Stalled insolvency market starts to thaw

Despite a "subdued insolvency market" stemming from state support for UK plc, Begbies Traynor (BEG) held up well in the six months to October. Buoyed by acquisitions – which accounted for most of the increase in the top line – operating margins rose to 14.6 per cent, from 13.2 per cent a year ago.

A track record of bolt-on deals has in the past obscured the small-to-mid-market insolvency practitioner’s cash generation. This time around, while underlying working capital was “pretty flat”, according to finance director Nick Taylor, a near doubling in free cash flow was largely down to a delayed £2.7m VAT bill payment.

That comes due in the second half, just as executive chairman Ric Traynor expects the government’s eventual withdrawal of business support measures to lead to a “significant increase in corporate distress”. The corollary of this, as investors in the group know full well, is likely to be an uptick in insolvencies.

Fellow corporate insolvency specialist FRP Advisory (FRP), which listed in March with a view to target higher-profile appointments, is also playing the waiting game. In the six months to October, the group saw its growth checked by a “significant reduction in the number of formal insolvency appointments within the marketplace”.

This hasn’t stopped chief executive Geoff Rowley from expanding the business, through the acquisition of three restructuring teams in Newcastle, East Anglia and Kent since FRP’s public listing. “The medium-term outlook for our market is positive, despite the substantial degree of uncertainty around the shape and scale of the UK's economic recovery,” said Mr Rowley ahead of half-year results on 16 December.

Within the market for larger restructuring mandates, the recent travails of super-leveraged Cineworld (CINE) are an interesting case study. After closing all its screens with the arrival of a second lockdown, the world’s second-largest cinema chain reportedly explored the possibility of a company voluntary agreement (CVA), which would have allowed it to access debt funds while it cut costs and reset rents with landlords.

It eventually struck a last-minute deal that included waivers on all bank covenants until June 2022, a new $450m (£337m) loan, extension of a $111m revolving credit facility, and the issue of equity warrants equal to around 10 per cent of its existing capital.

Such emergency deals have been good for investment bankers. Cast the net wider, and there is plenty of evidence that professional services firms have held up well this year, too. In the half year to October, acquisition-focused legal services group Knights (KGH) saw gross margins hold at 45 per cent and trading reach “near pre-Covid levels” from September.

Over the same period, fellow UK-centric law firm and 2019 stock market debutant DWF (DWF) saw revenues climb 14 per cent following the appointment of legal industry veteran Sir Nigel Knowles, while the smaller Gateley (GTLY) says it expects revenues of “no less than £50m” for its half year, down slightly from £51.8m the prior year.

Like legal services groups, Begbies has focused on diversifying its practice lines in recent years. Unlike FRP, however, the group is not chasing a client base with the scale or listing status to call on capital markets. By contrast, smaller businesses in distress are often limited to risk-averse banks or personal savings for sources of fresh capital – whether to stay afloat or participate in any recovery.

What Begbies has in common with any professional services firm handling long-running mandates, is decent earnings visibility. Citing an increased order book of future insolvency revenue and strong positioning, the group now expects full-year adjusted pre-tax profits to be “at least in line with current consensus” of £9.8m.

Raising their full-year estimate to this level, analysts at Canaccord Genuity upgraded their adjusted earnings forecast to 5.8p per share for the year to April, and see fair value in the shares at 125p. A premium rating of 17 times earnings is justified by cyclical tailwinds that were evident before the pandemic (88p, 12 Dec 2019). Buy.