The results were actually better than some analysts had anticipated with Fairpoint's fully diluted adjusted EPS of 19p ahead of joint house broker Panmure Gordon's estimate of 18.4p, and well up on the 17p figure reported in 2014. This reflects a 13 per cent rise in underlying pre-tax profits to £10.5m driven by a 41 per cent hike in revenues to £54m on the back of acquisitions made in legal services, full details of which I have highlighted in my previous articles. Moreover, with cash generation robust, the board was able to hike the payout from 6.4p to 6.8p a share. Net cash generated from operating activities increased by more than 40 per cent to £7.9m, enabling the board to pay out dividends of £2.9m to shareholders and use the balance of operating cash flow to part fund £11m-worth of earnings-accretive acquisitions in its legal services division.
Legal services growing strongly
Fairpoint's legal services division now accounts for two-thirds of pro-forma revenues, and rising, highlighting the sound strategic move to diversify revenue streams away from IVA services and debt management plans (DMPs).
Moreover, with the full benefits of last summer's legal services acquisitions set to come through in the current financial year, and year-end net debt of £13.6m equating to a third of shareholders' funds of £39.6m, implying £11.4m headroom on the company's £25m long-term debt facility, there is scope for Fairpoint to make more earnings-enhancing bolt-on acquisitions in order to boost the contribution from its legal services division even further.
Importantly, the acquired businesses are generating organic growth, too. For example, Simpson Millar LLP Solicitors, a consumer legal services business that was acquired in June 2014, achieved underlying revenue growth of 4 per cent last year. There are good prospects of this continuing. That's because following last summer's acquisition of Colemans-CTTS and Holiday Travel Watch, a provider of consumer-focused legal services specialising in volume personal injury, volume conveyancing and travel law, the Colemans trading brand has been retired and all legal activity is now harmonised under the Simpson Millar brand. A new marketing campaign has been developed and the legal services unit has launched around 70 fixed fee legal services in personal, family, employment and travel law. Simpson Millar's first major unified marketing campaign will start later in the spring using a combination of print, internet and social media marketing, and senior management is also considering other commercial opportunities where it can deploy its core skill of applying process to professional services.
I would also point out that only 8 per cent of Fairpoint revenues of £54.1m last year were derived from whiplash claims. That's an important point to note because investors were spooked when the chancellor announced plans in his Autumn Statement to restrict the ability of sufferers of minor whiplash injuries to claim compensation for minor motor accidents, specifically removing the right to seek general damages for minor soft tissue whiplash. The aim is to end the cycle in which responsible motorists pay higher premiums to cover false claims made by others. Those genuinely injured will still be entitled to claim for 'special damages' including loss of earnings and medical treatments. More injuries are now likely to be settled in the small claims court as the upper limit of these claims will be increased from £1,000 to £5,000.
Bearing this in mind, the changes to be implemented in April 2017 are likely to follow prior precedent, so are unlikely to be retrospective. This means that based on current case volumes Fairpoint's revenues earned from whiplash claims, and road traffic accidents in particular, look well underpinned through to the summer of 2018. Furthermore, Fairpoint has a competitive advantage over rivals looking to process volume legal work on low-cost claims, and I understand that changes in the legislation are likely to lead to some "interesting acquisition opportunities".
In turn, this should enhance the legal services offering and reduce the company's exposure to debt management books and IVA services. According to the latest market surveys, there are around 10,000 providers in the fragmented legal services market employing less than 10 people, so offering the potential for Fairpoint to act as a consolidator, too.
But even without factoring in additional acquisitions analyst Michael Donnelly at Panmure Gordon expects Fairpoint's legal services division to increase operating profits from £4.5m last year to £7.1m in 2016. This forecast is based on divisional revenues rising from £31.6m to £49m and reflects a full 12-month contribution from the Colemans acquisition. On this basis, legal services is set to account for almost three-quarters of Panmure's current year revenue estimate of £65.8m, and 60 per cent of its £11.8m operating profit estimate. Analyst Gary Greenwood at Fairpoint's other joint house broker, Shore Capital, is even more bullish, having upgraded both his 2016 and 2017 legal services profit forecasts to £7.4m and £8.9m, respectively, implying the division could be contributing almost 70 per cent of Fairpoint's total operating profit in 2017.
