The board’s policy is to pay dividends on a quarterly basis in March, June, September and December with the aim of returning two thirds of post tax earnings back to shareholders. So, with last year’s pre-tax profits surging by 30 per cent to just over £3m on revenues up 17 per cent to £7.1m, and EPS rising at the same rate as profits to 21.9p, then the total dividend has been lifted from 11.25p to 14.5p a share. The next quarterly payout of 3.75p a share will be made in a couple of weeks time, highlighting the benefit of having a regular income stream.
Interestingly, chief executive and chairman Andrew Grant notes that the business he founded in 1984 has enjoyed another strong start to the new financial year and he has reason to expect Jarvis to continue to deliver the bumper growth rates it has reported for the past couple of years. This makes current year forecasts from analyst Nick Spoliar at brokerage WH Ireland look far too conservative, in my opinion. Mr Spoliar is predicting a rise in revenues this year to £7.4m to lift pre-tax profits to £3.2m and produce EPS of 22.5p.
On this basis the dividend would still be lifted to 15.4p, implying a prospective yield of 3.3 per cent which is attractive enough. But realistically it could be much higher because those estimates look far too cautious in light of the strong momentum in the business. There is some history here because last year WH Ireland started out with a pre-tax profit estimate of £2.3m which was completely smashed following multiple bumper trading updates from Jarvis which in turn led to equally bumper earnings upgrades during the course of 2013.
Furthermore, if the drivers of this stellar underlying growth in the business continue, and I have every reason to think they will, then we are virtually guaranteed that Jarvis’s earnings upgrade cycle has some way to run. To understand why, it pays to look at the key drivers in each part of the business.
Higher retail trading volumes
On the retail side, Jarvis offers two main products: ShareDeal-Active, a low-cost execution-only service for nominee and certified accounts, Isas, Peps and Sipps; and X-O, an online share trading service enabling clients to trade for a flat fee of £5.95 per trade, one of the lowest rates in the market. Boosted by the launch of X-O, retail client numbers have been growing strongly at an annual average rate of 13.8 per cent over the past five years, with very little advertising according to Mr Spoliar. It was more of the same last year as Jarvis grew its client base in double digits once more.
As a result, the company now has more than 60,000 retail clients ranging from multimillionaires to day traders and screen-based dealing now accounts for half the business by volume. The unit has also been benefiting from exposure to the retail pension market, having launched its first low-cost execution-only Sipp product last year.
It’s hardly a surprise that the retail side has been growing strongly in the past year given the heightened interest in IPO's from retail investors. The most high profile one was Royal Mail, in which Jarvis gained some positive press exposure for its low cost execution only share dealing services and “attracted unprecedented demand for new accounts”, according to Mr Grant. Importantly, such high profile offerings not only lift transaction volumes, but also offer an opportunity to gain clients and entice new active traders into the stock market.
And with other big retail IPOs in the offing including over 50s financial service group Saga and Pets at Home, an operator of pet clinics, and retail market activity strong, it’s only reasonable to expect that Jarvis’ retail business will continue to pick up new accounts as it has done in the past few years.
Strong growth in corporate and retail businesses
On the corporate side, Jarvis provides outsourced and partnered financial administration services to a number of third-party organisations, including advisers, stockbrokers, banks and fund managers. The business tailors its administration processes by offering a bespoke service to meet the needs of each organisation and has built up a strong reputation for flexibility and cost-effectiveness.
Jarvis does not disclose the names of its clients, but is believed to have more than 25 household-name institutional clients, including asset management group Franklin Templeton and Goldman Sachs, attracted by the convenience of outsourcing time-consuming and laborious back-office/administration functions. Client wins in the past 12 months include brokerages Panmure Gordon and Daniel Stewart, Dartmoor Investment Trust and two of Chelverton's investment trusts.
Cash under administration averaged around £70m between 2010 and 2012, and is placed on a short-term deposit of less than one year with triple-A-rated banks. But with rising demand for Jarvis' low-cost model continuing to drive the business, and the back-office outsourcing proposition with its attendant cost benefits performing well, cash under administration has surged to £110m in the past year alone. That's significant because as soon as interest rates start to return to more normal levels, as one would expect as the UK economy hits escape velocity and is strong enough to withstand monetary tightening, the increase in interest income will provide significant profit upside to Jarvis and from a much higher base than a few years ago.
