Not that the first half was plain sailing. The resignation at the end of the first quarter of star fund managers George Godber and Georgina Hamilton who managed Miton’s flagship CF UK Value Opportunities Strategy Fund (‘Star asset managers poached from Miton Group’, 7 Apr 2016), prompted an outflow of funds. Assets under management (AUM) in that fund declined from £783m at the start of the second quarter to £388m at the end of June, and reversed strong fund inflows in the first quarter which boosted total AUM across all Miton’s funds from £2.78bn to £3.03bn by the end of March. Miton’s total AUM subsequently declined to £2.54bn by the end of June, largely reflecting the outflows from the UK Value Opportunities Strategy Fund and the immediate falls in the UK stock market post the EU Referendum.
Buoyed by a post Brexit bounce back in equity markets over the summer, and the top quartile performance from 9 of the 14 funds Miton runs, total AUM recovered to £2.71bn by the end of August so are almost back to where they were at the start of the year. Maintaining this positive momentum is important because the company’s net revenues of £9.1m in the first half of this year were earned on £2.79bn of average AUM and at slightly higher margins of 68 basis points. In the first half of 2015 the company generated net management fees of £7.1m on average AUM of £2.1bn, so with the £2.5m increase in fees in the first half of this year easily outpacing a 13 per cent rise in administration costs, then a material chunk of the incremental fees earned dropped straight down to the bottom line. This explains why Miton’s underlying pre-tax profit rose by £2.3m to £3.1m in the first half of 2016. There are sound reasons to believe that the company can maintain this momentum.
Funds are delivering
Firstly, having appointed Andrew Jackson to manage the company’s flagship CF UK Value Opportunities Strategy Fund from the start of July, the new fund manager has made a solid start and has posted first quartile performance in the past 12 weeks. He had previously managed the top quartile performing Ecclesiastical (now EdenTree) UK Equity Growth Fund from November 2003 until his departure in the summer of 2015. Under his leadership the fund returned 263 per cent, significantly ahead of the sector average return of 153 per cent. The CF Miton UK Value Opportunities Fund has a history of delivering attractive returns, with stock weightings that are largely independent of the mainstream indices, so Mr Jackson’s background as a classic, no-thrills stockpicker makes him well suited for the role. By the end of August, his fund had AUM of £363m, so the rate of outflows has slowed down significantly, suggesting that investors still on board are willing to back his investment strategies rather than head for the exit.
Moreover, several of Miton’s other funds continue to generate net inflows. For instance, despite the volatile market backdrop, CF Miton UK Multi Cap Income Fund increased AUM from £586m at the start of the year, to £641m at the end of June, rising to £721m by end August. The fund has returned 123 per cent since launch in October 2011 and its top 20 holdings includes a number of my top performing buy recommendations including litigation funding specialist Burford Capital (BUR:415p), uPVC replacement window company Safestyle (SFE: 278p) and Amino Technologies (AMO:143p), a Cambridge-based set-top-box designer of digital entertainment systems for IPTV, home multimedia and products that deliver content over the open internet. The fund now accounts for almost 27 per cent of Miton’s total AUM.
The CF Miton US Opportunities Fund continues to pull in new investors too, buoyed by its top quartile investment performance. AUM here rose from £129m to £184m in the first six months of this year, and subsequently hit £200m at the end of last month. The fund has returned 73 per cent in the two and half years post launch, beating its benchmark by 15 percentage points.
Other funds gaining traction include Miton’s European Opportunities Fund which has AUM in excess of £71m, having only launched in mid-December, and Miton UK MicroCap Trust (MINI), which is now worth £93m, having raised gross proceeds of £50m at launch in May 2015, and a further £28m through a ‘C’ share issue in February this year. In aggregate, these four funds have increased Miton’s AUM by more than £250m so far this year, helping to offset the negative fund outflows from the CF UK Value Opportunities Strategy Fund in the second quarter.
Cash rich and undervalued
Another key take for me was Miton’s cash generation. Net cash has swelled from £14m at the end of 2015, to £17.4m at the end of June, rising to £18.4m at the end of August. Based on 171m shares in issue, this equates to 10.75p a share, or 37 per cent of the current share price. Or put it another way, strip out net funds and the shares are in effect being rated on a forward PE ratio of 9, a chunky discount to other asset managers. Furthermore, Mr Duncan at Peel Hunt believes that his full-year EPS estimate could prove conservative if Miton’s AUM makes further progress, so there is potential further upside to these upgraded estimates.
In addition, and as I have highlighted, there is an operational gearing effect on profits to be earned from incremental net revenues. This explains why Mr Duncan at Peel Hunt believes that Miton can lift both pre-tax profits and EPS by 20 per cent to £5.4m and 2.4p, respectively, in 2017. The fact that the company has bounced back from the loss of its star fund managers in the spring gives weight to those estimates. And with net funds increasing sharply then this offers scope for the board to raise this year’s payout per share from 0.67p to 0.75p as Peel Hunt predict, rising to 0.9p in 2017. On this basis, the well covered dividend offers a prospective yield of 2.6 per cent, rising to 3.1 per cent in 2017.
