Priced for a profitable outcome

• Convex completes four corporate transactions in 2021.
• Scope for earnings upgrades.

Earnings momentum is clearly building at RBG (RBGP: 95p), a professional services group that owns law firm Rosenblatt, a nascent litigation funding arm and specialist finance boutique Convex Capital.

In early February, the company posted a 5 per cent earnings beat after Rosenblatt enjoyed its best year ever, increasing underlying revenue by 14 per cent to £20.7m and earning a gross margin above 40 per cent. The board also committed to declaring a final dividend of 3p a share in next month’s annual results  (‘Five small-caps with earnings upgrade tailwinds’, 5 February 2021).

It’s not just Rosenblatt that’s firing. Convex has completed four deals and earned total fee income of £2.6m since early January, the latest of which generated a hefty £1.5m commission fee. Moreover, Convex is working on a further eight transactions that have potential to complete in the short to medium term, and has an additional 16 deals in the pipeline. The mergers & acquisitions (M&A) market continues to improve, thus supporting demand for Convex’s services from owners of small- and medium-sized enterprises looking to cash in on healthy valuations being offered.

Bearing this in mind, analyst Andrew Simms at brokerage Arden Partners notes that “if market conditions remain well aligned, we could see good earnings upgrades as we travel through the year”. He has a point as house broker N+1 Singer is only factoring in £3.2m of fee income from Convex in its 2021 revenue estimate of £28m, up from £25.5m forecast in 2020. A high percentage of Convex’s incremental income drops through to profit given its relatively fixed cost base. So, although N+1 Singer is predicting a 42 per cent rise in 2021 pre-tax profit to £7.7m to produce earnings per share (EPS) of 7.3p and return RBG to its 2019 high-water mark, earnings risk is skewed to the upside. This adds weight to the forecast hike in the 2021 dividend to 4.4p a share.

RBG’s shares are up 40 per cent on my 68p entry point (Alpha Report: ‘Back a winning legal team’, 2 June 2020), and achieved my 100p initial target earlier this month. However, with earnings upgrades on the cards – N+1 Singer will revisit its forecasts in April – I feel that the 2021 prospective price/earnings (PE) ratio of 13 is still a decent entry point, and a forward dividend yield of 4.6 per cent is attractive, too. I raise my target price to 140p. Buy.