Brooks Macdonald ripe for re-rating

Following several years of frenetic growth, Aim-traded wealth manager Brooks had to dip into its pocket to invest in the infrastructure needed to underpin its on-going expansion. Earnings at the company have suffered as it has refreshed its IT systems and improved compliance, training and oversight. In addition, an office move this year will add £650,000 to annual property costs. But this cost-heavy period of Brooks' development is due to be completed next year and spending as a proportion of revenue has already peaked. That means the earnings growth hiatus should soon be over, as reflected in Peel Hunt's forecast for adjusted EPS growth in 2016 and 2017 of 20 per cent and 19 per cent respectively (see bar chart).

With expectations of EPS growth resurfacing, the shares have already begun to modestly re-rate and we think there could be much further to go. Indeed, the current rating of 15.5 times earnings, based on Bloomberg consensus next-twelve-month (NTM) forecasts, is in the bottom quarter of the valuation range over the past five years and well below the five-year median average of 16.7 times. It is also substantially off a five-year peak PE valuation of 24.2 times (see graph). The valuation is also below competitors such as Brewin Dolphin (BRW), Rathbone Brothers (RAT) and St. James’s Place (STJ).

Importantly, there is every reason to believe Brooks' long-term growth story remains intact. There remains a strong flow of new business to its core investment management operation, which accounted for over four fifths of last year's profits, from Brooks' extensive 700-strong network of professional advisers and 17 strategic alliances. Analysts at brokers Peel Hunt point to the quickening pace of organic growth (net new funds under management rather than market driven growth in funds under management) from 1.6 per cent in the first quarter of its current financial year, to 2 per cent in the second quarter and 3.6 per cent in the third quarter.

Meanwhile, having passed the £500m in assets mark, Brooks' own fund business should stop making losses in the second half of the current year before moving into profit next year. And while trading has been tougher in Brooks's financial planning and property businesses, the former is expected to have a stronger second half, while the company continues to invest in new business development for the latter.

Life is also generally good for UK wealth managers at the moment with rising markets boosting assets and fees - about half of a 7.4 per cent rise in discretionary funds in the three months to March to £7.5bn came from investment performance. The 7.4 per cent growth compared with a 4.2 per cent rise in the sector benchmark, the WMA Balanced Index, for the period.

Retirement reforms that came into effect in April should also benefit the sector by keeping people invested past the previous normal point of retirement. It is still too early to gauge the full significance of this, but wealth manager surveys and client experience support the industry's belief that clients will hold onto their money for longer.