Lighthouse Group — On track for full year expectations

Lighthouse reported good progress at the interim stage with revenue growth of 5% translating to a 12% increase in pre-tax profit. The recurring element of sales has continued to increase, now accounting for 51% of customer-derived revenue compared with 49% in the same period last year. The strength of the affinity business, including the level of service provided, has also been reaffirmed, with all eight contracts that have come up renewal this year (out of 21) being retained. The relationship with Unison has also been extended to include mortgage and protection advice. Revenue arising from these relationships increased by 20% and accounted for 19% of group and 51% of the National division’s revenues respectively.

Key points from the figures are highlighted below, and a profit and loss analysis is shown in Exhibit 1 (comparisons are with H117 unless stated).

The next table shows the segmental analysis of revenue and profit for the period. In the revenue analysis, the contrast between the National division (including the affinity business) and the gradual contraction of the Communities division (previously Network) is clear, while revenue growth in the Wealth Advisory division, serving high net worth clients, was strong at over 16%. Early-stage growth in the Luceo Asset Management business explains the rapid growth in Other segments revenue.

Turning to segmental profits (now presented excluding indirect operating costs), the contribution from National was maintained. The result was held back by the fact that the prior year period benefited from a £0.11m credit relating to past regulatory fees and the current year bore the cost of further investment in the division’s infrastructure. The division still has the highest segmental profit margin at 25% compared with 11% for Communities and 7% for Wealth Advisory. Although Communities’ revenue declined as some members moved to being directly regulated, profit increased versus H117 as risks have been reduced and the advisers who have left have tended to be less profitable. Wealth Advisory profitability in recent periods has been affected by investment in the Lighthouse Pensions Trust (LPT) automatic enrolment offering, which now has nearly 6,000 members. A strategic review of this business is now underway as part of a wider exercise to focus on the key growth areas for the group. We assume that while costs may arise from implementing the results of the review, there could also be valuable ongoing savings (for example, EBITDA losses relating to LPT for FY16 and FY17 were over £0.5m a year). The loss in Other segments reflects uncovered costs in Luceo Asset Management. The AUM of the five risk-profiled funds of funds here increased from £37m to £53m during the period, with one fund reaching the break-even level of c £20m. The fee rate is 75bp, of which Lighthouse retains 23bp with the balance paid to the investment manager, Octopus and the ACD, FundRock , as part of cost of sales. At current rates of asset accumulation, the company indicates that the business is likely to move into profitability during 2019. Finally, in this table we note that indirect costs, not allocated to divisions, were 9% lower reflecting continued focus on operational efficiencies.

In Exhibit 3, we summarise the eight affinity partner contract renewals announced year to date, together with the extension of the Unison contract. The renewals involved full tender processes and Lighthouse indicates that its partners pay close attention to service levels delivered when considering proposals. So far, the business has not lost a renewal tender, which is attributed to the extensive experience the group has in this sector and the infrastructure it has established to support service delivery.

We discussed the industry background and outlook for Lighthouse in our initiation note published in July this year. Key points included:

Lighthouse indicates that trading in the second half has started well, with adviser activity levels remaining good. The group has a positive view on achieving market expectations for the full year.

In discussing strategy, Lighthouse highlighted that it may now be appropriate to support development of the affinity business by investing some of its available cash (approximately £5m after regulatory requirements out of the £9.6m reported at the end of H118). Spending would be directed to recruiting additional field staff to liaise with partners and financial advisers to service rising client numbers. The ability to establish closer relations with partners should help generate additional fruitful leads from the six million individual members of the existing affinity organisations, while increased volume would require more advisers to service the new clients arising. Another use of cash could be to develop in-house specialist services or products to meet client needs. Acquisitions would also be considered where appropriate to achieve this, while management notes that prevailing pricing in the purchase of financial advisory firms has been generally unattractive in recent years so this seems less likely as a route for development.

In the next section, we discuss the modest changes we have made to our estimates.

The adjustments to our revenue, profit and earnings estimates are limited, with modest changes in the mix to reflect the first half results and to allow for changes in the format of divisional disclosure. PBT and EPS for both years are marginally higher. Ahead of further announcements, we have not allowed for any changes resulting from the current review of the LPT or a step-up in investment to support the affinity business in increasing its penetration of the membership base.

We have increased our dividend estimates following the significant increase in the interim payment. Based on a 40/60 split between interim and final we have assumed a final payment of 0.40p, giving 0.60p for FY18. On our estimates, dividend cover would be c 2.6x for both forecast years.

The balance sheet remains debt free and cash at the end of June stood at £9.6m compared with £8.7m at the end of 2017 and £8.1m at the end of H117. Lighthouse indicates that roughly half the cash is required to underpin regulatory requirements, leaving £5m available for group use, as noted above.

We have updated our peer group table in Exhibit 5. This includes a broad selection of companies including financial advice companies, discretionary fund managers and wealth managers (which we have grouped separately). While each has different characteristics, we believe they are companies investors interested in the area of financial advice and retail investment may consider. Compared with what we have labelled the adviser/DFM average, Lighthouse trades on a lower or similar P/E rating for this year and next, while the traditional wealth managers trade on lower prospective multiples in most cases and on average.

Our discounted cash flow valuation factors in the estimates detailed in the financial summary (Exhibit 7) and, assuming long-term growth of 3% and a discount rate of 9%, gives a valuation of c 44p (unchanged).

Finally, we include a price performance table. This shows that Lighthouse has enjoyed the strongest performance in the peer group over 12 months and year to date as the market gave recognition to a modest rating and attractive investment case.