Trading on a 17 per cent discount to book value, offering a decent dividend yield, and rated on 7.5 times next year’s cash adjusted earnings estimates, I feel that Miton’s shares are too lowly rated. So, having recommended buying them at 25p ahead of the interim results (‘Miton priced for recovery’, 4 Aug 2016), having first recommended buying at below 23p ('Poised for a profitable recovery', 4 Apr 2015), I have no hesitation re-iterating that advice. In fact, a move back to April’s 18-month high of 35p looks in order and that’s my new target price. On a bid-offer spread of 28p to 29p I rate the shares a buy.
Look east for profits
Investors have yet to exploit a major pricing anomaly in the Aim-traded shares of Eastern European property fund manager First Property (FPO:43p). It’s a company I know rather well, having recommended buying at 18.5p in my 2011 Bargain Shares Portfolio since when the board has paid out aggregate dividends of 6.865p a share to produce a total return of 168 per cent on the holding. I last rated the shares a buy at 46p (‘Exploiting sterling weakness’, 18 Aug 2016).
Interestingly, the company has just issued a trading update ahead of results for the six months to end September 2016 that are scheduled for release on Wednesday, 23 November 2016, and which will highlight an 11 per cent increase in First Property’s funds under management (FUM) from £353m to £393m since the end of March 2016. This performance reflects £26m of additional purchases in the UK for the Shipbuilding Industries Pension Scheme fund which means First Property has invested £85m of the client’s total commitment of £125m under that mandate (running to January 2025). That’s good news for management fees.
Of more interest to me though is the fact that £14m of the increase in FUM is down to the weakness of sterling. That’s because the company owns 11 directly held commercial properties, of which eight are located in Poland and three in Romania, that were valued at €197.9m on an open market basis by CBRE and BNP Paribas in First Property’s last set of annual accounts. So with sterling plunging from £1:€1.261 to £1:€1.15 since the end of March, the sterling value of these properties has risen by almost 10 per cent to £172m. Of course, the company has borrowings secured on these assets, so equity in the properties is still around €53.1m before taking into account any revaluations. But after the plunge in sterling this equity is now worth £46.2m, or £4m more than at the end of March. To put this sum into perspective, and based on 116m shares in issue, the currency movement adds 3.5p a share to First Property’s last reported adjusted net asset value of 43p a share.
Significant earnings upgrades likely
Moreover, these properties generate a high recurring revenue stream so there is a translation effect that will boost the sterling value of overseas earnings and one that I fully expect to prompt material earnings upgrades at the time of the first half results at the end of November. To put the potential upgrade into some perspective, these 11 directly held properties generate an average yield of 9.97 per cent based on their market value of $197.9m. That yield is three times higher than the average weighted borrowing cost of 2.96 per cent on the €144m worth of loans secured on the properties, so First Property makes around €13.5m of pre-tax profit pre-central overheads on its overseas investments.
Those profits were worth around £10m when they were translated into sterling at an average exchange rate of £1:€1.363 in last year’s accounts. In the six months since then the average cross rate has dropped to £1:€1.225 and if sterling stays at the current level of £1:€1.15 for the remainder of First Property’s financial year to end March 2017 then it will bring the average rate down to £1:€1.187. And because both the Polish Zloty and the Romanian New Leu have held steady against the euro, this means that the pre-tax profit of €13.5m earned from the 11 directly held properties in Poland and Romania could be worth £1.35m more to the company this year due to the fall in sterling.
The point is that the devaluation of sterling is not being factored into analyst forecasts. In a note to clients at the end of last week following First Property’s trading update at its annual meeting, analyst Chris Thomas of house broker Arden Partners pointed out that his pre-tax profit and EPS estimates of £7.2m and 4.6p, respectively, for the 12 months to end March 2017 are based on a cross rate of £1:€1.33 which “provides scope for upside if current foreign exchange rates are maintained”.
Arden’s estimates are based entirely on the rental income on First Property's portfolio and the recurring fund management fees earned on the nine closed-end funds and joint venture investments it manages. Indeed, around 95 per cent of Arden’s current year £21.9m revenue forecast is recurring which mitigates risk. Importantly, there appears negligible downside risk to the rental income earned from First Property’s directly held properties as voids are only 2.4 per cent, and the tenant quality is high.
Or put it another way, I can see clear potential for Arden to upgrade its pre-tax profit estimate by almost a fifth from £7.2m to £8.5m in a few months time and lift EPS estimates up from 4.6p to 5.5p. For good measure there is an attractive and well covered payout for shareholders which Arden believes will be raised from 1.5p to 1.55p a share in, implying a forward dividend yield of 3.6 per cent.
If that’s not compelling enough, by my reckoning First Property has £14m of free cash available to fund more high-yielding debt-funded deals in Eastern Europe, thus offering another avenue of earnings upgrade potential. Bearing this in mind, the outlook for Eastern European commercial property remains favourable and I understand that there are still opportunities to pick up quality secondary property at attractive valuations and which offer potential for the yield gap with prime Polish property to narrow.
Rated on a discount to spot net asset value, trading on just 8 times forward earnings based on my calculations above, and with significant upgrades highly likely in eight weeks time, the investment case is very solid. In the circumstances, I rate First Property’s shares a strong buy on a bid-offer spread of 42p to 43p ahead of November’s interim results and my initial target price is 56p, coinciding with the all-time high dating back to the end of last year. Buy.