IVA services and debt management under pressure
Admittedly, it hasn't all been plain sailing as Fairpoint's IVA services business remains under pressure. The backdrop of record low interest rates resulted in new IVA cases falling by a quarter to just under 40,000 last year, the lowest level since 2008. Fewer new cases, and a declining market size, in turn meant that Fairpoint's revenues from this activity dropped from £13.6m to £11.6m and the pre-tax profit contribution declined from £3.4m to £2.8m. This outcome also reflects an 11 per cent decline in margins per new IVA case to £3,045, and a 16 per cent fall in the total number of cases under management.
And because part of the IVA business was acquired in 2007 at a cost of £12.1m, at a time when default rates were far higher, the company has taken a non-cash impairment charge of £9m against the carrying value of this unit, leaving £2.3m of associated goodwill on the balance sheet. It's worth pointing out, though, that IVA activities are still very profitable, a point highlighted by a £28m cumulative contribution to Fairpoint's pre-tax profits since 2009. Mr Donnelly at Panmure Gordon expects the division to contribute £1.8m to operating profits this year, while analyst Gary Greenwood at Shore Capital predicts a £2m contribution. The cash flow generated is not only enabling Fairpoint to maintain its progressive dividend policy, but also continue to invest in its legal services arm to replace the income lost.
Revenues from DMP declined last year, too, by £1m to £7.3m, reflecting the decision to stop acquisition activity in this business segment. At the end of 2015, Fairpoint had just under 17,000 plans under management, down from 25,462 plans at the end of 2014, albeit adjusted profit margins have been maintained at 40 per cent and the division still contributed £2.9m of the company's pre-tax profit of £11m before accounting for central overheads of £574,000. It's still a useful source of profit, albeit this will decline further in terms of the mix as legal services increases in size. Both Panmure Gordon and Shore Capital expect the DMP business to contribute £2m of operating profits this year.
Forecasts for the year ahead
The bottom line is that even after accounting for the pressures on IVA and debt management work, the growing contribution from legal services, which is underpinned by last summer's acquisition of Colemans and the ongoing benefits from the Simpson Miller acquisition in June 2014, is set to more than make up for this and points towards another year of growth.
Panmure Gordon expect adjusted pre-tax profits to rise from £10.5m to £11.2m in 2016 to deliver fully diluted EPS of 19.4p and a dividend per share of 7p. Shore Capital is slightly more bullish on profits and also has a 7p a share estimate for the payout. On this basis, the shares currently trade on a forward PE ratio of eight, and offer a prospective dividend yield of 4.4 per cent with the payout covered 2.75 times by post-tax earnings.
That's a low rating for a company successfully executing a plan to diversify away from its weaker IVA and DMP business operations. In the circumstances, I would recommend running your healthy paper profits with Fairpoint shares currently trading on a bid-offer spread of 155p to 159p. Run profits.
Please note that I have written nine columns this week, all of which are listed below.
MORE FROM SIMON THOMPSON...
I have made a total of 105 investment recommendations on companies 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)
■ Plethora Solutions: Take profits at HK$0.079 ('On the takeover trail', 14 March 2016)
■ Somero Enterprises: Buy at 150p; target 185p ('A solid buy', 15 March 2016)
■ 32Red: Run profits at 150p ('32Red in the money, 15 March 2016)
■ Communisis: Sell at 44p ('Patience running short at Communisis', 15 March 2016)
■ Global Energy Development: Sell at 27p ('Global Energy plays waiting game', 15 March 2016)
■ Raven Russia: Sell at 30p ('Raven Russia battens down the hatches', 15 March 2016)
■ Stadium: Buy at 122p, new target price 150p ('Switch on for bumper gains', 16 March 2016)
■ French Connection: Buy at 42.75p ('Return to profitability looms for chic operator', 16 March 2016)
■ Fairpoint: Run profits at 159p ('Fairpoints to make', 17 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
