Analysts have pushed through earnings upgrades for Aim-traded STM (STM:44p), a company that is expanding both its UK and international self-invested personal pensions (Sipps) operations, following the company’s pre-close trading update last month. However, the shares have yet to react, possibly a reflection of the complex nature of the statement itself. Indeed, I have been asked by several readers to shed some light on it.
The first point worth considering is that when STM completed the acquisition of Carey, a UK Sipp business that has more than 4,000 members and assets under administration of £898m, the transaction was priced at below the fair value of the assets acquired when it completed in February this year. This sum has been quantified provisionally as ‘negative goodwill’ of £2.7m, which will appear in STM’s profit-and-loss account under IFRS3.
The reason why STM negotiated such a keen price was because Carey is lossmaking so there is an opportunity to reap cost savings this year and for the acquisition to be earnings accretive in 2020. The addition of Carey has also enabled STM to offer niche Sipp products to the UK market with minimal outlay, such as property Sipps, as well as scaling up the company’s existing UK and international Sipps business (1,915 and 1,271 members, respectively, at the start of 2019).
The latest guidance from STM’s directors is for Carey to report a loss of £600,000 in 2019, and break-even early in 2020. There will also be one-off integration costs of £500,000 for the Sipp business. The flipside is that we can expect annualised cost savings of £700,000 to be reaped in 2020 to turn the Carey business into profit. I understand that the integration process is progressing well.
In addition, and as I have noted previously, the company has sensibly been beefing-up its board in order to improve corporate governance and provide it with the operational structure to expand. This has resulted in the appointment of additional non-executive directors, and a newly appointed chief operating officer, the effect of which is to increase annual operating cash costs by £500,000 in the short term. There will also be a non-cash goodwill writedown of £700,000 in the interim results after the company exited its insurance management business.
The net impact of all these adjustments led analyst Nik Lysiuk at broking house FinnCap to raise his 2019 pre-tax profit estimate from £4.1m to £4.4m on revenues of £24.2m to produce earnings per share (EPS) of 5.8p and support a 10 per cent hike in the payout to 2.2p a share. The broker also upgraded its 2020 pre-tax profit estimate by £300,000 to £4.7m, implying EPS of 6.2p and a dividend of 2.4p a share. Strip out net cash of £15.6m from STM’s market capitalisation of £26.2m and effectively a business that should make a clean pre-tax profit of £4.7m in 2020 when the benefits of the Carey acquisition will be seen is being valued at little over £10m.
Importantly, I expect STM to use its cash pile to make further earnings-accretive acquisitions now that it has an operating structure in place to integrate them quickly and efficiently, the effect of which will be to drive more profit upgrades in due course. That possibility is simply not being priced into STM’s current valuation, which is why I continue to rate STM’s shares in a positive light, having last advised buying them at the time of the annual results (‘STM cashed up for acquisitions’, 26 March 2019). Buy.
■ Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £2.95, or £3.75 if you purchase both books. Details of the content of both books can be viewed on www.ypdbooks.com.