Interestingly, Mr Grant notes that Jarvis has “several significant new commercial relationships in place which went live in the last quarter of 2013, and the pipeline for further new business continues to look strong”. It’s therefore hardly a surprise that he is bullish on earnings prospects for 2014.
The growth in the business is unlikely to stop there either, as the company's share of the retail stock market is still relatively small, offering a potential opportunity to gain market share in the future. Changes to the individual savings account (Isa) rules have been good news for the growing retail client base too. It also helps explain the attraction of the shares for income investors given the company’s decent and rising income stream.
Robust income generation
In terms of income generation, gross interest earned on broking accounts, cash in the bank and overdrawn client accounts accounted for £3.1m of revenues last year, a 12 per cent increase on 2012. The balance of £4m was earned mainly from fees and commissions, a hefty 24 per cent rise on the prior year which highlights the stellar growth being seen in both parts of the company’s operations. As a result cash generation was equally robust with cash flow from operating activities rising in line with the 30 per cent increase in operating profits to over £3m. An impressive 100 per cent conversation rate of operating cashflow to operating profits, combined with tight working capital management, resulted in a near trebling of the cash pile from £3.6m to £10.3m. Jarvis has a debt free balance sheet, so net funds now equate to almost 100p a share. It also means that the company has ample cash available to fund working capital for new business wins.
Potential for rating to fall sharply
Following a seven per cent share price rise post results, Jarvis shares now trade on 20.8 times historic earnings, or 16 times on a cash adjusted basis. That’s not too punchy for a business that has lifted pre-tax profits and EPS by a total of 58 per cent in the past couple of years and raised the dividend by over 60 per cent too.
And those earnings multiples could drop sharply if Jarvis delivers similar growth rates in 2014 as it did in 2013, which Mr Grant clearly believes are achievable. He has good reason, too, because with IPO activity picking up demand for the low-cost retail execution only and SIPP offerings should prove attractive to retail investors and underpin fee income and commissions. Further growth in gross interest income also looks well underpinned on the corporate side as it’s only reasonable to expect additional client wins for the company’s partnered financial administration services as the pipeline of new clients is converted.
Positive technical set up
Following a sideways movement in the share price since the start of this year, the consolidation period now looks to have ended. Post results, Jarvis shares are just shy of the 468p January all-time high, but the reading on the 14-day relative strength indicator (RSI) is only slightly above 60, so is not that overbought and is still way off the reading (above 80) at those January highs at the last price peak. This gives additional credence that the upmove has some legs and a break-out above the January all-time high is firmly on the cards.
For good measure, the trend-following moving average convergence divergence momentum indicator, known as the MACD, has moved above its ‘signal line’ having been in a downtrend since the January highs. It not only looks as if it has bottomed out, but is on the verge of moving above zero and giving a buy signal. The MACD is calculated by subtracting the 26-day exponential moving average (EMA) of the share price from the 12-day EMA. A nine-day EMA of the MACD, called the ‘signal line’, is then plotted on top of the MACD, functioning as a trigger for buy and sell signals. In my opinion, a move of the MACD above zero, which looks imminent, would signal that the next leg of the bull run has started.
Target price
WH Ireland currently has a target price of 535p on the shares, having nudged this up post results. That doesn’t look unreasonable to me, assuming of course Jarvis Securities continues to deliver robust earnings growth this year. For instance, if the company grows both pre-tax profits and EPS by 20 per cent to £3.7m and 26.4p, respectively, and which would result in WH Ireland lifting its aforementioned conservative earnings estimates, then at a price of 535p the shares would still only be trading at 16 times cash adjusted fiscal earnings by the end of the year. I am prepared to bet on that eventuality and trading on a bid-offer spread of 450p to 458p, Jarvis shares rate a medium-term income buy. I have upgraded my target price to 535p.
