Duke Royalty (DUKE:34p), an Aim-traded company that makes its money by providing capital to companies in exchange for rights to a small percentage of their future revenues, is seeing increased dealflow from prospective partners, and of higher quality, too.
That’s because offering business owners long-term sustainable capital without dilution to their ownership or the requirement to make larger capital repayments is becoming increasingly attractive in the prevailing macroeconomic conditions and tighter capital markets. Unlike floating rate loans, monthly payments from royalty partners change once a year at the annual adjustment date according to the revenue performance of the business. The adjustment is capped, too.
Moreover, Duke is invested in the success of its royalty partners, operating a business model that combines both private equity and private credit. Importantly, the group is well capitalised, having increased its debt facility from £55mn to £100mn at a reduced interest spread – 5 per cent above the sterling overnight index average (Sonia) – and raised £20mn in a placing and primary bid offer.
This means that Duke can selectively deploy capital to well-managed and profitable small and medium-sized enterprises (SMEs) that are faced with higher global interest rates and the ongoing lack of loan demand from mainstream banks. Duke’s £185mn royalty portfolio now encompasses 14 royalty partners and 61 operating companies, which earn the group an average yield of 13.1 per cent, and deliver bumper free cash flow, too.
A highly cash-generative business
Duke’s investment team has been investing the capital raised wisely, deploying £26mn in two new royalty partners and four follow-on investments in the 12 months to 31 March 2023. The investments helped drive up the value of its investment portfolio (including loan and equity investments) by a fifth to £210mn, which in turn underpinned the increase in recurring cash revenue, FCF and the dividend.
At the financial year-end, Duke still had £42mn of untapped debt facilities and £8.9mn of cash available to deploy into new investments, hence why analysts at house broker Cenkos Securities expect recurring cash revenue to increase by 21 per cent to £26.4mn in the new financial year. In the first quarter to 30 June 2024, Duke achieved recurring cash revenue of £6mn, or 18 per cent higher than in the same period last year, so Cenkos forecasts look very sensible.
Moreover, analysts’ recurring cash revenue estimates exclude cash premiums received on profitable exits, which are likely to become an increasing feature as private equity circles its royalty partners. Indeed, Duke has just booked a $2.4mn (£1.9mn) gain on the $11.2mn exit from royalty partner Instor Solutions, a California-based product reseller and service provider focused on the data centre industry, that has been bought out by a private equity firm. Duke only made its $8.75mn initial investment in early March 2023.
Admittedly, the macro environment creates uncertainty, but Duke’s business model proved resilient through the Covid-19 downturn. Also, the inflationary environment is driving revenue of portfolio companies higher, thus creating a tailwind for royalty resets and portfolio valuation uplifts.
Duke’s shares have produced a 37.8 per cent total return (TR) in my 2021 Bargain Shares Portfolio, a marked outperformance of the FTSE Aim All-Share TR index which has declined 35 per cent in the same period. The 8.2 per cent dividend yield, 13.5 per cent share price discount to NAV and prospective 11 per cent FCF yield (based on current year FCF rising from 3.3p to 3.8p) are highly supportive of the outperformance continuing. Buy.
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