A good example of this is private wealth manager and corporate broking house WH Ireland (WHI: 109p). Having advised buying shares in the company on no fewer than four occasions between mid-February and August last year at prices ranging from 61p to 65p, they duly hit my 90p target price in December.
At the time, I took the opportunity to assess whether the factors driving the share price upwards were justified and concluded that not only was there enough momentum in the business to warrant the valuation, but the risk to earnings was clearly skewed to the upside. My decision to raise my target price by a third to 120p has been more than justified by full-year results that were way ahead of my expectations. That target was hit yesterday when the price traded at 131p intra-day post results yesterday, before pulling back.
It also means that everyone who followed my advice is massively in profit with many readers almost doubling their money. The good news is that the share price run is unlikely to end here either. The smart money has been betting on such a positive outcome too as fund managers at Oceanwood Global Opportunities accumulated a 9.54 per cent stake in WH Ireland in November.
Forecast busting results
The big surprise, and a very pleasant one at that, in the company’s full-year results to end November 2013 was the performance of WH Ireland’s corporate broking division. If you analyse the segmental performance then revenues from the unit rose from £3.08m in the six months to end May to £5.44m in the following six months. This 75 per cent step up in turnover resulted in pre-tax profits from the division more than trebling from £522,000 in the first half to £1.56m in the second half.
WH Ireland is the third largest NOMAD on the Alternative Investment Market (Aim) with 87 clients, or around 8 per cent of all the companies traded on the junior market. And for the first time since the financial crisis, market conditions have proved favourable across all its operations. Retained income on the corporate broking side increased by a third in the financial year to £3.2m and success fees rose by 16 per cent to £4.1m, reflecting fees earned from clients on fundraisings totalling £102m on 21 transactions, and mergers & acquisition deals worth a further £138m.
Moreover, buoyed by the increased retail interest in Aim shares following the government’s decision to allow their inclusion in ISAs last August, coupled with higher general activity in equity markets which boosted trading volumes, market-making revenues rose by 15 per cent to £1.4m. Income here was also boosted by secondary commissions as the brokerage made inroads into institutional accounts.
Clearly, the 15 per cent rise in the FTSE Aim index in the second half of WH Ireland’s financial year was a key contributor to the uplift in trading volumes in the company’s small market-making operation. It’s therefore worth noting that the Aim index has risen by a further 7.5 per cent in the first three months of the company’s new financial year. It’s also worth pointing out that WH Ireland’s first half numbers to end May last year did not benefit from the change in the ISA rules, so WH Ireland is up against some easy comparatives this time round. Both of these factors should help underpin profits in the current financial year.
True, the UK corporate broking sector remains very competitive, and will remain so, but if WH Ireland continues to gain critical mass, it’s only reasonable to expect further profit growth from this operation as it moves towards its short-term target of having 100 corporate clients.
Wealth management surging ahead
The other key take for me in the results was the robust performance from WH Ireland’s private wealth management business. Assets under management and administration (AUMA) rose by 43 per cent to £2.5bn in the 12 month period, including a £230m uplift in the second half alone.
Interestingly, only £300m, or less than half of the rise in AUMA was accounted for by WH Ireland’s acquisition of the private wealth management business of investment bank Seymour Pierce, which was placed into administration in February 2013. Those assets under management acquired made a £200,000 profit in the year to 30 September 2012, but in a distressed sale situation WH Ireland was able to buy this business from the administrators for a paltry £25,000. So, not only was it a smart bit of deal making, but it’s clear that this division is generating robust underlying growth too.
As a result, the wealth management unit increased revenues from £8.4m in the six months to end May, to £9.6m in the second half to end November. In turn, its contribution to pre-tax profits rose from £2.1m in the first half to £2.3m in the second half of last year. This meant that profits from wealth management jumped by over half to £4.4m, excluding central overheads, on revenues up 25 per cent to £18m.
It’s worth flagging up that there were very few client losses arising from the Seymour Pierce acquisition when they were transferred over to WH Ireland’s own platform. So apart from eliminating double running costs and producing significant cost savings, then it’s realistic to expect an uplift in profits this year as the full benefits of the acquisition feed through. In addition, WH Ireland’s Isle of Man subsidiary has just gained regulatory approval to launch a new office on the island, with the aim of targeting clients with portfolios in excess of £250,000. I understand from chief executive Richard Killingbeck that the target is to attract between £80m to £100m of AUMA within 12 to 18 months.
These factors will not only be very supportive of profits this year and next, but with financial markets remaining strong, the strong current tailwind WH Ireland is experiencing clearly underpins the fee income generated from this activity.
Strong operational progress
The third key take for me was that operational progress is following a trend: in the financial year to end-November 2012, WH Ireland’s turnover hit a record £25.1m, including an increasing amount of recurring revenue as the wealth management side develops. In fact, recurring revenue accounted for 30 per cent of the company’s record turnover of £29.7m in the latest financial year, up from 27 per cent the prior year. The ultimate target is for half of revenue to be recurring.
It’s worth noting too that with both engines of the business enjoying favourable market conditions, profits are on a sharp upward curve. In fact, at the start of December, analyst John Borgars at equity research house Equity Development was pencilling in pre-tax profits of £750,000 for the full year to November 2013. WH Ireland absolutely smashed those estimates by reporting pre-tax profits of £1.27m and EPS of 3.69p, once you strip out an exceptional £370,000 gain.
