Cube Midcap Report (10 March 2020) – The bear roars #MNG #FUTR #TCAP #CBG
The FTSE is up 150 points as I type, which takes some of the pressure off my long FTSE trade (still heavily underwater). What a crazy few days in the markets.
I see a lot of cheapness in the UK, and would want to increase the size of my long index trade if funds allowed it. I’m still waiting for better value in the US, before I even consider doing anything with the S&P500.
The high for the FTSE in May 2018 was 7877.45 (at the close of trading), and yesterday’s close was 5965.77. That’s a 24% drop from the all-time high.
From the more recent high (January 17th, 2020) at 7674.56, it’s a 22% drop. This means we are in a bear market.
As many of us have learned, the psychology of bear markets can persist for a long time.
From a timing perspective, therefore, perhaps I don’t need to be in too much of a rush to increase position sizes!
Some companies I’m interested in today:
- M&G (MNG)
- Future (FUTR)
- TP ICAP (TCAP)
- Close Brothers (CBG)
There has also been an update from the small-cap H&T (HAT), which is one of my larger positions. I will look to cover this one in a separate article.
PS: I found Roland’s treatment of the oil situation in yesterday’s report to be very educational. Worth a look, if you haven’t seen it yet.
- Share price: 176.75p (+2.5%)
- Market cap: £4.6 billion
This is the bizarrely cheap fund manager, spun out of Prudential (PRU). It is thought to trade at around 7x earnings (based on FY Dec 2020 estimates).
One negative news story around it has been the suspension of dealings in shares of its Property Portfolio Fund.
This £2.3 billion fund was suspended back in December, while the Woodford suspensions were still making headlines.
In February, it was announced that the suspension would continue, while the managers of the fund raised cash by selling off predominantly retail units. 30% of the fund’s annual charge has been waived during the suspension – there are good arguments that 100% of the charge should be suspended, since liquidity was a key element of what investors in the fund were offered.
For context, total assets under management and administration at M&G at the end of 2019 were £352 billion. This is up from £321 billion at the end of 2018. So while the Property Portfolio Fund is important in terms of its PR impact, it shouldn’t be overestimated as a percentage of total AUMA.
Since client inflows were net negative, the growth in AUMU for 2019 was driven by investment returns – not very exciting, since M&G can’t control market conditions.
Flows – there were net outflows in Asset Management, offset by net inflows in UK Retail Savings. The end-result was a small net outflow of £1.3 billion.
Performance – 59% of mutual funds, weighted by AUM, are ahead of median returns over a 3-year period.
This strikes me as very average – while I don’t know M&G’s precise tactics, I do know that underperforming funds tend to get shut down or to be amalgamated into better-performing alternatives (and the new combined fund is then considered to be a better-performing fund, with the history of the underperforming fund conveniently forgotten about).
In addition, better-performing funds will see their AuM increase faster, by definition. The 59% number will be influenced by that factor, too.
Finally, the median return in the actively-managed fund space might not be any better than what you’d get in a passive tracker fund (depending on which type of investment we are talking about).
I would be surprised to ever see a fund manager reporting that less than 50% of its funds, weighted by AUM, were outperforming. So I’m not too impressed by this 59% metric from M&G.
The outlook statement refers to Covid-19, the growth of passive funds, and “changes in the distribution landscape”. Plenty of headwinds, then!
The response is to cut costs and focus on the growing, profitable parts of the business:
At M&G plc, we are rising to this challenge by reducing costs through restructuring and through concentrating our resources on areas where client demand is rising and profit margins are resilient.
A voluntary redundancy scheme will reduce staff costs by 10% this year. Total annual cost savings of £145 million are planned by the end of 2022.
When it comes to growth opportunities the PruFunds service, under a different name, will be rolled out in Europe.
“Capital generation”* was £1.5 billion in 2019, driven by c. £1 billion in one-off factors (£455 million from one-off actions/assumption changes/model improvements and £538 million in market movements).
The target for cumulative capital generation from 2020 to 2022 (inclusive) is £2.2 billion, i.e. just over £700 million per year. This is “a realistic and achievable, yet stretching, target“.
The target is in line with consensus net income forecasts for this year and next year of £700 million.
*Capital generation is “the change in the Group’s Solvency II surplus before dividend payments, capital movements and capital generation from discontinued operations”. In my own words, it’s the increase in the value that could be distributed to shareholders and that is generated by continuing operations only.
The more I read, the more I can understand investor scepticism when it comes to M&G, and reluctance to award it a “normal” earnings multiple.
M&G’s operations are split into “Savings & Asset Management” and “Heritage”, which consists of traditional with-profits funds and annuities.
Heritage is closed to new customers, but will continue to generate profits. It is “a stable and predictable source of earnings for a number of years in normal financial conditions”.
Heritage is not very interesting, but it was responsible for 61% of M&G’s adjusted pre-tax operating profit in 2019 (before accounting for central corporate costs).
In 2018, Heritage was responsible for 71% of the total adjusted pre-tax operating profit.
