IFG Group — Update 8 September 2016

IFG’s activities as a financial services group began in 1989 and it listed on the Irish Stock Exchange in 1996 and on the London Stock Exchange in 2000. The group expanded organically and through acquisitions, with key purchases including IPS Pensions in 2002 (a provider of self-invested personal pensions or SIPPs), James Hay Holdings (SIPP provider, 2010) and financial adviser, Saunderson House in 2001. In more recent years the group has focused on its two main, UK-based, businesses James Hay and Saunderson House, with disposals freeing cash to pay down debt and invest in further growth.

James Hay Partnership (JHP) is a leading provider of SIPPs and has broadened its capabilities and invested in IT so that it can describe itself as the sixth largest platform in the UK specialising in retirement wealth planning and with assets under administration of over £20bn. It has secured partnership agreements with companies such as Capita and Towry (2014 and 2015 respectively) and is in the process of focusing its efforts on the higher end of the adviser market to achieve more profitable growth. Key indicators for JHP include the number of clients, client usage of different services and, to a limited but growing extent, the level of trading.

Saunderson House (SH) is a financial advisor based in the City of London that provides financial and investment planning, charging fees on an hourly rate. The SH staff includes 52 chartered financial planners and five chartered financial analysts. Its clients are typically drawn from the professions including partners in legal and accounting firms. This is reflected in average assets under advice (AUA) per client of over £2m. At the end of June AUA stood at £4.1bn. SH’s key indicators comprise chargeable time, capacity utilisation, number of clients, investment performance, staff retention and assets under advice.

In the first half of 2016 IFG’s assets under advice and administration increased by 14% from H115, primarily reflecting an increase in the number of clients for both JHP (SIPPs +14%) and SH (+8%). This and increased demand for advice from SH clients around the time of the EU referendum contributed to an overall increase in revenues of 16%. With underlying costs up 13%, helped modestly by a lower FSCS levy, adjusted operating income increased 31%, which translated into a substantial rise in adjusted EPS (+41%). The interim dividend has been increased by 11%.

Reported operating income of £4.4m versus £2.2m benefited from lower net exceptional costs. In the first half of last year there were nearly £1.4m of exceptional costs, mainly arising from disposals made in 2014, whereas for H116 there was a net charge of £0.8m. This included a provision of £1.3m for costs relating to IFG’s decision to move its remaining group functions from Dublin to London, offset in part by a £0.5m gain following agreement of the final amount to be received on the 2014 sale of the IFG UK Financial Services business.

First half revenues were more than 15% above the same period last year, but the group notes that this was a challenging period for the industry and for JHP. The number of SIPPs at the end of June was up nearly 14% compared with the same point last year, but was marginally lower than the year-end figure, reflecting in part the impact on client/adviser activity of market volatility in the run up to and following the EU referendum (Exhibit 2). At the same time JHP has been focusing its marketing efforts on a smaller number of higher-value/volume adviser partners. This has also been reflected in pricing changes that took effect in the second half of last year designed to provide a better match with costs. Taken together, this has prompted a faster than expected drop-off within the ‘tail’ of smaller accounts; reflecting this, the level of business outside the top 200 advisers fell by 75% in the first half. Further, where appropriate, JHP has encouraged a merging of clients’ protected benefit and other accounts (over 900 in the first half). The company intends to continue to migrate legacy products to the Modular iPlan product (MiPlan) where this is in the interest of clients.

These changes mesh well with IFG’s ongoing investment in IT and a move towards functional specialisation of operational staff to ease training and increase the efficiency of service delivery. The company is in the process moving towards a digital platform that will improve client service, enhance scaleability and facilitate new service developments. In developing this platform IFG highlights the advantages of control and flexibility conferred by its proprietary in house technology.

SH’s first half performance was also affected by the EU referendum with a marked increase in client demand for advice contributing to the 16% increase in revenue, but also prompting a slowdown in the rate of new client wins (126 versus 166 in H115), with decisions hiring a financial adviser being deferred. A 6% increase in the fee rate at the beginning of the year, the first for some years, was a positive factor for revenues. Client attrition appears to have jumped (40 versus 20), but this included only 12 clients who moved to alternative providers, with death or other reasons accounting for the balance. As a proportion of the average number of clients during the period the annual rate of attrition (for all reasons) remains low at c 4%, albeit an area to which management pays close attention.

Important in retaining and building the client base is the fact that SH advice, as captured by its balanced model portfolio, has delivered performance ahead of its private client benchmark, the FTSE All-Share index and inflation over most periods, as illustrated in Exhibit 4. Over the periods shown, the SH portfolio was ahead of its comparator benchmark with volatility that was somewhat higher. It also outperformed the FTSE All-Share index for one, three and 10 years with significantly lower volatility.

The market and economic background on a medium-term view retains the overlay of uncertainty associated with Brexit negotiations. However, the near-term reaction has been more resilient than some expectations and if this is maintained then the reduction in economic growth estimates that has followed the referendum may prove conservative and investor confidence could be sustained. The equity market has fared well since the referendum and year to date the FTSE All-Share index is up by more than 7% (as at 31 August).

While renewed periods of market volatility seem quite likely these should pass and for both JHP and SH the longer-term background of an ageing population and increase in pension flexibility seems likely to support demand for their investment platform and advice services.

For JHP there is one important near-term brake on performance in the shape of the 25bp reduction in the Bank of England’s base rate that followed the EU referendum. IFG has indicated a potential cost of £1.2m in the second half of 2016 with a larger impact in 2017: we assume around twice the impact on unchanged assumptions. We estimate about £1bn or nearly 5% of AUA is held on deposit on behalf of clients. Prospectively, JHP is considering adjustments to its fees to counter this impact and this may moderate the impact during 2017 and beyond (we assume the adverse interest income effect is largely neutralised by 2018 either through prices and/or a change in rates).

JHP has also noted that continued investment in the business will be required, and in the near term a reduction in revenue growth expectations, reflecting the slowdown in SIPP account growth already seen in the first half, creates what IFG acknowledges is a “revenue challenge”.

Strategically, JHP will continue to monitor developments in its industry where, in common with other participants, it expects to see further consolidation, particularly as higher capital requirements pressure smaller players. Otherwise, the company will continue to focus on the higher end of the adviser market as a source of business. Partnerships such as those with Towry and Capita are attractive as they provide a good flow of new accounts and impose a lower proportionate administrative burden than would be the case for smaller, less active advisers.

At SH the surge in demand for client advice around the time of the referendum is likely to subside to some extent, but this will allow greater focus on winning new clients and if markets remain relatively calm then the environment for this should be more favourable. We therefore look for a reacceleration of the growth in clients for 2017 and 2018, while allowing for some reduction in the average revenue per client to allow for growth in the number of younger clients with smaller portfolios and less complex requirements for advice.

Reflecting the Brexit-related reduction in interest income and the slower rate of SIPP account growth highlighted above, we have trimmed our estimates for both this year and next, as shown in Exhibit 5. We have also introduced an estimate for 2018 that assumes the resumption of more rapid growth in accounts and clients flowing through to revenues, together with the neutralisation of the negative interest income effect through pricing or rate changes. Operational gearing is expected to generate a marked strengthening in margin over the forecast period (pre-exceptional operating margin is estimated to increase from 10.7% to 16.5%).

Compared with H115 the group’s net cash balance increased by 23% to £23.5m, a reduction of £3.8m compared with the year end after dividend payments of £3m and capital spending of £2m.

The capital position of the group remains strong. The Pillar 3 disclosure for end 2015 showed capital resources of £40.5m compared with a requirement of £5.7m (coverage over 7x). New capital requirements for SIPP operators come into force this month (September) enhancing the capital requirements in respect of non-standard investments held in SIPPs. IFG has indicated that it will continue to have sufficient resources to meet these requirements and, subject to further information on the size of the additional requirement, would appear to have significant capital headroom to support prospective growth.

Following the adjustments to our estimates detailed above, we have refreshed our DCF valuation with the main assumptions including a 10% discount rate, 10x terminal multiple and a 4% longer-term growth rate beyond 2020. We have allowed for two years of 10% growth in 2019-20. This results in a central value, as shown in Exhibit 6, of 181p compared with 186p previously. The relatively small reduction in indicated value reflects the near-term estimate downgrade and our assumption of more rapid growth resuming in 2017 and 2018, together with the retention of a reasonably robust growth rate for the intermediate period. Changes to these assumptions would have a significant impact on the outcome in addition to the sensitivities shown in the table below. Flexing the growth rate to match the current share price would require both a long and intermediate growth rate of c 2%, suggesting the market is currently inclined to take a relatively risk-averse approach when assessing the valuation.

We have also updated our sum-of-the-parts valuation, this time setting it so that it matches the output of our DCF valuation to provide a sense check. This has required the assumption of a higher multiple for JHP than we have used previously (23.5x versus 18.0x), reflecting lowered earnings estimates and the expectation of a resumption in growth (Exhibit 7).

Finally, we set out a platform comparison including Curtis Banks, Hargreaves Lansdown, Alliance Trust Savings and Share plc. Differences in scale, particularly for Hargreaves Lansdown, and business mix means this should be treated with some caution. The comparison shows the respective revenues and AUA, together with corresponding multiples and, where available, consensus P/E ratios. For JHP we have taken the valuation assumed in our sum-of-the-parts, allowing a crude sense check of the higher multiple we have applied to the business. In terms of value to revenue and to AUA and on P/Es, JHP ranks closer to the bottom of the range, arguably suggesting support for a valuation at around this level.