Duke Royalty (DUKE:47.5p), an Aim-traded company that makes its money by providing capital to companies in exchange for rights to a small percentage of their future revenues over a typical term of 25-40 years, has reported a robust set of annual results and a new credit line that has prompted analysts to material upgrade their forecasts.
Having raised £44m of new equity capital in the summer of 2018, and subsequently acquired its only known competitor, Capital Steps, Duke Royalty trebled the number of royalty partners to 12 in the 12 months to 31 March 2019. The company has since posted record quarterly cash revenue in the first quarter of the 2019-20 financial year. Including follow-on investments made since the financial year-end, the royalty portfolio is currently worth £74m at current exchange rates, of which €25.37m (£22.75m) is invested in European companies.
The terms of these agreements stipulate that in the first year the royalty partner typically pays Duke Royalty a monthly distribution or royalty equal to 12-15 per cent a year of the financing amount. In the second year, and each year going forward, the monthly distribution is then linked to the year-on-year growth in the revenue of the royalty partner collared at 6 per cent a year of the total increase or decrease in the royalty partner’s revenue over the prior year.
To date, all four annual royalty adjustments have delivered positive uplifts and more than half of the royalty portfolio by value is scheduled for annual adjustments in the first quarter of 2020, providing scope for compounding of previous resets. Duke also has £9.6m of loan receivables on its balance sheet which earn interest income at rates between 5 per cent and 16 per cent. In the 2018-19 financial year, the company generated operational cash flow of £4.1m.
Robust cash flow generation to support bumper dividend hikes
Duke’s cash flow is set to benefit from the refinancing the company announced this week. Year-end net borrowings of £5.8m equated to a modest 8 per cent of shareholder funds and had previously been funded from a £15m facility priced at 9.5 per cent above Libor with Honeycomb Investment Trust, a credit fund run by Pollen Street Capital, a spin-out of Royal Bank of Scotland. The directors have just signed a £30m five-year credit facility priced at Libor, plus 7.25 per cent with Honeycomb, and have an uncommitted accordion facility which can increase the total facility to £50m. This provides substantial additional capital to invest into high return follow-on and new investments in the company’s active pipeline.
Analysts have taken note. Alan Howard at brokerage Miribaud Securities upgraded his operating cash flow estimate from £5.3m to £6.9m for the current financial year to 31 March 2020 after factoring in the new financing structure and factoring in growth in the portfolio of royalty and loan investments to in excess of £100m by the March 2020 financial year-end. Duke will also benefit from a full 12-month contribution from the royalty companies acquired as part of the Capital Steps acquisition in February 2019, and other new royalty investments made last year. On this basis, Mirabaud forecasts a trebling of Duke’s current year pre-tax profit to more than treble to £6.3m on a doubling of revenue to £11.2m to produce earnings per share (EPS) of 2.84p (1.1p in the 2018-19 financial year). In turn this supports a 10 per cent hike in the payout to 3.1p per share, which is fully covered by forecast operating cash flow per share of 3.45p.
Mr Howard at Mirabuad has also just released forecasts for the 2020-21 financial year when he expects Duke to increase operating cash flow to £8.48m (4.24p a share) and deliver pre-tax profit of £9m on revenue of £13.9m. On this basis, expect EPS of 4.07p to fully cover a forecast dividend of 3.5p a share, implying the shares are rated on a prospective price/earnings (PE) ratio of less than 12 and offer a forward dividend yield of 7.4 per cent.
I first advised buying Duke’s shares, at 41.6p, in my February Alpha Report ('Duke Royalty: A royal high-yielding investment', 18 February 2019). Since then the board has paid out two quarterly dividends of 0.7p a share to give a total return of 16 per cent on an offer-to-bid basis, during which time the FTSE Aim All-Share Total Return index has declined by 2.2 per cent. With cash flow per share set to improve dramatically, the board adopting a progressive dividend policy, and royalty portfolio companies performing well, then I expect the outperformance to continue and maintain my 55p target price. Buy.
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