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AFH Financial offers undervalued growth

Unlike other wealth management peers, AFH Financial is not only cheap, but has a clear path to growth
August 1, 2019

Blockbuster dealmaking generates headlines and plenty of investor noise. But is it a good idea? A study by consultancy McKinsey suggests not, and that bet-the-company M&A is less likely to succeed than a consistent programme of multiple small acquisitions executed over years. Companies that do this “become true masters of the art of identifying, negotiating and integrating acquisitions”, concluded the report’s authors.

IC TIP: Buy at 344p
Tip style
Growth
Risk rating
Medium
Timescale
Medium Term
Bull points

Fresh fundraising

Clear growth strategy

Track record

Diversified

Bear points

In-house distribution model

Threat of D2C/platforms

All of which brings us neatly to AFH Financial (AFHP) an Aim-traded financial advisory outfit with designs on becoming the UK’s number one financial-planning-led wealth manager. Founded in 1990 by chief executive and 15.4 per cent shareholder Alan Hudson, the group is a small fish in a large pool of UK wealth managers. But it has a clear acquisition-led strategy in a structurally undersupplied and fragmented market, and what it lacks in assets or brand it more than compensates for in growth opportunities.

Potential investors need only scour the recent track record for proof. Since its initial public offering in 2014, the group has completed the purchase of more than 45 teams of independent financial advisers (IFAs) and protection advisers, helping it to boost funds under management to £5.4bn by the end of April – up nearly threefold in three years, and well ahead of a three-to-five-year target. Last October, AFH reset those aspirational targets, and now aims to hit funds under management of £10bn and annual revenues of £140m by 2023, all the while boosting its underlying cash profit margin to 25 per cent.

As broker Shore Capital points out, meeting these goals “will be heavily determined by the availability of acquisitions at acceptable prices”. But there are good reasons to think this is achievable, and that AFH can maintain its mastery of identifying, negotiating and integrating acquisitions.

The first is the nature of the UK’s IFA market. AFH estimates that there are around 13,700 IFA businesses, with on average just under five advisers per firm, headed by a principal whose average age is 58, and typically unable to offer discretionary services. Although their services are increasingly in demand, the burden to comply with regulation and meet the rising cost of professional indemnity insurance both act as strong drivers of small-scale consolidation.

AFH tries to stick to a set of rules when acquiring these businesses. Typically, transaction prices are around four times project cash profits (Ebitda) for businesses with 30 per cent margins, and designed to generate positive cash flow from the third year of ownership. So far, the track record of integration and client retention has been reportedly successful. Up-front payments are generally limited to 50 per cent of a maximum agreed take-out price, meaning around £39.5m of contingent considerations – around three-quarters of all AFH liabilities – sit on the balance sheet.

AFH Financial Group (AFHP)   
ORD PRICE:351pMARKET VALUE:£150m 
TOUCH:351-353p12-MONTH HIGH:424pLOW:300p
FORWARD DIVIDEND YIELD:2.8%FORWARD PE RATIO:10 
NET ASSET VALUE:174p*NET CASH:£7.7m 
Year to 31 OctTurnover (£m)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
201733.65.415.64.00
201850.710.320.76.00
2019**77.117.029.98.00
2020**89.320.635.610.00
% change+16+21+19+25
Normal market size:500    
Beta:-0.29    
*Includes intangible assets of £93m, or 219p a share. Figures prior to fundraising.
**Shore Capital forecasts, adjusted PTP and EPS figures