price/earnings ratio (x)           8.0
Operational cashflow/share (p) 26.5 33.8 32.0 42.3 37.1 32.7
Capital expenditure/share (p) 0.6 2.0 0.8 1.1 0.7 0.8
Free cashflow/share (p) 25.9 31.8 31.2 41.2 36.4 31.9
Dividend per share (p) 13.2 14.6 14.7 17.1 17.1 17.1
Covered by earnings (x) 2.1 2.0 2.0 2.0 1.8 1.6
Yield (%)           7.4
Cash (£m) 299 317 331 368 390 391
Net debt (£m) -296 -307 -317 -332 -390 -333
Net assets (£m) 586 603 610 640 624 612
Net assets per share (p) 128 132 133 140 136 134
             
Source: historic Company REFS and company accounts            

This is why Jupiter has appeared periodically on institutional broker’ ‘buy’ lists, for pension funds especially, and it ought to represent sound income. However, in terms of total return, the all-time chart shows the stock has retreated back to 2012, hence anyone buying on the way up to 590p (the peak achieved in early 2018) will have lost materially, even after dividends. The chart says Jupiter has been doing something wrong versus, say, Liontrust Asset Management (LSE:LIO), capitalised at around £800 million and which I have favoured since 2012. Its chart rose similarly as Jupiter's, but went parabolic and has sustained its level.   

I suggest the dividend is key because a circa 7.5% prospective yield (with 17.5p projected for 2021) is highly competitive. So, if risks are perceived to be reducing, then Jupiter’s stock price will adjust upwards. The trigger for dividend prospects in turn depends on the trend in net asset flows.    

Yet the interim cash flow statement implies a debt prop

At the end-July interims, the directors spoke of a “progressive” dividend policy targeting a 50% pay-out ratio of earnings, and, despite these being lower than last year, an unchanged interim pay-out of 7.9p a share was made. With 457.7 million shares in issue, its cost was therefore £36.2 million relative to the cash flow statement showing £43.9 million net cash inflow from operations, down 2% like-for-like. 

However, on the “investing activities” side of the statement, the net outcome of buying and selling financial assets meant a £25.5 million outflow. The statement can be interpreted as £49 million debt proceeds (see the “financing activities” side of the statement) as propping the pay-out, at least in the short term. 

Chief executive serially adds to his shareholding 

Last August, the CEO bought 230,000 shares at 214.3p after page 97 of the 2019 annual report showed him holding 508,157 shares in total, a 45% increase. The price continued to drift down to 201p a month ago, then improved during September. At 211.5p near the month-end, the CEO bought a further 25,000 shares, hence this year he has raised his stake by just over 50% to 763,157 shares.

Clearly, he is confident in his strategy which also benefits from a partnership with NZS Capital for “expanded product line-up and additional strength in UK and overseas distribution”.  

Assuming markets remain broadly supported then, yes, I think Jupiter is worth accumulating by enterprising investors - especially if markets sell off at some point. Asset management stocks tend to get clobbered in the short term, but there is plenty cash on the side-lines and investors have followed a "buy the drop" strategy this year. Mind, Jupiter has yet to prove its risk/reward profile is weighed favourably, hence I should add a “speculative” tag. Buy

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

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