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Awaiting a profit rebound

Awaiting a profit rebound
September 16, 2014
Awaiting a profit rebound
IC TIP: Hold at 14.5p

In fact, having seen AUM decline by 5.5 per cent in the first quarter, the company reported almost 10 per cent growth in the second quarter to end the half year with AUM of $2.83bn, or $100m more than at the start of the year. This primarily reflects continued inflows into its Magna mutual funds. Charlemagne's emerging market income and growth strategies enjoyed notable inflows, a trend that is set to continue according to analysts. Over the past 18 months, net inflows into the Magna range of funds have totalled $317m and have been buoyed by a doubling of the number of products on offer, highlighting their popularity.

Performance fees impacted by low returns

That said, there is no getting away from the fact that the ongoing uncertain geopolitical situation in Russia is having an impact on the performance of the company’s long-short OCCO fund, accounting for around a quarter of AUM and which generated two thirds of the $23.9m performance fees earned by the company last year after adjusting for minority interests.

OCCO has a solid long term track record and has provided investors with a compound annual growth rate of over 10 per cent for the last 12 years. However, 2014 has so far been a challenging year for Charlemagne’s OCCO Eastern European Fund which has delivered flat performance during the latest six month period, largely due to the unfavourable backdrop in Russia. As the fund's strategy is focused on generating ‘alpha’ through its bottom up research process, the investment strategy sometimes struggles in markets which are primarily dominated by top down drivers. That said the MSCI Russia and benchmark Eastern European indices are each down by over 10 per cent this year, so the fund has clearly delivered on its mandate of being an absolute return fund. The problem is that although OCCO has outperformed benchmarks on a relative basis, the absence of absolute performance means that performance fees for the full-year will be impacted.

In fact, analyst Andrew Watson at broking house N+1 Singer only expects Charlemagne to earn $900,000 of performance fees this year in aggregate and management fees of $26.2m. As a result he now expects full-year pre-tax profits of $4.2m on revenues of $28.4m, down from $9.5m and $41.3m in 2013. On this basis, adjusted EPS halves from 1.4 cents to 0.7 cents and means last year’s 1.5 cents dividend is uncovered.

The company’s policy is to payout all its net profits as dividends and has declared a 0.5 cents (0.3p) payout for the latest half year even though EPS of 0.11 cents for the period means it was uncovered. That said, Charlemagne has net cash and investments worth £18.3m on its balance sheet, or the equivalent of 6.5p a share, so has the cash available to do so. Mr Watson is predicting a final dividend of 0.2 cents based on the reduced EPS estimates this year, although the board could again use some of that cash pile to cover the earnings shortfall especially if there is an improvement in the emerging market spectrum in the next six months.

Potential for earnings rebound

Bearing that in mind, Charlemagne’s directors note that emerging markets have continued to rally in August and have now outperformed developed markets since the start of the year. This is based on optimism that “policy risk is generally lower, with meaningful reforms in some key emerging economies, while many investors remain underweight in the asset class.” Moreover, the heavy outflows from emerging markets equity earlier this year have started to reverse too. While the initial beneficiaries of this rally have included some larger, laggard stocks, if this trend continues then it is likely that investors' attention will again switch to high quality, well-managed companies with good profit margins across the capitalisation spectrum - the type of businesses that Charlemagne’s asset managers focus on.

This is one reason why analyst Andrew Watson at broking house N+1 Singer predicts a rebound in fees earned next year, pencilling in revenues of $40m for fiscal 2015. If achieved, pre-tax profit would recover to $10.1m to produce EPS of 1.4¢, or 0.86p, and support a dividend of the same magnitude. On this basis, the shares are offering a prospective yield of 6 per cent for next year. It also means that with net funds and investments accounting for 6.5p of Charlemagne’s current 14.5p share price, then the cash adjusted PE ratio is only 9 for 2015, albeit one that factors in a significant earnings recovery. Also, net of cash the company's equity is only being valued at 1 per cent of assets under management (AUM) of £1.7bn at the end of August, a modest rating relative to peers.

So although the shares have fallen 10 per cent since I included them at 16p in my 2014 Bargain Shares Portfolio, I am happy to recommend you hold onto them at 14.5p for a potential profit rebound next year. In the meantime, the 0.6p a share final dividend banked in April, and the 0.3p a share interim dividend (ex-dividend: 24 September) payable next month, offer some compensation.

Please note that Thalassa (THAL), IQE (IQE), Flowtech Fluidpower (FLO) and Global Energy Development (GED) have all reported half year results today. I will update my view all of these companies shortly. I have also published another two columns today, both of which are available on my IC homepage...

■ Simon Thompson's new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'