I am always on the hunt for operationally geared companies with asset-light business models that earn a high return on equity and generate positive free cash flow. This type of business should be able to recycle cash flow to enhance shareholder value, while offering potential to outpace earnings guidance in a positive sales cycle.
Aim-traded fintech payments group Equals (EQLS:87p), a leading challenger brand in banking and international payments, offers exactly that. In early December, analysts upgraded their revenue and earnings estimates, and have been forced to do so again after Equals reported 59 per cent higher annual revenue of £69.7mn, lifted gross profit by 39 per cent to £33.6mn and delivered cash profit marginally above £12mn (6 per cent beat), representing 79 per cent growth year on year. Net cash is up a third to £15mn (8.3p a share), too.
Analysts at house broker Canaccord Genuity expect current-year cash profit to rise to £15.5mn on revenue of £80mn – conservative-looking estimates – to deliver a third higher earnings per share (EPS) of 6.4p. This implies the shares are rated on a modest cash-adjusted price/earnings (PE) ratio of 12.3 and enterprise value to cash profit multiple of nine. I reiterate my 144p target (‘Profiting from SMEs, 7 September 2022), or almost double my 77p entry point (Alpha Research: ‘A high tech fintech payments opportunity’, 8 April 2022). Buy.
Bombshell from LionFish hits RBG share price
- Litigation funding subsidiary loses two cases
- Non-cash write-off of £4mn
- Analysts downgrade 2022 and 2023 EPS estimates
Last month’s profit warning from RBG (RBGP:70p), a professional services group that encompasses one of London’s mid-tier law firms (Rosenblatt and Memery Crystal), litigation funding arm LionFish and corporate finance boutique Convex Capital, has sent its share price back to my 68p entry point (Alpha Research: ‘Back a winning legal team’, 2 June 2020).
Although RBG’s legal services division performance last year exceeded management’s expectations, and Convex Capital has been trading robustly, as I highlighted when I covered the interim results last autumn (‘Exploiting valuation anomalies, 13 September 2022), the directors dropped a bombshell at LionFish.
The issue being that the subsidiary recently lost two court cases that it had invested in and appealing the cases is no longer viable. As a result, LionFish will suffer a £4mn non-cash write-off and the division will miss prior profit guidance of £2.3mn. LionFish had invested £1.1mn cash in the cases and has committed funding of £3.3mn to other ongoing cases over the next two years. Sensibly, the directors plan to reduce the company’s direct exposure to the remaining committed funding.
Taking account of the non-cash impairment charge, analysts at Progressive Equity Research reduced their 2022 cash profit estimate by a third to £11mn, implying pre-tax profit of £5.8mn or less than half their prior estimate. On this basis, expect 2022 EPS of 4.4p and a dividend per share of 3.5p, down from 8.5p and 5p, respectively, in 2021.
There is recovery potential though, albeit Progressive Equity Research’s new 2023 pre-tax profit estimate of £10.1mn on revenue of £51.6mn is a 36 per cent downgrade on previous profit estimates. However, it still implies that the shares are rated on a modest forward price/earnings ratio of 9 and offer a 6.6 per cent prospective dividend yield of 6.5 per cent for the 2023 financial year. Importantly, the issues at LionFish have had a modest impact on net debt assumptions. Expect closing 2022 net borrowings of around £16.9mn to fall to £14.2mn by the end of 2023, driven by estimated free cash flow of £9.6mn (10p a share) that supports a potential dividend of 4.6p this year based on a 60 per cent payout ratio. Hold.
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