Margin pressure hits Hargreaves Lansdown

Is Hargreaves Lansdown (HL.) past its peak? On one level, the question feels absurd. Full-year results for the investment platform giant detail improving net client inflows, more benefits from surging markets, a record increase in customers and an 8 per cent rise in underlying pre-tax profit.

How then should we square this with the 10 per cent share price drop that greeted these numbers?

One place to start is with the cost base, which climbed 24 per cent to £266m owing to higher client activity levels and investments in staff homeworking. This, together with a higher tax take and a £39m gain on a disposal booked in 2020, explains the decline in statutory profits.

Investors are – and should be – more concerned with margins. The revenue margin on cash, which is the closest thing to a free lunch you’re likely to find, has contracted, and though average client cash assets climbed from £12.3bn to £13bn, a full year of lower interest rates meant revenue earned on client savings fell from £91.1m to £50.7m.

The cash revenue margin – which stood at 0.74 per cent a year ago – is now expected to dip to between 0.15 and 0.2 per cent this year, assuming there are no changes in interest rates.

Other signs of revenue pressure abound. These include the mandates in Hargreaves’ own bespoke funds, which slipped from £8.7bn to £8.4bn year on year. It could be a sign that investors are less inclined to pay an average 0.72 per cent management fee on top of a flat platform fee.

That isn’t necessarily a problem if fund and share dealing volumes hold up. The latter segment, which generates fees from stockbroking commissions and equity holding charges, was the single largest contributor to the top line in FY21, even though funds are a larger source of client assets.

Citing a slowdown in dealing volumes and client activity, management now expects the revenue margin to dip from 0.57 per cent to as little as 0.35 per cent. The net effect, according to analysts at Jefferies, could be a 5 per cent fall in revenues this year. With little sign of an abatement in cost inflation, this year’s bottom line, special dividend prospects and a consensus forecast for earnings of 57.8p per share all look under pressure.

Clearly, there’s still room for growth; Hargreaves expects the UK’s “addressable wealth market” to expand from £1.4tn to £1.8tn in the next four years, with direct-to-customer investment platforms accounting for just under a quarter of that pie. Client retention levels remain robust. But stalling profit growth complicates the task of equity valuation. Back to hold.

Last IC View: Buy, 1,676p, 13 May 2021