Beating forecasts, potential equity issue

AFH Financial Group 9 November 2015 Update

AFH Financial Group

Beating forecasts, potential equity issue

Trading statement

Financial services

9 November 2015

Price

169p

Market cap

£34m

Gross cash (£m) at 30 April 2015

4.3

Shares in issue

20.12m

Free float

46%

Code

AFHP

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

4.0

12.3

12.3

Rel (local)

3.6

18.6

13.0

52-week high/low

169.0p

145.0p

Business description

AFH Financial Group is a national independent financial advisory (IFA) and discretionary wealth management firm based in Bromsgrove. It has actively consolidated in the fragmented IFA market, making 11 acquisitions in 2015.

Next event

FY15 results

February 2016

Analysts

Mark Thomas

+44 (0)20 3077 5700

Martyn King

+44 (0)20 3077 5745

AFH Financial Group is a research client of Edison Investment Research Limited

AFH is reporting strong organic and inorganic growth with a 30%+ increase in turnover FY15 on FY14. We have increased our FY15 revenue estimates by 4%, all of which is above expected organic growth. The company expects the FY15 results to be above market expectations. It also highlights that it is considering issuing further equity to take advantage of current market opportunities. We expect the latter to be measured and consistent with evolutionary rather than revolutionary acquisitions.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

10/13

10.8

1.1

5.80

1.25

29.1

0.7

10/14

15.0

1.4

5.83

1.50

29.0

0.9

10/15e

20.5

2.6

10.56

1.75

16.0

1.0

10/16e

27.0

3.6

13.93

2.00

12.1

1.2

Note: *PBT and EPS are normalised, excluding intangible amortisation, exceptional items and share-based payments.

FY15 trading update

AFH reports a strong H215, with revenues for the full year expected to exceed £20m (H115: £8.22m, our previous estimate £19.7m). Despite funding significant acquisitions, cash balances at 31 October 2015 were in excess of £3m (in line with our previous estimate of £3.3m). Funds under management are reported as approaching £2bn at 31 October 2015. Management reports strong organic growth and we note that any beat against our estimates will be all organic growth. AFH has increased its national footprint by completing 11 acquisitions (including a small one not requiring RNS announcement) in FY15.

Outlook

We have increased our forecasts to reflect the outperformance reported for FY15, with an increase of 4% in revenue and a small operational efficiency gain. We note there has been an increase in the size and rate of acquisitions and management’s outlook highlights further increases in inorganic opportunities. AFH is considering additional financing options, including further share issues, to take advantage of these developing opportunities. We expect the size of any equity issue to be relatively modest. AFH is likely to want to pre-fund a number of deals rather than making repeated calls on its shareholders and the average deal size in 2015 was just over £1m. However, it may issue equity as part of deal structures and, historically, inorganic growth has been in digestible bites (the largest deal less than 10% of market capitalisation) and we expect this evolutionary rather than revolutionary approach to acquisitions to continue.

Valuation: Nearly 30% upside

We have increased estimates for both the organic beat in H215 and to include the Davisons deal (which completed after our last note was published). These earnings uplifts see our average valuation increase to 217p from 206p. We will include the effect of any equity issue and deals once they are announced.

Acquisitions update

Deal activity in H215 was a little slower than H115, but AFH still completed deals with maximum consideration totalling £4m. Management was focused on integrating its H115 deals, including the relatively large and more complex than usual IFS acquisition (see below). We believe this demonstrates appropriate discipline and is a much lower-risk approach than simply dashing for scale. With Davisons it has completed a second deal where shares formed part of the consideration. We note that Old Mutual has become a consolidator in the IFA market, but that its deal size is typically well above the level that is of interest to AFH. Some of the private equity consolidators appear to have overcommitted resources and, if anything, are less active in making new deals. AFH is also of most interest to vendors who want to continue with their businesses. For these reasons the pressure on pricing new acquisitions in the AFH targeted space appears to be less than in some other areas of the market.

