I had an informative results call this morning with the directors of Aim-traded STM (STM:42p), a company that is expanding both its UK and international self-invested personal pensions (Sipps) operations. The headline numbers make for a good read with STM’s interim pre-tax profit up from £2.1m to £3.4m, albeit that included a net £1.6m bargain purchase gain from the February 2019 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 £400,000, so well below the £2m fair value of the assets acquired when it completed in February this year. The bargain purchase price reflects the fact that Carey was loss-making at the time of the acquisition. Indeed, it reported an operating loss of £282,000 between 12 February and the half year end and STM finance director Therese Neish believes that Carey will accumulate total operating losses of between £500,000 to £600,000 by the time it hits break-even in late 2019 or early 2020. But the business will be earnings accretive in 2020, and the addition of Carey has 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 businesses which now have 5,863 and 1,317 members, respectively.
There is also a great opportunity to exploit Carey’s position in the workplace pensions market where it has 75,000 members. That’s because a number of firms are entering the final stages of the Master Trust authorisation process after the Pensions Regulator amended the regulatory requirements. This has provided the opportunity for the remaining players (including Carey which is in the process of gaining authorisation under the amended regime) to pursue consolidation opportunities.
Analyst Nik Lysiuk at house broker finnCap notes that “before the new legislation was introduced in late 2018 there were approximately 85 Master Trusts operating across the sector. As a direct result of the increased compliance burden, and regulatory requirements, and those with smaller membership bases, the Pension Regulator has confirmed that only 38 providers are proceeding with the authorisation process.” Mr Lysiuk points out that “those operators [not proceeding with Master Trust status under the amended regime] will be required to offload their membership in the coming months”, adding that “if all current applications for Master Trusts are granted, there will be approximately 55 schemes looking for a home among the remaining 30 operators”.
Bearing this in mind, Carey is one such applicant and the newly authorised business will have the ability to enter the bid process for the remaining books of business, boosting the potential for acquisitive growth. STM is certainly cashed up to exploit the market opportunity as the company’s net cash position swelled from £15.6m to £17.3m (29p) in the first half of this year, buoyed by a £2.2m net cash inflow from operations that enabled the company to pay out £772,000 in dividends, settle a £825,000 bank loan and pay out the consideration on the Carey acquisition.
There are also consolidation opportunities in STM’s QROPS business, an offshore pension scheme used by 12,229 expatriates and internationally mobile employees whose tax domicile can change as a consequence of employment, albeit it’s taking longer to exploit them. I would flag up, too, that this is not just an acquisitive growth story as STM is launching new products, including a flexible annuity product that competes with a SIPP, and the existing SIPPs business has been receiving 50 new applications per month since the end of the first half.
Significantly undervaluation worth exploiting
The point being that almost 70 per cent of STM’s share price is backed by cash in the bank, so the potential for some of this cash to be deployed on earnings accretive acquisition opportunities is not being factored into the valuation. In fact, Mr Kentish says that STM is actively looking at a number of targets.
Corporate activity aside, the shares are hardly over rated in the first place. That’s because at the time of the pre-close trading update Mr Lysiuk at finnCap raised his 2019 pre-tax profit estimate from £4.1m to £4.4m based on annual revenues of £24.2m. On this basis, expect STM to produce earnings per share (EPS) of 5.8p to support a hike in the annual payout from 2p to 2.2p a share. The interim payout was raised from 0.7p to 0.75p a share. Mr Lysiuk also upgraded his 2020 pre-tax profit estimate by £300,000 to £4.7m during the summer, a sensible forecast given that STM’s performance next year will not be held back by losses at Carey. This implies 2020 EPS of 6.2p and scope for the annual dividend to be raised to 2.4p a share.
Strip out net cash of £17.3m (29p a share) from STM’s market capitalisation of £25m and effectively the company’s operating businesses are being valued at 1.6 times 2020 pre-tax profit and operating profit forecasts. The prospective dividend yield of 5.4 per cent for the 2019 financial year is attractive, too.
Importantly, I expect STM to start deploying its cash pile to make earnings-accretive acquisitions sooner rather than later to drive even 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 around the current level ahead of the results (‘STM priced for a re-rating’, 23 July 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 £3.25 [UK]. Postage and packaging is only £3.95 for purchases of both books.
Details of the content of both books can be viewed on www.ypdbooks.com. They include case studies of Simon Thompson’s market beating Bargain Share Portfolio companies outlining the investment characteristics that made them successful investments. Simon also highlights many other investment approaches and stock screens he uses to identify small-cap companies with investment potential, too.
Simon Thompson has been named 2019 Small Cap Journalist of the year at the 2019 Small Cap Awards, a prestigious event celebrating the best and rewarding the finest professionals and companies that work within the AIM and NEX communities. It is attended by institutions, fund managers, brokers and advisors operating in the sub-£100m market cap quoted company sector.
