Moreover, having assessed the latest results and trading trends, I feel comfortable with my 80p fair value price target. I am not the only one who was impressed as analyst Duncan Hall house broker finnCap raised his target price from 60p to 70p.
There were several positives to note. Firstly, with cash generation strong and more than 100 per cent of cash profits being converted into cashflow, STM’s cash pile rose from £5.7m to £8m, a sum worth 13.5p a share. An outstanding £300,000 convertible loan note will be repaid at the end of this month through working capital to leave STM in a debt free and very strong cash position. Only £3.5m of that cash pile is being used to meet regulatory solvency requirements for STM’s life insurance unit, giving the board significant scope to continue to grow the business. The life operation offers a bond wrapper product which enables clients effectively to place assets into a portfolio bond, allowing investments to roll-up tax free before being drawn down. Underlying assets of the life business meet liabilities and STM benefits from net movements on the long-term fund and annual fee based revenue, so offering a high degree of predictability.
Robust growth in pensions business
But it’s the high margin pensions business where the growth is coming from and this explains why the company’s pre-tax profits surged from £1.7m to £2.7m last year on revenue up by 2 per cent to £16.3m to produce EPS of 3.8p.
This reflects the robust performance of STM's Qualifying Recognised Overseas Pension Schemes (QROPS) business, an offshore pension scheme approved by HMRC and used by expatriates and internationally mobile employees whose tax domicile can change as a consequence of employment. STM has an office in Malta as a responsible EU jurisdiction to act as a pension hub for the business, and another in Gibraltar. Malta has a Double Tax Agreement with a number of countries, especially in the Middle East, and is also being used to tap into the US market. And STM has widened its geographic spread of potential new clients by opening new offices in South Africa, South East Asia and the Middle East in order to broaden its intermediary network of financial advisers with whom it works closely.
It’s paying off as the pensions operation has been growing quickly and now has over 9,700 clients globally, having added 2,100 schemes last year. Each one of these generated a client sign on fee of £900 and an annual management fee of £700 to account for £3.4m of that total revenue figure. The 7,600 existing schemes produced an annual management fee of £5.2m, so by my reckoning the division now has recurring revenue of £6.6m. Add to that recurring revenue from the Life business and STM started 2016 with a recurring income stream accounting for £11.3m, or 70 per cent of last year’s revenues.
Furthermore, at the end of last year STM had £1.8m of accrued income in the form of work performed for clients but not billed, and deferred income of £2.6m, up from £2.3m 12 months earlier, representing fees billed in advance yet to be credited to the statement of comprehensive income. This means that £4.4m of fees will be invoiced and earned in 2016, thus providing further added visibility on future revenues.
And with a forecast monthly run-rate of around 160 new cases for QROPS schemes, then Mr Hall at finnCap believes that new cases will produce revenues of £2.9m for STM this year while the 9,700 existing clients will generate £6.2m of annual management fees. This means that the pension business should account for £9.1m, or 55 per cent of STM’s total revenue. It’s highly profitable too as the division accounted for £2.7m of STM’s cash profits of £3.1m last year and that contribution is forecast to increase to £3.95m in 2016, implying a cash profit margin of 43 per cent.
Furthermore, given that QROPS is a long-term retirement vehicle, the annual management fees STM earns can be treated as an annuity type of recurring income given the pensions business enjoys high customer retention rates of around 98 per cent. I would point out that the product offering is administration service only, with the fund management responsibilities falling to the client, or its IFA, so this is purely a plain vanilla product offering based on the price STM charges the client and the service it offers. Clearly, STM’s clients are happy with the service offering otherwise the churn rate would be far higher.
Sharply rising profits and deep ratings discount to peers
So, with the investment made in new offices last year, and the business now reaching critical scale, a significant proportion of incremental revenue is now flowing straight to the bottom line. This explains why the company should be able to grow pre-tax profits by £1m to £3.7m and boost EPS from 3.8p to 4.9p based on a relatively modest rise in revenues. And with net cash equating to 13p a share, this means that the cash adjusted PE ratio is set to fall by a quarter from 11 to 8.5, an incredibly low valuation both in nominal terms, relative to peers, and based on recent consolidation activity in the sector.