Exhibit 1: Key financial dynamics from acquisitions made in FY15 (£000s)

Date

Name

Income multiplier

Recurring income

Max consideration

Upfront

Deferred

Upfront

Consideration as % FUM

03/11/2014

Knight O'Byrne

N/D

N/D

1,200.0

525.0

675.0

44%

N/D

30/01/2015

Roxborough Consultancy

N/D

N/D

970.0

535.0

545.0

55%

1.8%

02/02/2015

First Class Financial Management

3.0

28

84.0

42.0

42.0

50%

N/D

09/02/2015

K.L. Plester Financial Services

3.1

600

1,833.0

860.2

972.8

47%

N/D

27/02/2015

CIB Wealth Management

N/D

N/D

973.4

500.9

472.5

51%

2.4%

01/04/2015

Clarendon Financial Solutions

N/D

N/D

483.0

252.5

230.5

52%

1.9%

30/04/2015

IFS

N/D

2,600

4,255.0

605.0

3,650.0

11%

N/D

27/07/2015

Quest Financial Management

N/D

N/D*

585.0

292.5

292.5

50%

N/D

27/07/2015

Phoenix Independent Financial Services

N/D

N/D*

489.0

240.0

249.0

49%

N/D

06/08/2015

Davisons Financial Management

N/D

N/D

2,865

1,071

1,680

37%

N/D

Source: AFH, Edison Investment Research. Note: *In total Quest and Phoenix are expected to add c £320k to recurring income, implying an aggregate 3.35x multiple. N/D = not disclosed. FUM = funds under management.

Exhibit 2: Key business dynamics from acquisitions made in FY15 (£000s)

Date

Names

Location

Advisers kept

FUM (£m)

Client portfolio (£000s)

As % consideration

03/11/2014**

Knight O'Byrne

Cornwall

Y

51

N/D

N/D

30/01/2015*

Roxborough Consultancy

Didcot

N

55

916

94%

02/02/2015**

First Class Financial Management

West Bromwich

Y

N/D

N/D

N/D

09/02/2015*

K.L. Plester Financial Services

Kidderminster

Y

N/D

1,717

94%

27/02/2015**

CIB Wealth Management

Rochester

Y

41

N/D

N/D

01/04/2015*

Clarendon Financial Solutions

Nottingham

Y

25

461

95%

30/04/2015*

IFS

National (Stroud)

Y

N/D

4,100

96%

27/07/2015**

Quest Financial Management

Derby

N

N/D

N/D

N/D

27/07/2015*

Phoenix Independent Financial Services

Blackburn

N

N/D

N/D

N/D

06/08/2015**

Davisons Financial Management

Devon

Y

N/D

N/D

N/D

Source: AFH, Edison Investment Research. Note: *Acquisition accounted; **asset purchase accounted.

IFS (UK)

The scale and nature of IFS meant it was treated differently from the other deals. It was not immediately integrated into AFH's existing infrastructure and AFH incurred the full existing cost base of IFS for this period. The reason for this was that there was much more uncertainty than usual over the retention of advisers given that the proportion of those who held equity was lower (giving them less of a deal benefit), as well as a different remuneration structure and working practices. IFS provided a different service proposition to its advisers and paid them accordingly (cost of sales mainly paid to advisers typically 70% against AFH average of c 48%). The existing arrangements were continued until 1 November 2015 to give the advisers time to consider whether they wanted to migrate to AFH. AFH built into the deal structure with a much lower upfront consideration, with the right to review the maximum consideration after six months and if there were departures the cap would reduce.

AFH announced in the trading statement that the number of advisers who have been authorised under AFH, and hence the price to be paid for IFS UK, has reduced from the maximum level, although at this stage we have not been given detailed numbers. The exceptional cost of integrating the business is expected to be less than half of the £500,000 provisionally set aside. We would expect the level of departure to be less than the 50% drop in restructuring charges, as some of the latter are more fixed costs and non-staff related. We understand that the majority of the advisers who chose to leave did so in the initial stages of takeover and that any further departures will be in the course of normal business rather than integration related. We also note management’s comment that it is very happy with the quality of the advisers who stayed – an implication at least that the departing advisers had a spread of capabilities and it was not just the best who exited. It is worth noting that while the cap has been reduced (more details to be given with the results), it is still a performance-related payout. The initial consideration was just £450k, which would be well under a quarter of the revised maximum cap if the latter reduced pro rata with the restructuring cost and, as noted above, we would actually expect a smaller rate of departure (and cap reduction) than this. Critically, the reduction in cap and performance-related buyouts means the risk of staff departures/under delivery lies largely with the seller of the business/the staff and not with AFH shareholders.

