Brooks Macdonald (BRK), although well known in the industry, is still a wealth manager that lives in the shadows. It may lack the opulent size of St James’s Place, or the brand recognition of, say, Charles Stanley. Nevertheless, Brooks is starting to benefit from the actions that its management has taken to reorganise the business over the past three years. The net result is that the growth prospects for Brooks now in place demand a higher rating for the shares than its obvious competitors; and that rating may rise as investors increasingly recognise the improvement in the company’s operational performance that should drive its earnings growth.
- Leaner and better organised than in the past
- Acquisitions to drive long-term growth
- Inflation should ensure fund inflows
- Rating attractive for the sector
- Exposed to the financial market risks
Wealth management in the UK is enjoying something of a renaissance, with most companies picking the low-hanging fruit of higher market activity and commensurately higher fees. True, this might be a temporary phenomenon – it is doubtful that many of us will continue to save 16 per cent of our earnings as was the case in 2020. Even so, the unprecedented flow of investors' funds into wealth management's coffers and, by extension, into those of asset managers is as much a response to the unprecedentedly low interest rates that savers have endured since the 2008 financial crash as to any outstanding merit on the part of the managers.
Special situations
If the environment is currently benign, it still can’t be understated how much corporate actions affect how wealth and asset managers perform. The business model is fundamentally simple – money is pulled in, administered, then mandated out to asset managers while the fees for service come in at the end of the day. This means the business, while exposed to the vagaries of the stock market, is also responsive to changes in its structure and function. That puts it well within the parameters of a special investment situation, particularly as Brooks's current rating has room to respond to corporate actions.
Brooks’s chief challenge over the past few years has been to maintain the quality of its earnings at times when the market was at its most volatile. As with almost all financial institutions, it is easy for Brooks to make money when times are good, but it is also clear to see how profits can crumble when the going gets tough and client redemptions and lower transaction volumes cut its fee income. After a particularly tough time for all wealth and asset managers in 2018, Brooks’s bosses realised that the firm needed to come up with a response.
In the first instance, this was to streamline costs by axing admin and IT staff as well as losing several veteran department heads in its regional offices. Cost control has generally been tight and operating costs have come in consistently lower than City analysts expected. Brooks has also got on top of some difficult legacy litigation in relation to Spearpoint, a subsidiary it acquired in 2012. Allegations of negligent financial advice emerged from Spearpoint after the acquisition and Brooks has made a £600,000 provision in its accounts to attempt to draw a line under the affair. However, sorting out legacy issues and cutting costs is only a short-term fix for underlying issues with profitability. It is the focus on organic growth and acquisitions that will attract investors' attention.
Wealth and asset management remains a business based on personal relationships to a large extent. Customers notice poor service and indifferent administration quickly. So part of the growth plan was to improve Brooks’s earnings profile by adding more advisers with long-term client relationships, which can only really be achieved within a short space of time through acquisitions. A £30m share placing in June 2019 gave the company the firepower it needed to add to its offering. Crucially, it was how that capital was deployed that piques the interest.
The two large acquisitions Brooks completed in 2020 shows how it intends to generate better quality earnings. The £9m Brooks paid for Lloyds Bank International Channel Islands wealth management brought a stable 1,000 client relationships, but also an agreement with Lloyds to generate mutual referrals. It is a longstanding aim of the Lloyds Group to make a greater proportion of its income from wealth management and clearly it intends to outsource at least part of that to specialist companies such as Brooks. Backed by Lloyds' size, Brooks should have little trouble generating a steadily rising return from its acquisition.
The second company Brooks acquired, Cornelian Asset Managers, illustrates how part of its strategy is to generate more fees from existing IFA relationships. The hefty £39m that Brooks paid for the company comprised £22m in cash, £9m in shares plus £8m dependent on Cornelian meeting agreed performance targets and the acquisition brought in over £1.4bn of discretionary managed funds. The price reflected, in part, Cornelian’s ability to offer bespoke portfolios and investment advice through an existing network of IFAs – all of which should generate better quality of earnings for Brooks through regular and more predictable fees. The other way the company can grow is through opening new offices and adding headcount. So far, it has plans to open on the Isle of Man.
The downsides with Brooks Macdonald are partly generic to the sector, and partly a result of uncertainty generated by a recent management change. The sector risks are easy to pinpoint. If the tide goes out in the markets, then investors will pull funds from wealth managers to cover their positions, or simply as the result of fear or the need to cover sudden expenses. Another clear risk is the direction of macroeconomic policy, particularly of interest rates. Inflation is broadly positive for wealth managers because, at a time of low interest rates, this tends to push savers towards them in preference to savings accounts. What is not clear is whether an eventual rise in interest rates will reverse the trend, prompting savers to hold greater amounts of cash at higher rates in preference to shares or bonds.
At the top of the business Andrew Shepherd has replaced Caroline Connellan, who was arguably the architect of Brooks's turnaround strategy over the past three years. Her departure to run part of Abrdn raises questions over where the company goes from here. The consensus among analysts is that Shepherd, who is a long-term Brooks insider, will not fundamentally divert from the course set by his predecessor.
The bottom line
At a multiple of 13 times 2021-22's forecast earnings, Brooks Macdonald's shares looks attractive compared with other companies in the sector with a similar market capitalisation; shares in Charles Stanley trade at 17 times forward earnings, for examploe. Meanwhile, the PEG factor of 0.4 puts the shares firmly in value territory and the combination of tight cost control and the effect of acquisitions has led to some impressive performance ratios; for example, even taking account of a likely pandemic effect, Brooks MacDonald generates a return on equity of over 15 per cent.
Even Brooks’s traditionally underperforming operating profit margin – around 21 per cent compared with the sector average of 23 per cent – has been pushing upwards, which is why analysts have been consistently upgrading profit forecasts for 2021-22 by an average of 4 per cent. Overall, Brooks Macdonald could well prove the stock market adage that it is often good to buy the chaos, in the context of a special investment situation, and wait for the profits to materialise when everything settles down. Buy.
