Alpha FX offers more than forex

The UK is the biggest centre for forex activity in the world, taking 38 per cent of global market revenue, according to latest data from the Bank of England. There are several London-listed options for investors interested in the sector. One example is Argentex (AGFX), which pointed to favourable market dynamics in this week's half-year results in which it posted a 75 per cent revenue uplift.   

Another option is Alpha FX (AFX), which is about six times bigger than Argentex, although it still sits at a sub-£1bn stock market value. The company is well regarded among fund managers, coming out at the top of the list in our latest look at managers’ favourite UK small-cap companies. It put out an unscheduled update last month in which it said it expects full-year profits to be “materially ahead of expectations”, revealed it would post around £6mn of additional interest income over four months due to higher interest rates and confirmed that, despite market volatility, it has not seen a worsening in client default rates.

Operations

Alpha FX's shares launched on the Aim market in 2017, since when it has developed a deeper presence in international markets due to client demand. It works with clients based in over 50 countries and now has corporate offices in Milan, Amsterdam and Toronto, as well as in London. Its customer base of corporates and institutions is well diversified. Financial-services clients, unsurprisingly, are the most significant, but there is also a good number of manufacturing, ecommerce, wholesale and media customers on its books, among others. 

When it comes to revenue generation, FX risk management is the main driver. This is where the company derives revenues from providing forex forward, spot, and option contracts. In the latest results, for the half year to 30 June, this took 70 per cent of the total sales pie.

But, despite appearances, Alpha FX isn’t just a purveyor of forex services. Indeed, a general meeting is due later this month to get shareholders' approval to change the company’s name to Alpha Group International and its stock ticker to ALPH. According to management, this reflects its evolution into a business which now offers “a wider (and growing) range of financial solutions”.

These solutions can be seen on the other side of the business, in a segment called 'alternative banking solutions'. Revenue here is taken from fees and forex spot contracts related to clients' cross border payments and accounts, with recurring annual account fees and trading commission. This revenue stream is growing at a faster pace than FX risk management, and was up by 47 per cent in the latest half.

The growth opportunity

Analysts and fund managers see much potential with this segment. Fraser Mackersie, manager of the Unicorn UK Growth Fund (GB0031217937), told Investors’ Chronicle that alternative banking offers Alpha FX “an exciting and highly scalable additional driver of growth”. He added that “the size of this market opportunity is significant in our view and initial traction with clients is very encouraging”. The company is the fund's biggest holding and has been in the portfolio since its flotation.  

More generally, as it looks to the future, Alpha FX can point to a strong track record. It has increased revenues organically every year since inception, has a history of beating City forecasts, and has built up balance sheet firepower with a strong and growing net cash position. The company has differentiated itself from competitors through its focus on and investment in driving growth through technology, and its "formalised and structured" hedging approach, which steers away from speculative trading. 

According to Unicorn’s Mackersie, “the investment in technology, both customer facing and operational, has been significant and is a source of competitive advantage within its sector and embedded value within the shares”.

That may be so, but increased levels of investment in technology and people (the employee headcount is growing as the company expands) means that profit margins have been affected. The pre-tax profit margin fell by four percentage points to 39 per cent in the latest results, while City analysts are forecasting a 410 basis point reduction in the cash profit margin to 42.1 per cent for the full financial year. Yet the aim is that, as well as driving top-line growth, investment will also spur improved profitability. 

Encouragingly, the demand side of the equation looks robust. In its latest disclosure of client numbers, the company revealed that FX risk management clients were up 11 per cent to 975 and alternative banking solutions accounts were up by three-quarters to 3,061 in the six months to 30 June.

The connection between technology investment and client growth was made by Katen Patel, fund manager of the JPMorgan UK Smaller Companies Investment Trust (JMI). Alpha FX is the largest holding in the trust and Patel says the company “stands out because of its technology and customer service-led approach in what has historically been a poorly served sector. As a result, the company has grown its client base 10-fold and revenue per client fivefold in the past 10 years”. It wouldn't be a surprise, in our view, if more good news on client numbers emerges at the next results announcement.

While higher interest rates are helping with short-term growth, the company is sensibly not taking that trend for granted. Alternative banking solutions may be benefiting handsomely from sterling, euro, and dollar funds held overnight on account, but this is a “potentially transitory” situation. The important point to consider is that a return to lower interest rates would not be some sort of disaster – the company’s growth prospects don't rely on exceptional interest income, as demonstrated by its top-line history.

A (deserved) premium rating

The shares have fallen by around 17 per cent in the year to date, which is still better than on the sector-adjacent performance of asset managers. Despite strong results, the company has been caught in the nervous market’s wider sell-off. This has led to a de-rating, with the shares trading at 26 times forward earnings, according to data-provider FactSet – below the five-year average of 30 times. House broker Liberum, which raised its target price fractionally from 2,425p to 2,460p after the latest trading update, forecasts sales growth of 47 per cent and cash profit growth of 44 per cent between 2021 and 2023. It says the current rating is “an attractive entry point to a high-quality growth company". That looks a fair conclusion. 

Unicorn’s Mackersie says the investment the company is making in its future, its chunky earnings growth, and its track record of beating expectations mean that a premium rating is justified. JPMorgan’s Patel, meanwhile, says that Alpha FX “will become a much bigger business in times to come” if it can capitalise on international opportunities. We think it looks up to the challenge. Buy.