Valuation

The average of our valuation approaches for the existing business is 217p (previously 206p) per share, equivalent to 15.5x 2016e earnings, reflecting the long-term, double-digit growth story and the potential benefits of deploying further resources into acquisition opportunities. This multiple is in line with AFH’s broad peer group. Over time, delivery of earnings and a continued effective execution of the acquisition strategy are the most likely catalysts to a higher share price.

Peer comparisons

Exhibit 3: Peer valuation comparatives

P/E (x)

Yield (%)

Market cap (£m)

2015e

2016e

2015e

AFH*

34

16.0

12.1

1.0

IFA businesses

Lighthouse Group

13

17.7

11.8

2.9

Frenkel Topping

37

27.9

22.7

1.6

Professional service groups

IFG Group*

163

21.9

17.0

2.9

Mattioli Woods (May following year)

161

22.7

19.8

1.8

Wealth managers

Brooks Macdonald (June)

245

18.3

N/A

1.7

Charles Stanley (March following year)

186

31.0

16.4

1.6

St James’s Place

5,016

32.6

25.0

2.9

Platform providers

Hargreaves Lansdown

6,862

37.2

N/A

2.5

Share plc**

43

26.3

20.2

2.5

Source: Thompson Reuters, Edison Investment Research. Note: *Edison Investment Research forecasts, **Edison cash-adjusted basis. Priced at 5 November 2015.

For the reasons identified above, we believe AFH’s business model is differentiated from peers. The companies above should only be taken as illustrative of AFH’s business.

Discounted cash flow: 272p, previously 257p

We explicitly forecast operating cash generation until 2016, then apply a 5% growth rate for 10 years and a 10x multiple to the final year to establish the terminal value and add this to existing cash balances. This is then discounted at the cost of capital (10% assumed), generating a fair value of 272p (up from our previous estimate of 257p). The rise is due to the earnings estimates increase, including the benefit of the Davisons deal.

Gordon’s growth model: 161p, previously 155p

We believe that a skill-based business, with suitable economies of scale, should be able to generate returns safely above its cost of capital. We assume AFH’s long-term return will be c 15%, against a cost of capital of 10% and long-term growth of 5%. The base case indicates it should therefore trade at c 2x book. We then apply a premium for near-term performance as, despite recent equity raisings, the normalised 2015-16e ROE is around our long-term estimates and the equity growth rate well above. This indicates a fair value of 161p (up from our previous estimate of 155p due to the profitability generated from the now included acquisitions and the issue of shares above NAV). The sensitivities are given below.

Exhibit 4: Gordon’s growth model and sensitivity

Base

1% ROE

1% g

1% COE

ROE

15.0%

16.0%

15.0%

15.0%

Growth

5.0%

5.0%

6.0%

5.0%

COE

10.0%

10.0%

10.0%

11.0%

P/B

2.0

2.2

2.3

1.7

2016e NAV

0.70

0.70

0.70

0.70

Implied price

1.40

1.54

1.58

1.17

Premium for near-term performance

15%

15%

15%

15%

Fair value

1.61

1.77

1.81

1.34

Difference

0.16

0.20

-0.27

Source: Edison Investment Research

Any model that focuses on statutory earnings (such as Gordon’s growth model) will include the amortisation charge and so is likely to show a lower valuation than a cash-based model (which does not include the amortisation as it is a non-cash item).