For instance, rival Curtis Banks (CBP) recently acquired Suffolk Life from Legal & General for £45m, a take-out price equivalent to 11 times Suffolk Life's normalised profits of £4m. Suffolk Life’s operations included a SIPP business of 26,000 accounts and an insurance business. To put this into perspective, STM is expected to report cash profits of £4.1m in 2016, but its business is being valued on less than £25m after factoring in cash on the balance sheet.
STM offers attractions for income holders too. Having just declared a payout of 0.9p a share, the company’s board aims to pursue a dividend policy to pay out between a third and half of net profits to shareholders. This implies a current year dividend of at least 1.6p a share and a prospective dividend yield of 2.8 per cent. That’s very competitive as Curtis Banks only offers a 1.6 per cent prospective dividend yield, and its shares are rated on double the forward PE ratio of STM. Mattioli Woods (MTW) shares are priced on 20 times forward earnings or 16 times net of cash (June 2016 year-end), and offer a prospective dividend yield of 2 per cent. In other words, after adjusting for cash on the balance sheet, STM’s shares are rated on a 50 per cent-plus earnings multiple discount to rivals.
In my opinion, fair value for the company’s equity is nearer to £48m, or £40m net of cash on the balance sheet, implying a target price of 80p a share. Needless to say, I continue to rate STM’s shares a buy on a bid-offer spread of 53p to 55p ahead of the next trading update at the annual meeting in May. Buy.
MORE FROM SIMON THOMPSON...
I have written articles on the following 81 companies since the start of this year:
■ Grainger: Buy at 243.5p, target 280p; Dart: Take profits at 580p; Crystal Amber: Hold at 159p; Redde: Take profits at 203p; Burford Capital: Run profits at 196.5p; Renew Holdings: Run profits at 404p; Plethora Solutions: Speculative buy at 4.5p ('Stock check', 5 Jan 2016)
■ Elegant Hotels: Buy at 118p, target price 130p to 135p ('Check in for a profitable stay', 6 Jan 2016)
■ Safestyle: Run profits at 272p ahead of pre-close statement on 25 Jan 2016 ('Clear cut gains', 6 Jan 2016)
■ Epwin: Run profits at 143p, new target 170p ('Epwin on the acquisition trail', 6 Jan 2016)
■ GLI Finance: Recovery buy at 37.5p ('GLI shelves fundraise and its chief executive', 6 Jan 2016)
■ LXB Retail Properties: Buy at 97.5p, new six-month target 120p; Urban&Civic: Buy at 286.5p, target 325p; Conygar: Buy at 172p, target 200p ('Hot property, 7 Jan 2015)
■ Somero Enterprises: Buy at 139p, target 185p; 1pm: Buy at 70p, target 82p; First Property: Run profits at 53p; Avation: Buy at 145p, target 200p ('Small-cap value plays', 11 Jan 2016)
■ 32Red: Run profits at 147p; Netplay TV: Buy at 7p ('Chipping in', 12 Jan 2016)
■ Cambria Automobiles: Buy at 87p, new target 95p; Vertu Motors: Buy at 76p, target range 85p to 90p ('Motoring ahead', 12 Jan 2016)
■ Global Energy Development: Hold at 24p ('Cash rich, but unloved', 12 Jan 2016)
■ KBC Advanced Technologies: Bank profits and sell in the market at 183p ('Tech watch, 13 Jan 2015)
■ Sanderson: Buy at 75p, target range 85p to 90p ('Tech watch, 13 Jan 2015)
■ Trakm8: Buy at 300p, new target 400p ('Tech watch, 13 Jan 2015)
■ Amino Technologies: Buy at 120p, new target range 155p to 160p ('Amino has the ammunition', 14 Jan 2015)
■ easyHotels: Buy at 89p, initial target 100p ('easyHotels ramps up expansion', 14 Jan 2015)
■ Stanley Gibbons: Hold at 58p ('Stanley Gibbons fundraise', 14 Jan 2015)
■ Miton: Buy at 28p, target 35p; Moss Bros: Buy at 97p, target 120p to 130p; Bioquell: Buy at 140p, minimum target 170p; UTV Media: Trading buy at 184p ('An awesome foursome', 18 Jan 2015)
■ Equity market strategy ('Bear Market signals', 25 Jan 2015)
