There are multiple benefits of targeting cash generative asset light companies which produce a high return on capital and have modest capital expenditure requirements.
The most obvious one is that a chunk of cash flow from operating activities can be recycled back into the business to boost shareholder returns while at the same time offering the board flexibility to adopt a progressive dividend policy. Investors have a habit of latching onto companies that can deliver consistent earnings and dividend growth, and create shareholder value, too.
Another feature of asset light businesses is that they are operationally geared, so operating margins widen as revenue rise because an increasing amount of operating profit is earned on incremental sales.
The latest results from Jarvis Securities (JIM), a financial services outsourcer and retail client stockbroker, highlight all these dynamics at work. Revenue per employee shot up 13 per cent in the latest six-month period, and cash flow from operations equated to 100 per cent of operating profit (pre-corporation tax payments), thus enabling the board to lift the normal pay-out by almost half and declare a special dividend. The company is also on course to produce a current year post-tax return on equity of 100 per cent.
An asset light prodigious cash generator
- Interim pre-tax profit surges 27 per cent and prompts 15 per cent earnings upgrades.
- Net cash more than doubles year-on-year.
- Special dividend of 8.5p a share declared.
- Normal interim dividend hiked 46 per cent to 6.5p a share.
Jarvis Securities (JIM:275p), a financial services outsourcer and retail client stockbroker, has delivered eye-catching first-half results which have prompted major earnings upgrades.
First half pre-tax profit and earnings per share (EPS) surged 27 per cent to £4.6m and 8.45p, respectively, on 19 per cent higher revenue of £8.1m, the key drivers being: ongoing demand from pension funds and wealth managers looking to make cost savings by outsourcing their financial administration services to the company’s corporate division; and favourable trading conditions for the 100,000-plus retail clients who use Jarvis’s ShareDeal-Active and X-O low-cost online share trading services.
Chairman Andrew Grant highlights that his company onboarded two new institutional clients during the six-month period, has a healthy pipeline of enquiries and an existing client base that continues to grow organically. Analyst Nick Spoliar at house broker WH Ireland estimates that cash under administration is now well over £300m, a point worth noting as and when the UK economy hits escape velocity and the Bank of England starts to normalise interest rates.
Jarvis’ strong cash generation from its asset light business model, attractive operational leverage and high profit margins were all features of the results. Net cash from operating activities of £4m enabled the board to lift the first half dividend by 46 per cent to 6.5p a share (at a cost of £2.9m) and boost net cash by 120 per cent to £7.1m year-on-year, the sale of £2.2m of shares held in treasury being the other contributor to the cash position. The board’s progressive dividend policy is also supplemented with additional special pay-outs. Jarvis has not disappointed on that front, declaring 8.5p a share special dividend at a cost of £3.7m (ex-dividend: 29 July).
The strong operational gearing of the business is reflected in a 13 per cent increase in revenue per employee to £258,000, and a near four percentage point rise in pre-tax profit margin to 56.6 per cent. With the benefit of a relatively fixed cost base, an increasing amount of margin earned on incremental revenue drops through to operating profit, one reason why WH Ireland has upgraded its full-year pre-tax profit estimate by 15 per cent to £8.5m, so outpacing the 9 per cent upgrade in revenue to £15m. On this basis, expect EPS of 15.6p, up from 12.7p in 2020, and an annual dividend per share of 13.2p (10 per cent upgrade) excluding the special pay-out, implying a normal dividend yield of 4.8 per cent. Spoliar has also upgraded his target price from 325p to 350p.
The holding has produced a 161 per cent return including 31.25p a share in dividends since I reinitiated coverage at 115p (‘Jarvis offers medium-term value’, 15 August 2018) and the share price hit my 300p target price after my last buy advice at 260p (‘Riding earnings’ upgrade cycles’, 12 March 2021). However, with margins materially higher than I anticipated, and Jarvis’s corporate outsourced settlements and administration division firing on all cylinders, I feel the earnings upgrade cycle is far from over. That is certainly not reflected in a current year forward price/earnings (PE) ratio of 17. In the circumstances, I am raising my target price from 300p to 330p. Buy.
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