Financials

Exhibit 5: Estimates changes

 

Revenue (£m)

Adjusted PBT (£m)

EPS (p)

Dividend (p)

Old

New

Change
(%)

Old

New

Change
(%)

Old

New

Change
(%)

Old

New

Change
(%)

FY15e

19.7

20.5

4

2.3

2.6

13

9.36

10.56

13

1.75

1.75

0

FY16e

25.5

27.0

6

3.3

3.6

8

13.16

13.93

6

2.00

2.00

0

Source: Edison Investment Research

The revenue guidance in the trading statement was over £20m, at least 2% ahead of our previous estimate of £19.7m. We have increased both 2015 (to £20.5m) and 2016 revenue (to £27.0m) accordingly. We have also included £1m of revenue for the Davisons deal announced in August primarily in 2016. We have assumed a small improvement in efficiency with operational leverage and so our profit and earnings estimates rise well ahead of the revenue uplift. We have assumed most of the higher revenue feeds through to debtors, leaving our cash forecast largely unchanged.

Exhibit 6: Financial summary

£000s

2012

2013

2014

2015e

2016e

Year end 31 October

PROFIT & LOSS

Revenue

 

7,201

10,797

15,037

20,500

27,000

Cost of Sales (exc amortisation and depreciation)

(6,826)

(9,581)

(13,514)

(17,750)

(23,240)

EBITDA

 

375

1,216

1,523

2,751

3,760

Depreciation

 

(29)

(54)

(84)

(100)

(115)

Amortisation

(44)

(91)

(343)

(837)

(975)

Operating profit (pre-exceptional)

 

301

1,071

1,096

1,813

2,670

Exceptionals

0

0

(196)

(250)

0

Other

0

0

0

0

0

Investment revenues

1

(22)

(39)

(164)

(215)

Profit Before Tax (FRS 3)

 

302

1,049

861

1,399

2,456

Profit Before Tax (norm)

 

541

1,140

1,439

2,606

3,551

Tax

(127)

(245)

(260)

(447)

(686)

Profit After Tax (FRS 3)

 

168

804

601

952

1,770

Profit After Tax (norm)

 

357

875

1,061

2,085

2,840

Average Number of Shares Outstanding (m)

14.3

15.1

18.2

19.7

20.4

EPS - normalised (p)

 

2.50

5.80

5.83

10.56

13.93

EPS - FRS3 (p)

 

1.18

5.33

3.31

4.82

8.68

Dividend per share (p)

1.00

1.25

1.50

1.75

2.00

Cost sales as % revenue

-48%

-48%

-49%

-49%

-47%

Admin cost (exc amortisation) as % revenue

-47%

-41%

-42%

-39%

-40%

EBITDA Margin (%)

5.2%

11.3%

10.1%

13.4%

13.9%

Operating Margin (before GW and except.) (%)

4.2%

9.9%

7.3%

8.8%

9.9%

ROE

4.7%

14.2%

6.7%

8.4%

13.4%

Normalised ROE

10.0%

15.4%

11.9%

18.4%

21.5%

BALANCE SHEET

Fixed Assets

 

4,496

7,628

9,987

19,764

18,750

Current Assets

 

2,923

6,959

8,127

6,212

6,631

Total Assets

 

7,420

14,587

18,114

25,977

25,381

Deferred consideration due >1 yr

 

(606)

(1,839)

(2,266)

(3,377)

(2,843)

Other current liabilities

 

(1,873)

(2,456)

(2,650)

(3,240)

(3,847)

Deferred consideration due <1 yr

(853)

(2,220)

(1,866)

(4,285)

(1,442)

Other LT liabilities

(16)

(786)

(794)

(2,936)

(2,939)

Net Assets

 

4,072

7,285

10,538

12,138

14,309

NAV per share

 

0.28

0.43

0.54

0.61

0.70

CASH FLOW

Operating Cash Flow

 

(197)

811

1,581

2,708

3,407

Net cash from investing activities

(2,383)

(3,139)

(2,761)

(7,602)

(2,807)

Net cash from (used in) financing

1,780

5,739

2,499

2,628

(572)

Net Cash Flow

 

(799)

3,411

1,319

(2,266)

28

 

 

 

 

 

 

 

Gross Cash

 

2012

2013

2014

2015e

2016e

Opening

 

1,722

923

4,334

5,653

3,387

Change in cash

 

(799)

3,411

1,319

(2,266)

28

Closing balance sheet

 

923

4,334

5,653

3,387

3,415

Source: AFH, Edison Investment Research

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United Kingdom

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

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