This seems harsh considering the company is set to announce a 10 per cent rise in full-year revenues to £20.1m in the 12 months to March 2014 according to analyst Martyn King at Edison. In turn, he predicts pre-tax profits will rise from £5.8m to £6.9m to drive up EPS to 2.4p, from 2p in the prior financial year. Those estimates look sound given that Record’s pre-tax profits rose 12 per cent to £3.1m in the first half to end September 2013 on a similar rise in revenues to £9.9m. Moreover, the company has just released a pre-close trading statement ahead of full-year results to end March 2014 scheduled for release on 17 June.
True, a prospective PE ratio of 15 may seem fair, but you also need to factor in Record’s cash rich balance sheet when valuing the company. That’s because net funds of around £27.7m equate to a over a third of the current market capitalisation. On a cash adjusted basis, the prospective PE ratio is only 10 for the fiscal year just ended. There is also decent dividend support as a 1.5p a share annual payout (covered 1.6 times by post tax earnings) means the rolling yield is 4.4 per cent. A dividend of 1.57p a share is forecast by Edison in the financial year to March 2015 which implies a prospective yield of 4.6 per cent.
Factors impacting share price
In my view, the lacklustre share price performance is down to three key factors. Firstly, the much expected appreciation of the US Dollar has failed to materialise even though the US Federal Reserve has already started tapering its quantitative easing programme. In turn, US clients have suffered a modest negative performance in their investment returns in the first quarter this year, although a lowering of hedge ratios limited losses on Japanese yen and Australian dollar hedges. Also, range trading in the Euro:US dollar exchange rate has increased risk management costs and held back returns. It was a similar story for UK clients as sterling was pretty much range bound during the first three months of 2014 which dampened returns.
Secondly, the lack of dollar appreciation has cooled interest in Record’s currency hedging strategies as one would expect when foreign exchange markets are range bound. That said, interest could easily return if markets either break out of their trading ranges or if there is a spike in general risk aversion which would increase volatility in forex markets.
The third reason for the share price weakness reflects the loss of a dynamic hedging mandate on 1 April which came after Record’s financial year end. This will reduce revenues by £700,000 in the current financial year and impact profits by around £500,000. Reflecting this mandate loss, Edison cut their pre-tax estimate to £6.3m for the 12 months to end March 2015. On this basis, expect EPS of 2.2p, down from 2.4p in the financial year just ended and the 2.47p previously forecast.
However, it’s worth flagging up that analysts have not factored any new business wins into these earnings estimates, so it would not take much in the way of new mandate wins to make up the shortfall given the company’s scalable investment platform.
It’s also worth mentioning that Record’s management team are still seeking out prospective clients and investment consultants in North America, UK and Switzerland in order to bring in new business. The company’s base of 46 clients is made up largely of pension funds, charities, foundations, endowments, and family offices, as well as corporate clients. In total, these clients had $51.9bn of assets under management with Record at the end of March, split 80:20 in favour of passive hedging mandates.
Currency watch
True, until Record starts announcing new mandate wins, then the share price is likely to move sideways. But I see this as an opportunity to pick up shares in an undervalued special situation ahead of what will ultimately be a period of US dollar appreciation. That’s because I feel that the European Central Bank (ECB) will have little choice but to unleash a quantitative easing programme of their own to counter the real threat of a debt deflation spiral in the most overly indebted members in the region. Let’s not forget that the plunging inflation rate in the Eurozone means it is just a quarter of the two per cent target, and falling. It is also well below the one per cent level that even ECB president Mario Draghi considers to be the ‘danger zone’.
This is critical because there comes a point at which the lack of economic growth coupled with low to negative inflation will make it virtually impossible for highly indebted countries to service their borrowings, balance their budgets and become more competitive. For instance, banking analysts believe that if the low inflation environment continues for another four years then Italy’s public debt mountain will spiral to 148 per cent of GDP by 2018, a level from which there will be no return.
And the latest economic indicators don’t paint a pretty picture either. For instance, output prices fell for the 25th consecutive month in Markit's latest survey of companies across the Eurozone. With selling prices falling at the fastest pace for eight months, deflationary pressures appear to be intensifying. Ultimately, the ECB will have no choice but to respond with action rather than words. That view is given further credence when you consider the damaging impact of an appreciating Euro. This has in part been driven by Eurozone banks repatriating funds from overseas in order to shrink their balance sheets and improve capital ratios ahead of the new banking stress tests in October. These capital inflows have sent the Euro spiralling up against the US Dollar just as parts of the region appear to be sleepwalking into a deflationary nightmare.
Something has to give here as any further appreciation in the Euro:US dollar rate can only negatively impact the eurozone’s economic recovery, greatly undermine the competiveness of the region’s exporters and add to the deflationary pressures by reducing import prices. The most obvious solution is for monetary easing on a grand scale to arrest the rise of the Euro, improve the price competitiveness of European companies and add to inflationary pressures. Smart investors have clearly been betting on this outcome hence the falling yields of southern Mediterranean block government bonds. In Portugal, yields on 10-year sovereign bonds have hit their lowest level since 2009 and are at record lows on 12-month Treasury bills.
Averting a deflationary disaster
And such a policy doesn’t necessarily have to be implemented through outright government bond buying. For instance, the ECB could decide to buy private sector debt by purchasing asset-backed securities of small and medium sized companies to fuel liquidity into much needed segments of the market. Alternatively, and ahead of the banking stress tests, the ECB could buy covered bonds of corporate loan books from the region’s banks.
The bottom line is that the Euro’s ascent could be nipped in the bud pretty quickly if the ECB does go down this line. Both the US Dollar and sterling would be major beneficiaries if this were to happen. In turn that would create demand for Record’s currency hedging strategies.
I am pretty convinced the ECB will make a major announcement to address this critical issue before the new banking stress tests are implemented in October. If I am right, then the odds favour a positive outcome for Record. And with the company’s equity in effect only being valued at £48m net of cash, or 10 times post tax profits for the fiscal year just ended, the three point rating discount to peers looks unjustified. In my view, Record can still reward by the year-end and, at 34.5p, I continue to rate the shares a value buy.
Please note that I am working my way through a long list of companies on my watchlist that have reported results or made announcements recently including: Pure Wafer (PUR), Eros (EROS), Inland (INL), API (API), H&T (HAT), Charlemagne Capital (CCAP), Oakley Capital Investments (OCL), Pittards (PTD), Thalassa (THAL), Camkids (CAMK), Taylor Wimpey (TW.), Barratt Developments (BDEV), Bovis Homes (BVS) and Terrace Hill (THG).
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