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A jewel in the north

Prior to last week's results release, and on the back of a pre-close trading update in April, house broker Liberum Capital had previously upgraded its pre-tax profit and EPS estimates by 13 per cent. In the event, Ramsdens managed to beat those upgraded profit numbers by a few percentage points, posting a 73 per cent rise in pre-tax profit to £4m on revenues up 15 per cent to £34.5m, delivering adjusted EPS of 10.1p, excluding the costs of the IPO.

Profits have been on an upward trajectory for some time, as Ramsden has increased its annual cash profits by more than two-thirds to £6m since chief executive Peter Kenyon led a management buyout of the company in the autumn of 2014, backed by private equity firm NorthEdge Capital. Headquartered in Middlesbrough, and with an estate of 127 stores mainly located in Scotland, the north-east of England, and Wales, the board has been accelerating the diversification of the business mix to increase the focus on its foreign exchange and jewellery retail segments, while at the same time acquiring pawnbroking books from rivals to bulk up that side of the business.

It's clearly working: in the latest 12-month trading period, Ramsdens' foreign currency arm exchanged £408m-worth of currency with more than 600,000 retail customers to deliver an 18 per cent hike in the division's gross profit to £9m. The segment now accounts for 37 per cent of the company's total gross profits - and there is no reason to expect the growth to stall here. Mr Kenyon points out that the success of the business is not just down to the highly competitive exchange rates offered, but also to the fact that Ramsdens is a trusted provider of foreign currency services. In fact, it has gained a 10-12 per cent market share in towns where it has a high-street presence, well above its 3 per cent share of this £13bn market dominated by players such as Travelex and M&S. The business is also exploiting opportunities in a number of areas, including offering international payments through a relationship with Currency Direct; a pre-paid MasterCard in US dollars and euros with Wirecard Solutions, which holds the money and has an e-money licence; and an online click-and-collect and home delivery offering.

Pawnbroking is still a significant part of the overall operation, accounting for a quarter of the company's gross profits of £24.2m in the year just ended, servicing the needs of 33,000 customers. It's still quite a small player, as a year-end closing loan book of £6.1m means it has a 4 per cent market share of the UK market. The average loan is around £192, and although the average interest rate charged is 8.8 per cent a month over a five-month term, around 85 per cent of all pledges are still redeemed by customers. Gross profits from pawnbroking rose from £5.7m to £6.1m last year, helped in part by the rise in the gold price and the pound's devaluation since the EU referendum, which has dramatically increased the sterling value of dollar-denominated gold holdings. The company also acquired loan books from rivals, while the decision to sell an increasing number of unredeemed pledges through its jewellery retail operations rather than scrapping them for their intrinsic precious metal value continues to boost recovery rates on defaulted loans.

The third part of the business relates to the purchase of unwanted gold, jewellery and other precious metals from customers, which are then sold through Ramsdens' store network or online, and very profitably too. This unit accounted for almost a third of the company's full-year revenues of £34.5m and £4.3m of its gross profit of £24.2m, representing strong year-on-year growth. The increasing proportion of jewellery being sold through its retail outlets, in many cases after being refurbished following purchase, and increasing stock on the retail merchandising side (up from £3.46m to £4.3m in the six months to end-March 2017), largely explains why gross profits from this particular segment have surged by two-thirds to £3.3m in the past three financial years on a near-doubling of revenues to £5.9m. I would flag up too some useful profit contributions from cheque cashing, Western Union money transfers, the sale and buyback of electronic goods, and credit broking services.


Rollout plans and profit trajectory

Having raised £3.9m of fresh funds in the flotation, net of expenses, Ramsdens ended the March 2017 financial year with net funds of £9.5m, so is heavily cashed up to pursue its growth plans. These include opening 12 new stores each year in the medium term at a total cash cost of around £220,000 per unit, of which capital expenditure accounts for a third of that sum. Based on a 30-month targeted payback of capital, it makes sense to do so. During my results call with directors, they revealed that they are in serious negotiations on five sites, supporting the rollout strategy outlined at the time of the admission of the shares to Aim.

They also point out that the strong trading performance in the year just ended has continued into the new financial year, adding further weight to Liberum Capital's predictions that the company will increase revenues by almost 8 per cent to £37.2m in the 12 months to end-March 2018, of which more than half the increase is forecast to come from the foreign currency business. On this basis, expect both cash profit and operating profit to increase by £400,000 to £6.4m and to £5m, respectively.

So, with the benefit of a lower interest charge, in part reflecting the extra cash raised at the flotation, this should deliver a 20 per cent hike in pre-tax profits to £4.8m and a 25 per cent increase in adjusted EPS to 12.6p. This means that the shares, which have risen strongly since listing at 86p in late February, are priced on a modest 10.5 times forward earnings, a 17 per cent ratings discount to that of larger rival H&T (HAT:296p), a company I have followed successfully for several years and a constituent of my 2017 Bargain Shares portfolio.

But that doesn't tell the full story, as Ramsdens has a cash-rich balance sheet, so a more appropriate way of comparing the two companies is on an enterprise value (market value plus net debt or less net funds) to cash profits basis. On this metric, H&T is valued on 7.8 times cash profits, so applying the same multiple to Ramsdens projected cash profits this year, and after factoring in a bumper cash pile forecast to rise by 40 per cent to £13.4m by March 2018 based on Liberum's estimates, this suggests a value for the 30.8m shares in issue north of 200p if the two companies were attributed the same rating. The broking house is more conservative in having a target price of 162p.

Of course, there are risks to consider in any investment and there are several in the case of Ramsdens.


Risk assessment

As is the case with all businesses dealing in precious metals, exposure to currency movements is a major risk. In the latest 12-month trading period, the uplift in the gold price and sterling's devaluation contributed between £400,000 and £500,000 to Ramsdens' gross profits on its precious metal purchasing operations, according to finance director Martin Clyburn. But this works both ways, as a fall in the value of gold and precious metals may reduce the value of the company's assets and also adversely impact liquidity. Moreover, a sustained fall would affect the value of the collateral offered by customers as pledges on the pawnbroking side, as well as undermining the resale value of these assets if the customer's loan is defaulted on.

Another risk is adverse currency movements. Although the company uses a monthly hedge for core foreign currency stock levels, and a weekly one for intra-month variations, there is a risk of a negative movement in exchanges rates in the time between buying currency on the wholesale market, receiving the hard cash the following day, and then selling it on to clients.

Economic uncertainty is another obvious risk factor and, in particular, the UK's planned exit from the European Union. This has potential to destabilise UK consumer confidence and increase risk aversion if the domestic economic backdrop deteriorates. It could also lead to sterling currency weakness, prompting more UK holidaymakers to opt for 'staycation' holidays. Moreover, even if Brexit negotiations are successful, then the spate of terrorism activity in Europe could deter people from travelling abroad.

It's also worth noting that Ramsdens is a small player and operates in a highly competitive market place across all parts of its business. It competes against some large rivals, including banks, the Post Office and supermarkets in foreign currency; and alternative lenders and much larger pawnbrokers on the precious metal and jewellery side of the business. That said, the foreign currency business has increased the amount of currency exchanged for its customers from £166m three years ago to £408m in the last financial year, despite the competitive market environment. Its geographic bias works in its favour too - as the UK's largest pawnbroker, H&T, which has a 29 per cent market share, has a south of England bias, whereas Ramsdens has a northern bias. Also, unlike other alternative lenders, the company is not a payday lender, so is completely unaffected by the tightening of regulation on this type of high-interest lending activity.

Another risk to consider is the fact that NorthEdge still owns 30 per cent of the issued share capital having offloaded £8m-worth of shares at the time of the flotation. It has agreed not to offload any more shares within six months of the shares being admitted to Aim, but may be tempted to do so thereafter, given Ramsdens' share price is up 55 per cent on the listing price. Other shareholders controlling 4 per cent of the equity, and the directors who own almost 7 per cent, have agreed to a 12-month lock-in post flotation. However, there shouldn't be a problem placing shares with institutions if existing shareholders decide to sell down their stakes, assuming of course that the company continues reporting the strong growth it has being generating in the past few years.

Another point to note on the shareholder base is that 79 per cent of the issued share capital is held by the top nine investors, which reduces liquidity. This works both ways, as good news released by the company is likely to prompt larger than normal share price rises, whereas any trading disappointments are likely to see far larger share price falls.


Target price

Having taken all the risks into consideration, I still feel there is scope for Ramsdens' shares to continue their re-rating, and the valuation discount with larger rival H&T to narrow further. I also feel that if the company continues to overdeliver as it has done so in its short life on the junior London market to date, then the odds of Liberum's 162p target price being surpassed are favourable. In fact, I believe that fair value of 180p a share is a more appropriate level for the equity, implying a market value of £55.4m and a current enterprise value of £45.8m, equating to seven times forecast cash profits in the current financial year.

For good measure, the shares also offer a dividend. The board have just declared a maiden final payout of 1.3p a share, which goes ex-dividend on 22 August and is payable on 20 September. Analysts at Liberum Capital predict that the board will pay out 6.5p a share in the current financial year, rising to 7.1p in the 2018-19 financial year, covered 1.9 times by projected EPS of 12.6p and 13.6p, respectively. On this basis, the shares are rated on a forward PE ratio of 10.5, falling to 10 in 2018-19, and offer prospective dividend yields of 4.8 per cent and 5.3 per cent, respectively - a rating that should continue to attract income investors.

So, on a bid-offer spread of 129p-132p, valuing Ramsdens' equity at £40.6m, I rate the shares a buy and have a 180p target price on a 12-month basis. Buy.



A comprehensive list of all the investment columns I have written in 2017 is available here.

The archive of all the share recommendations I made in 2016 is available here

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