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Jarvis offers medium-term value

The stockbroker and financial services outsourcer has taken a hit from the new Mifid II regulations, but has addressed its commercial fee structure and should return to growth in 2019

Exactly a year ago, I recommended top slicing your holdings in Jarvis Securities (JIM:460p), a stockbroker and financial services outsourcer (‘Targeting a break-out’, 21 August 2017), having first suggested buying at 305p, in the autumn of 2016 ('High-yielding income play with capital upside', 15 November 2016).

Admittedly, I failed to call the very top as the company's share price subsequently went on to hit a record high of 645p as investors warmed further to improved trading prospects for both of Jarvis’s business units: a corporate division, which provides outsourced and partnered financial administration services to a number of third-party organisations and has cash under administration in excess of £150m, all of which is placed on short-term deposit with triple-A-rated banks; and a broking operation that has more than 100,000 retail clients who use its ShareDeal-Active and X-O low-cost online share trading services. They had reason to be positive as the company subsequently delivered a 22 per cent surge in its 2017 pre-tax profits and EPS to a record £4.4m and 32.4p, respectively, and rewarded shareholders with a 23 per cent hike in the payout per share to 23.5p.

One reason for maintaining a financial interest when I last reviewed the investment case (‘Repeat buying opportunities’, 26 February 2018) is because the turn in the UK interest rate cycle is highly significant to Jarvis. That’s because interest earned from Treasury and bank cash deposits accounts for over 40 per cent of the annual revenue it earns, although it will need to see a series of base rate rises before there is a material impact on profits.

In the meantime, the business continues to trade well, but has faced higher than expected costs (around £500,000) associated with implementing the new Markets in Financial Instruments Directive (Mifid II). This factor alone explains why Jarvis’ pre-tax profits for the first half this year slipped from £2.35m to £2.08m on flat revenues of £4.8m, prompting Jarvis’ board to restructure its commercial fee tariffs at the end of the first half to take into account the additional costs it's incurring. 

Importantly, the business continues to win new corporate clients – cash under administration increased by 8 per cent in the latest six-month period – so it’s reasonable to expect the second half performance to outpace the first six months of this year to make up some of the profit shortfall. Indeed, analyst Nick Spoliar at broking house WH Ireland still expects the company to post full-year pre-tax profit of £4.3m, down only marginally on 2017's record performance and that's after the aforementioned £500,000 hit. Furthermore, he actually raised his revenue estimate by £250,000 to £9.65m, a reflection that Jarvis is providing its corporate customers with more services as a result of regulation. It’s worth pointing out that the £50m market cap company makes eye-watering returns, generating a 65 per cent post-tax return on equity in 2017, and is in a healthy financial position – after accounting for £3.6m cash held for settlement purposes, it has net funds of £5.2m.

That's good news for the dividend, especially as the majority of profits are returned to shareholders, reflecting the directors' policy to pay out two-thirds of EPS as a quarterly dividend. The payout was a major bull point in my original analysis and the board has overdelivered, having declared eight quarterly dividends worth 45.75p a share since I first advised buying, at 305p, in the autumn of 2016.

Offering a healthy dividend yield of 5.1 per cent, and priced on a cash-adjusted PE ratio of 12.75, there should be upside if, as expected, Jarvis returns to growth in 2019 – WH Ireland is predicting pre-tax profits of £4.6m and EPS of almost 34p – and if the Bank of England rate setters push through more base rate rises next year. Medium-term buy.

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