As Heritage continues to decline, M&G’s total profits will remain under continued pressure. Growth in the Savings & Asset Management business might not be enough to offset this.
One reason for this is that fee margins in asset management are under pressure, and rightfully so, as the widespread transfer to passive funds continues. M&G reports that its fee margin was 38bps in 2019, versus 40bps in 2018.
So would I invest in M&G at 7x earnings?
If I wanted income, I’d certainly consider it. The ordinary dividend is 12p, offering a monster yield.
In summary: M&G has poor or at least questionable growth prospects, but is priced to reflect that and offers huge payouts to those who want it.
- Share price: £10.62 (+8%)
- Market cap: £1,040 million
Future was recently the victim of a bear attack. Given this, and the state of markets more generally, it’s impressive that the shares are only down by around a third from their highs.
This update has helped: no impact is expected from the virus:
Given the continued momentum within the Group, the Board does not expect there to be an impact on profit for the year to 30 September 2020 and no impact on the following financial year.
A few events have been postponed – The Photography Show and The Homebuilding and Renovating Show, both in Birmingham (as a reminder, Future is a media group incorporating a wide range of websites, events and magazines). Future says their postponement won’t have an impact on profit.
Other smaller events will be affected by the virus too, but “their impact to the wider group is not material”.
It’s a very reassuring update. I guess when people are trapped indoors, they have more time to browse the internet and read magazines – which is not bad for Future!
- Share price: 363.75p (+2.6%)
- Market cap: £2.05 billion
This is the inter-dealer broker formed by the merger of ICAP and Tullett Prebon.
Headline results are a bit mixed:
- Total revenues up 1% at constant FX
- Broking revenue down 3% at constant FX: credit and equities weaker, energy and commodities stronger
- Institutional Services revenue up 21% at constant FX
- Data & Analytics revenue up 11% at constant Fx.
Operationally, the integration of ICAP is now complete and cost synergies have been achieved (TP bought it in December 2016).
The underlying operating margin is slightly lower for 2019 at 15.2% – not bad. FX rates are blamed for the reduction.
Underlying PBT for 2019 is £230 million, down 6% compared to the previous year.
I’m annoyed to see a huge discrepancy versus statutory PBT, which is only £93 million. This reflects “acquisition, disposal and integration costs, and exceptional items”.
The discrepancy was even bigger last year.
Broking is less interesting at the moment than Institutional Services, which provides buy-side clients “trade and venue selection, order routing and post-trade analytics across listed derivatives, FX, government bonds, cleared interest rate swaps and, as of December 2019, cash equities“.
It’s noteworthy that “non-banks” such as TCAP are becoming more influential in this kind of service.
Growth here was driven by “client demand in our core product offering in FX, listed derivatives, relative value execution and cleared interest rate swaps”. Sounds like there is scope for continued organic growth.
Data & Analytics also had a good year. This division provides “unbiased data products that facilitate trading, enhance transparency, reduce risk and improve operational efficiency”. This sort of data is incredibly valuable – and TCAP wants to accelerate the development of this side of the business.
Brexit – TCAP has a new company in Paris, TP ICAP Europe, to protect the continuation of European trading in the event of a hard Brexit. There are also three new EU venues, compliant with MiFID II.
TCAP is “prepared for all presently foreseeable outcomes”. Personally, I would be surprised if post-Brexit EU protectionism was so severe that TCAP lost out on business.
Moving to Jersey – while its tax domicile will remain in the UK, TCAP wants to use a new Jersey-based holding company for the entire group. This will “provide greater financial flexibility” and “improve competitiveness”. I wonder how?
Near term outlook – rather like the spread bet companies, TCAP might benefit from increased trading activity in turbulent times.
The overall macroeconomic backdrop remains uncertain driven largely by Covid-19, global growth and ongoing Brexit negotiations. While this environment impacts our clients’ activity, the resulting volatility also creates market opportunities that give us confidence for the future.
This might be worth a second look. If the exceptional and “non-underlying” costs can reduce from this year, then it starts to look cheap – financial software packages put this on a forward P/E multiple of just 11x.
A cheap business with a great track record of profitability is always interesting to me. It’s a shame that ROE/ROCE aren’t very exciting- but they’ll improve if profitability makes a step change next year, as promised.
Close Brothers (CBG)
- Share price: 1132p (-0.5%)
- Market cap: £1,710 million
These are uninspiring results which reflect “the consistent application of our business model in a period of lower activity in the UK economy, with lower profits in Banking partially offset by higher profits in our market-facing businesses“.
The “market-facing businesses” include asset management and Winterflood, the market-maker which many of you have probably traded with (perhaps unknowingly).
The bottom line is that this is another cheap bank/financial stock (P/E around 9x). Its return on equity is solid (16% according to its own calculations) and so I’d certainly want to own something like this before I invested in any of the high street banks.
That will do it for today.
The FTSE has given back its gains for the day, and is at 5980.
I have mixed feelings about this. I enjoyed seeing some of my paper losses go away this morning. On the other hand, I can remain a very enthusiastic buyer with fresh funds!