Duke Royalty (DUKE:44.5p), 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 raised £17.4m at 44p a share through a placing, retail offer and small open offer. The new equity equates to 16 per cent of Duke’s enlarged share capital.
Alongside a new £30m five-year credit facility priced at Libor plus 7.25 per cent with Honeycomb Investment Trust (HONY), and an uncommitted accordion facility which can increase the total facility to £50m, Duke now has substantial additional capital to invest into high return follow-on and new investments in its active pipeline. The board has paid down the £11.65m outstanding balance on the revolving credit facility which saves on interest charges while it’s carrying out due diligence on new investments.
Around £8m has been slated to provide royalty funding to a 30-year old support services company in Ireland which supplies teams of experienced managers to mainly government clients on long-term contracts. Based on an initial cash yield of 13.2 per cent, and a 30-year financing term, Duke should receive an annual distribution of €1.14m (£1m).
Duke is also planning to provide £16.4m of follow-on royalty funding to five of its 12 existing portfolio companies including: £8m to Brightwater Selection to fund its acquisition of a healthcare/life sciences recruitment business; and £2m to Welltel, a fast growing Dublin-based telecom services company, for the acquisition of a SME-focused IT services provider. The new investments have an initial cash yield of 13 to 14 per cent, highlighting the high returns that can be made. Moreover, the board are evaluating £85m of funding opportunities in new royalty partnerships across the healthcare, aerospace, telecoms, and business services industries. Around £24m of capital is expected to be invested in this longer term pipeline.
By recycling the proceeds of the equity raise in a capital efficient manner Duke should be able to increase its royalty funding portfolio by a third to £100m by the March year-end and deliver another step change in profitability. Analysts at Edison expect Duke to be able to deploy £45m of capital in the next 12 months, suggesting a portfolio worth £120m by this time next year.
On this basis, Edison expects pre-tax profit to double to £6.2m to produce earnings per share (EPS) of 2.8p and support a dividend per share of 3p in the 12 months to 31 March 2020, rising to pre-tax profit of £10.2m, EPS of 3.7p and a dividend per share of 4p the year after. Please note that net operating cash flow is set to double to £8.2m (3.76p a share) in the current financial year, rising to £15.2m (5.46p a share) in the 12 months to 31 March 2021, which fully covers forecast dividend and interest costs. This implies Duke’s shares are priced on a forward price/earnings ratio of 15, falling to 12 in the 2020/21 financial year, and offer a prospective dividend yield of 6.7 per cent and 9 per cent, respectively.
Since I suggested buying the shares in my February Alpha Report the holding has produced a total return of 12.5 per cent in a down market for Aim-traded shares ('Duke Royalty: A royal high-yielding investment', 18 February 2019). I expect the outperformance to continue and maintain my 55p target price. Buy.
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