■ STM: Buy at 47p, target 80p; Stadium: Trading buy at 103p; Fairpoint: Run profits at 150p, target range 200p to 220p ('Exploiting market anomalies', 1 Feb 2015)
■ Character: Buy at 505p, target 600p; 1pm: Buy at 67p, target 82p; and Entu: Hold at 68p ('A trio of small-cap plays', 2 Feb 2016)
■ Inland: Buy at 83p; Henry Boot: Buy at 220p, target 260p; FTSE 350 housebuilding sector: Trading buy ('Playing the housing market', 3 Feb 2016)
■ Flowtech Fluidpower: Buy at 109p ('Undervalued and ripe for a re-rating', 4 Feb 2016)
■ Safestyle: Run profits at 253p ('Awaiting news on a cash return', 4 Feb 2016)
■ Bowleven; Volvere; French Connection; Bioquell; Juridica; Mind + Machines; Oakley Capital; Gresham House; Gresham House Strategic; Walker Crips ('Bargain shares', 4 Feb 2016)
■ AB Dynamics; Inspired Capital; H&T; Netplay TV; Mountview Estates; Crystal Amber; Arbuthnot Banking; Record; Pittards; Stanley Gibbons ('How the 2015 Bargain share portfolio fared', 4 Feb 2016)
■ IS Solutions: Buy at 120p, target 150p ('Big data, big profits', 8 February 2016)
■ 32Red: Run profits at 133p, easyHotel: Run profits at 99p; Burford Capital: Run profits at 230p; Bilby: Buy at 136.5p ('Hitting record highs', 9 February 2016)
■ BP Marsh & Partners : Buy at 157p, new target 190p ('Primed for investment gains', 10 February 2016)
■ Gama Aviation: Hold at 270p ('Gama hits guidance', 10 February 2016)
■ Bloomsbury Publishing: Buy at 150p, target range 175p to 185p ('Book into a trading play', 11 February 2016)
■ PV Crystalox Solar: Speculative buy at 8.2p ('Lights brighten at PV Crystalox Solar', 11 February 2016)
■ Alpha Real Trust: Buy at 80p, target 105p ('High yield property play', 15 February 2016)
■ LMS Capital: Buy at 68p; Leaf Clean Energy: Await news on Invenergy; Eurovestech: Sell at 7p ('Investment company watch', 16 February 2016)
■ GLI Finance: Buy at 31p ('GLI Finance review offers potential for gains', 17 February 2016)
■ Trifast: Buy at 112p, target 140p ('Engineered for a higher rating', 17 February 2016)
■ 600 Group: Sell at 10p ('600 Group warns', 17 February 2016)
■ Marwyn Value Investors: Buy at 190p ('Undervalued, cash rich investment, 18 February 2016)
■ Henry Boot: Buy at 220p; Moss Bros: Buy at 102p, target range 120p to 130p; Creston: Sell at 103p; Minds + Machines: Buy at 8.5p ('Changing places', 22 February 2016)
■ CareTech: Buy at 245p, target price 300p ('Asset backed, lowly rated property play', 23 February 2016)
■ WH Ireland: Buy at 90p, medium-term target 120p ('WH Ireland hit by FCA fine', 23 February 2016)
■ Stanley Gibbons: Sell at 44p ('Stanley Gibbons rescue equity raise', 23 February 2016)
■ Gresham House: Buy at 325p ('Gresham House spruces up forestry deal', 24 February 2016)
■ Avation: Buy at 140p ('Aircraft deliveries mask Avation's lift off', 24 February 2016)
■ Tristel: Take profits at 125p ('Investors spooked by bugbuster's sales slowdown', 24 February 2016)
■ Town Centre Securities: Buy at 305p, target price 350p ('Property income play with capital upside', 25 February 2016)
■ Capital & Regional: Buy at 60.25p, target 66.5p to 70p ('Short-term trading buy', 29 February 2016)
■ Cambria Automobiles: Buy at 83p, target 95p; Vertu Motors: Buy at 71.75p, target 85p to 90p ('Lowly rated car dealers motoring back', 7 March 2016)
■ Sanderson: Buy at 80p, target 90p ('Tapping into cloud based profits', 8 March 2016)
■ H&T: Buy at 195p ('A golden opportunity', 8 March 2016)
■ Software Radio Technology: Buy at 25p, target 40p ('Software Radio surges on huge contract win', 9 March 2016)
■ STM: Buy at 55p, target 80p ('Lowly rated, cash rich pensions play', 10 March 2016)
■ Simon Thompson's 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 £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking
