IFG Group — Update 22 April 2016

Now focused on its two core businesses, JHP and SH, the group delivered growth in clients, assets and revenues, as well as higher profits in both divisions during 2015. Notably, JH appears to have reached an inflexion point where the benefits of past investment can be clearly seen in revenue growth and margin expansion. IFG is well positioned for further revenue and profit growth, supported by a strong and liquid balance sheet, in markets that offer attractive prospects for long-term growth potential with further consolidation opportunities.

H215 profit performance was well ahead of our expectations, largely because of earlier margin improvement at JHP than we had allowed for. We have increased our 2016 forecasts slightly (see page 5).

Key features of the FY15 results

Client numbers and assets under administration (AUA) both grew strongly in 2015. At the end of the year JHP administered c 52k SIPPS, a 20% increase on the year, and served more than 56k clients across its range of SSIPs, ISAs, GIAs and SSASs. AUA grew £3.5bn (19%) to £19.5bn, with £3.5bn of gross new inflows and good retention. James Hay is now the sixth largest platform in the UK.

The strategic partnerships established with Towry and Capita made an important contribution to growth, adding c 8,000 accounts from the total new additions of 12,084. Management reports stable attrition levels on average accounts of c 6%. Organic growth has been supported by the introduction of pension flexibility with increased demand from clients with larger pension funds seeking flexible investment and drawdown options. JHP was well prepared for the changes and able to offer online income management solutions from day one.

Currently, revenues are predominantly driven by client account numbers. As JHP takes more client trading of assets onto the platform, charging a basis point fee, the revenue link to AUA will gradually increase with a positive impact on operating margin over time.

Revenue growth of 19% outstripped the 13% growth in average accounts with revenue per average account benefiting from the maturing of completely new accounts opened in the prior year period (typically taking up to six months to fund and achieve a full revenue contribution) and re-pricing initiatives. The latter contributed to H215 revenues and will benefit 2016 for a full year. Underlying operating profit per average account increased by 51% with a levelling out of investment allowing scale efficiencies in addition to the revenue benefit. Growth in 2015 was achieved with no increase in the headcount. The longer term trend is for JHP’s newer products to generate lower average fees but more than off-set by lower average administration costs.

The adjusted operating margin in the year saw significant improvement (from 15.8% to 22.5%) skewed very much towards H215 (26.2%), greatly increased on H115 (18.3%), which carried continued investment cost, including costs associated with Towry and Capita book acquisitions.

The client base increased from 1,608 to 1,809, with another year of strong new client wins (243 after 247 in 2014) and a high level of retention. Assets under advice (AUA) reached £4.0bn from £3.7bn at the end of 2014, which management attributes in part to continuing strong investment performance. Adjusted operating profit growth of c 10% was only a little behind the 12% revenue growth, despite a noticeable increase in the FSCS levy (all charged in H1). The adjusted operating margin was 21.6% (2014: 21.9%).

Revenue per average client was down marginally (c 2%) for the year as a whole, although the normally seasonally weaker H2 (H1 typically benefits from tax year-end advice) was actually a little ahead of H114. In general, there is an underlying trend towards lower average revenues reflecting the growth in younger clients with less complex and smaller average portfolio balances and average fees, which is reflected in our forecasts. SH has launched a discretionary management offering following a pilot programme last year. It expects this to appeal to clients at an earlier stage of their careers and asset accumulation plans, thereby establishing SH’s position with them and complementing SH’s historical offering. This service should also be very relevant to customers at the upper end of SH’s market; it will facilitate wealthy clients who may wish to have a part of their money managed on a discretionary basis, perhaps where they are involved with trusts and Charities, to do so with SH.

For 2016 we are looking for:

2015 revenues were a little ahead of our forecast but H2 profitability was much stronger than we had expected, reflected in both JHP and SH, and to a lesser extent in central costs. For JHP the inflexion point, where investment cost slows and revenue benefits become evident, has been reached sooner than we expected. SH continued to attract new clients and average revenues per client were more robust than we had allowed for.

The upgrade to our 2016 forecast is relatively modest as we had already been anticipating an improving trend in both divisions. We have introduced a 2017 forecast for the first time.

In this section we consider a sum-of-the-parts approach for the group that is broadly based on a comparison of peer valuations for JH. In addition, we perform a discounted cash flow valuation. Within our sum-of-the-parts valuation, for JHP, a comparison with peer investment platform operators is limited by available public information. We have taken data from the quoted Curtis Banks (CBP), Share plc (SHRE) and Hargreaves Lansdown (HL) as well as recently publicly disclosed information made available on Alliance Trust Savings by the parent, Alliance Trust (ATST). While this does not give a clear valuation steer for JHP, it does suggest that a higher P/E multiple than we have previously used would be appropriate. Our sum-of-the-parts “relative” valuation for the group is now €2.45 (196p) or c 20x forecast 2016 normalised earnings. This is supported by our central DCF valuation of €2.33 (186p) which would put the shares on a multiple of c 19x. Previously, our average valuation was €2.11.

There is a relatively limited pool of quoted peers for JHP. In Exhibit 6 below we have collated comparative figures for JHP and four other investment platform businesses for which we can identify revenues, AUA, and a valuation: Curtis Banks, Hargreaves Lansdown, Share plc (see Edison research), and Alliance Trust Savings (subsidiary of Alliance Trust: see Edison research).

Curtis Banks perhaps provides the most obvious comparison as like JHP it is among the leading providers in the SIPP market with more than £9bn of AUA. On completion of its proposed acquisition of Suffolk Life (awaiting regulatory approval) AUA should reach more than £18bn. Curtis Banks has already raised equity to part fund the acquisition and we would expect that the current market capitalisation already reflects the expanded size of the business to a large extent. For this reason we show the implied valuation both excluding and including Suffolk Life (including our estimate of the residual acquisition debt funding). We note that Curtis Banks commands a prospective P/E ratio of 24x for 2016e and 20x for 2017e (source: Bloomberg).

Alliance Trust Savings has been in a sustained investment phase and last year recorded an FY15 loss (before an unusual provision) of £3m, although management expects it to move into profit in FY16. The valuation of Alliance Trust Savings of £54m is an external valuation for the board of Alliance Trust based on discounted cash flow, revenue and EBITDA multiples. Share plc is also embarking on a programme of increased investment, which we forecast to generate a temporary accounting loss in FY16. Hargreaves Lansdown benefits from scale and has a strong growth record. Not only does it trade at a substantially higher percentage of AUA and multiple of revenues but also commands a prospective P/E ratio of over 30x for both FY16e and FY17e (source: Bloomberg).

In this context, we have used a multiple of 18x for JH business in our sum-of-parts valuation, shown in Exhibit 5 below. We have placed SH on a slightly lower P/E multiple of 16.0x. Given its high net worth focus and relationship-based approach, there is again little to directly compare it with. Its growth prospects would seem broadly as attractive as JHP and barriers to competition much higher than with JHP, although its potential for operational gearing would seem lower than for the platform business.

We have not ascribed any additional value to the group’s material cash balance. While this is ample and provides a solid platform for external growth, we also note it is seasonal and H1 is typically lower (with final dividend and bonus payments) than the full year. In aggregate, our sum-of-the-parts valuation for the group is €2.45 or 196p (was €2.15 or 158p previously).

To back-test our multiple selection, we have performed a peer comparison of certain assets and revenue based metrics using implied JHP valuation below (Exhibit 6).

While it is difficult to draw overriding conclusions on the resulting metrics given the wide range within the small peer group, our valuation of JHP does not appear overly optimistic. We are also conscious that the JH business needs to carry its share of the IFG central overhead.

Our discounted cash flow valuation for IFG Group is €2.33 or 186p per share. We have used our revised forecasts for 2016 and 2017 and assume an additional three years of 10% net cash flow growth from there, before reverting to a long-term rate of 5%. Other assumptions include a discount rate of 10% and a terminal multiple of 10x. The terminal value represents 35% of the overall value and existing net cash an additional 14%. The valuation increases/decreases to €2.49/€2.18 if the discount rate is decreased/increased by 1%. An increase/decrease in the long term growth rate by 1% increases/decreases the value to €2.45/€2.21. A 1 x increase/decrease in the terminal value multiple similarly increases/decreases the valuation to €2.41/€2.25.