In turn, this enabled the board to treble the dividend to 1.5p a share, double Equity Development’s estimates. For the current financial year, Mr Borgars is predicting a payout of 2p, so the prospective dividend yield is 1.7 per cent, although I would not be surprised at all to see it lifted by much more given that analysts predict, and conservatively in my view, that underlying pre-tax profits will rise to £1.9m this year to produce EPS of 6.2p. In other words, a 2p a share payout would be more than three times covered.
Furthermore, WH Ireland has net funds and liquid investments of around £5m on its balance sheet after you adjust for finance leases and borrowings. A 2p a share dividend would only cost £474,000 to pay so the board have ample scope to continue with its very progressive dividend policy.
Valuation well underpinned
True, WH Ireland shares are now trading on 18 times earnings forecasts, but given the drivers in the business I feel that current profit estimates are likely to prove far too conservative as the year progresses.
Moreover, adjust for the 21p a share net cash pile, and the cash adjusted PE ratio for the financial year to November 2014 is only 14.6. That multiple could fall very sharply if WH Ireland continues to produce double-digit revenue growth. Let me explain.
In the last financial year, central costs rose by around £600,000 to £4.86m at the pre-tax level, so before accounting for these costs the total profit contribution from corporate broking and wealth management was £6.5m, up from £4.2m in fiscal 2012, driven by a £5m rise in revenues for these two businesses. In other words, given the company’s high fixed cost base, you would expect a higher proportion of new revenues to drop straight down to the bottom line even after factoring in additional recruitment of staff to facilitate the growth. Frankly, unless the financial markets fall out of bed, I would be astonished if WH Ireland doesn’t report profits significantly ahead of the £1.9m forecast by Equity Development.
Hidden value
There are valuable assets on the balance sheet too. Apart from a cash pile of £6m, WH Ireland also owns property worth £5.6m including its Manchester head office, both of which offer solid asset backing and help justify a current market capitalisation of two times book value of £13m.
That’s because even if you attribute no value at all to the company’s corporate broking division, which would be unreasonable considering it has just trebled its profit contribution to £1.5m in the second half of last year, then WH Ireland’s wealth management business with £2.5bn of AUMA is worth more than the company’s market value of £26.5m. According to Mr Borgars at Equity Development, if you apply a very conservative valuation of 0.5 per cent of execution-only, financial planning and assets administered for third parties, and taking “a rule-of-thumb 2 per cent of discretionary and advisory FUM, then the unit is worth £30.4m”.
Factor in unencumbered property assets and cash on the balance sheet less regulatory requirements, and Mr Borgars arrives at a sum-of-the-parts valuation of 146p a share, or 20 per cent above the current share price. However, this completely ignores the corporate broking business which could be worth around £18m, or almost 80p a share. This is based on valuing the division’s recurring revenues of £2.9m on a multiple of five times, or around £14.5m; placing a value of £1.4m on the market-making activities, or one times annual revenue; and valuing assets under management (AUM) at 1 per cent for IFAs value wealth planning, and 0.75 per cent for execution-only AUM.
Upgraded price target
Applying a modest liquidity discount to Equity Development’s valuation, given WH Ireland’s smaller scale, and taking the potential for earnings upgrades as the year progresses, I have upgraded my fair value target to 180p, well below Equity Development’s sum-of-the-parts valuation of 227p. This neatly coincides with a major high during the 2003-2007 bull market in April 2006. Beyond that the all-time high of 195p dating back to October 2007 is the next target.
True, the shares beame very overbought with the 14-day relative strength indicator (RSI) showing a reading of 80 earlier this week. Also, following a share tip last weekend by a national newspaper there has been some hot money banking profits post this week’s results and the large price move. As a result the 14-day RSI is unwinding the overbought position and is now around 60. Moreover, with WH Ireland’s share price breaking out above January’s high of 105p this week, then a medium-term run up to 180p looks on the cards, a target that should be achievable later this year assuming further earnings upgrades come through.
Interestingly, there is every incentive for chief executive Richard Killingbeck to make sure his company continues to make operational progress needed to drive the share price towards my target price. At the end of last year, he entered into a new joint share ownership agreement in relation to one million shares, or 4.3 per cent of the issued share capital. The exercise of the new scheme is subject to a formula based on a total return to WH Ireland shareholders over a three-year period and is based on the mid-market price of an ordinary shares on 28 October 2016 together with the aggregate dividends paid over the preceding three-year period.
The main terms of the formula are that, in the event that the three year value is less than or equal to 115p a share, the exercise price will be 74.5p. However, if it is 200p a share or more, the exercise price will be nil; and if the three year value is between 115p and 200p the exercise price will decrease on a sliding scale from 74.5p to nil. In other words, only if WH Ireland shareholders are well rewarded will Mr Killingbeck reap the full benefits of his share ownership agreement. That seems reasonable to me and I don’t think many investors will begrudge him an option over one million shares at nil cost if WH Ireland’s share price is north of 200p.
Needless to say, I continue to rate the shares a buy on bid-offer spread of 107p to 109p and my year-end target price is 180p. I would use the current price weakness on profit taking post results as a very decent medium-term buying opportunity given the share price has pulled back from an overbought position and is on the point of retesting the 105p break-out point.
I firmly expect a retest, if it happens, to be successful. Furthermore, with the 14-day RSI at a more palatable level, the platform is in place for the shares to make headway towards my upgraded target price of 180p. In the circumstances, I am more than happy recommending a buy on WH Ireland shares at 109p.
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