Corporate distress spells success for Begbies Traynor

Every quarter, the Aim-traded insolvency practice publishes a ‘red flag alert’ about the state of the economy. Since 2020, it has noted a growing number of companies in “significant distress”, with a solemnity that doesn’t quite mask its own good cheer. During the depths of lockdown, however, the group’s doom-laden forecasts collided with government support schemes, which kept insolvency levels eerily low. 

Following the phase out of emergency measures in autumn 2021, however, businesses are going it alone, in the midst of a global energy crisis, a cost of living crunch, and rising interest rates. Last month, Begbies noted that the number of businesses in “critical financial distress”  jumped by 37 per cent in the second quarter of 2022, with bars, restaurants and general retailers driving the increase. Its predictions, it seems, are finally becoming a reality. 

Even without a steepening of this trend, the Manchester-headquartered group has proved remarkably resilient across several economic cycles. Ebitda have risen by 18 per cent on a compound basis over the past five years, and unlike Manolete (MANO) – a litigation funder which specialises in insolvency cases – Begbies managed to grow its revenue through the quiet pandemic period, aided by its diverse income streams. These are dominated by two core divisions: a business recovery & advisory services, and a smaller property services arm which serve an extensive regional network of small- and medium-sized clients. 

The group is an insolvency specialist at heart, however, and around 70 per cent of its revenue is counter-cyclical. As the economic backdrop darkens, momentum is building. Its share price has more than doubled since lockdown was announced in March 2020 and – after an expectation-beating set of results this summer – analysts at Canaccord Genuity nudged up their profit forecasts for the financial year to April 2023, noting “favourable cycle dynamics”, “clear catalysts” for expansion, and decent order book growth of 4 per cent. 

Business is likely to expand as recession bites. While creditors’ voluntary liquidations are at a record high, compulsory liquidations and administrations, which tend to be more complex and thus more lucrative, are still well below pre-pandemic levels. The numbers have recently started to pick up, and executive chairman Ric Traynor said “larger and more complex appointments [are] growing, as anticipated, following successfully integrated acquisitions”. 

Buying spree

These acquisitions are not inconsiderable, and Begbies has been priming itself for growth for the past year and a half. According to FactSet, the company has splashed out £85mn on deals since January 2021, compared with just £20mn in 2019 and 2020 combined. The buying spree has impacted short-term profitability, with statutory earnings per share (EPS) falling into negative territory in the 12 months to 30 April 2022. 

However, top-line growth has been excellent – fuelled by a notable pick up in insolvency work – and analysts expect total operating profit to shoot up in 2023.  Begbies’ market share by number of appointments has also risen from 12 per cent to 14 per cent year on year. 

Acquisitions often broaden a group’s commercial offering, but they can have a punishing effect on liquidity. In spite of its hefty outgoings, however, Begbies has managed to maintain a strong cash position. Dividends have continued to rise throughout the pandemic and improved cash generation resulted in a net cash balance before lease liabilities of £4.7mn at 30 April 2022, up from £3mn a year earlier. 

It is important to keep a close eye on cash generation when looking at professional services firms, particularly when it comes to those whose clients are in varying stages of financial collapse. Unbilled income forms over 70 per cent of Begbies’ trade receivables and its auditors this year warned of the "significant risk" around the value, recoverability and provisioning of work carried out but not yet paid for in cash. A “high degree of subjectivity involved in the estimate of unbilled revenue” also creates "potential for material misstatement", the group's accountants at Crowe UK wrote.

Begbies’ track record is reassuring, however. Debtors generally have 30 days to pay and only 4 per cent of receivables were written off in 2021. This figure has remained steady in recent years. Management also stressed that the credit risk relating to formal insolvency appointments – the group’s bread-and-butter work – is “extremely low”, because invoices are typically raised after creditors have given the go-ahead to draw fees. 

Cost control 

Another issue professional services firms are wrestling with at the moment is employee wages. As a result of Begbies’ buying spree, the number full-time partners and employees working at the firm has grown from 710 in 2021 to around 900 in 2022. In spite of a 29 per cent jump in staff costs, however, profitability is improving. Operating margins expanded to 16.9 per cent in 2022, from 14.8 per cent in 2021 and 11.6 per cent in 2019.

Management said this reflected the benefits of increased scale, with shared and central costs shrinking as a percentage of total turnover. Keeping hold of staff doesn’t seem to be a problem, either. In the year to 30 April 2022, retention remained high at 90 per cent, down from 92 per cent the previous year.

Mixed blessings 

The range of services offered by Begbies' staff is one of its key strengths. However, it is worth noting that a fifth of the group's business activities are cyclical. Some lines of work – particularly in its property division – could be hit by a downturn. Its commercial property agency, valuation and auction businesses suffered during lockdown, for example, suggesting the group is not immune to economic pressures.

Property services generate just a quarter of sales and less than 20 per cent of group profits, however, and are less profitable: the division’s operating margins sit at 16 per cent, compared with 26 per cent in business recovery and financial advisory. The fact it is growing more slowly than the insolvency arm, and could be impacted by a recession, is not too worrying, therefore, as any impact should be comfortably counteracted by counter-cyclical client work. 

As mentioned above, Begbies' shares have risen sharply since Covid struck. However, its forward PE ratio of 14.1 is in line with the five-year average and is certainly not unreasonable given the ghoulish opportunities on offer. It is also significantly cheaper than FRP Advisory Group (FRP), an Aim-traded restructuring specialist with a forward PE ratio of 20.2. 

Few companies will celebrate the success of an insolvency firm. However, the red flags highlighted by Begbies could be a green light for investors in search of a high-quality, defensive investment opportunity.