Cube Midcap Report (10 Oct 2019) – Hargreaves Lansdown still has it #HL #DNLM #SBRE

Cube Midcap Report (10 Oct 2019) – Hargreaves Lansdown still has it #HL #DNLM #SBRE

Good morning! It’s Roland here with the Midcap Report.

On my list for today are:

  • Hargreaves Lansdown (HL) – trading update from the retail broker, which scrapped client exit fees in the wake of the Neil Woodford fund suspension
  • Dunelm (DNLM) trading update from this resurgent FTSE 250 retailer
  • Sabre Insurance (SBRE) – trading update from this FTSE 250 motor insurer, which earns above-average margins from high-risk drivers.

This report is now complete (11.15).

Hargreaves Lansdown (HL)

  • Share price: 1,800p (-1%)
  • Market cap: £8.6bn

Trading statement

FTSE 100 retail broker and fund supermarket Hargreaves Lansdown was a long time cheerleader for fund manager Neil Woodford.

The firm was seen by some as slow to act when problems emerged at Mr Woodford’s Equity Income fund. HL did not remove the fund from its best buy list until after trading was suspended, leaving retail investors unable to exit the fund (a situation that continues).

There was speculation that the firm would see a client exodus in the wake of these events. However, today’s trading statement suggests that these concerns were overblown.

Q1 highlights: Hargreaves added 35,000 new clients during the three months to 30 September, taking its total to 1.26m. This represents an increased rate of growth from the same period last year, when the firm signed up 29,000 new clients.

Net new business during the period totalled £1.7bn, while assets under administration rose by 3% to £101.8bn. Again, this is an increase on last year, when the equivalent figures were £1.3bn and £94.1bn.

Net revenue for the period rose by 6% to £128.1m.

It’s probably worth pointing out that this year’s performance was boosted by a £900m back book transfer from J. P. Morgan and Baillie Gifford. This adds to £1.2bn of transfers logged by the firm last year.

Without these wholesale transfers, my guess is that growth would have looked a bit more pedestrian.

Indeed, chief executive Chris Hill warns that “weak investor sentiment” is hitting new business. All the usual suspects are blamed — Brexit, macro uncertainty and the US-China trade war.

My view: Hargreaves’ recent decision to scrap exit fees on its accounts has put it ahead of several major rivals and could help to make it more attractive to new clients.

There was no mention of Woodford in today’s statement and I don’t have a clear feeling for how significant this fund is in the context of the group’s 1.26m clients and £102bn AUA. However, I suspect that the passage of time will dilute any eventual impact from this fiasco.

In the meantime, HL remains the clear market leader and a highly profitable business. Management say that after two years of investment in staff and services, spending will slow over the coming year to reflect the rate of growth.

I note that Reuters consensus forecasts indicate that the group’s dividend is expected to rise by c.40% to 46.7p this year, lifting the yield to 2.6%.

With its large scale and steady growth, I can see HL re-rating to become an attractive dividend stock. However, I’m not sure we’re quite there yet. Given the uncertain outlook, I don’t see any need to rush in. I plan to maintain a watching brief for now, but could be tempted if the stock falls below 1,500p.

Dunelm (DNLM)

  • Share price: 767p (-6%)
  • Market cap: £1.6bn

Trading update

This homeware retailer has staged a — to me — impressive recovery over the last year or so. However, the shares have kept pace and today’s more cautious update has triggered a modest sell-off, despite continued LFL growth.

Checking back through the archives, I see that I last covered Dunelm in June. With hindsight, we can see that this may have been a high watermark for the shares, which have fallen by about 20% since then:

DNLM 1yr chart 101019

Source: Google Finance

Is this the start of a weaker period, or simply a case of froth coming off the retailer’s valuation?

Let’s take a closer look at the numbers for any clues.

Q1 highlights: Today’s figures show LFL store sales up by 2.9% during the three months to 28 September, with LFL sales including online up by 6.4%. Here’s how the numbers break down:

DNLM 1Q20 results

Checking back to last year’s results, we can see that the pace of improvement has slowed significantly. LFL store growth of 2.9% in Q1 is a big reduction from the rate of 10.9% seen during the second half of last year.

Reassuringly, online growth has remained stable at 35%. It’s also interesting to note that Dunelm is about to roll out a new website which it expects to launch before Christmas. Assuming this launch is successful, it could reinforce the firm’s strong online performance.

Gross margin rose by 1.3% during the first quarter, but the company expects overall margin performance to be flat this year due to FX headwinds.

Full-year guidance is left unchanged. Based on consensus forecasts, this suggests that earnings per share will rise by about 3% this year.

My view: I continue to see this as a high quality retailer. The company refers to itself as a specialist and it’s probably fair to say that it has few direct competitors on this scale (although Next Home springs to mind).

However, after last year’s strong recovery, growth appear to be returning to more typical levels for a large, mature retail business. Chief executive Nick Wilkinson also sounded a note of caution today, warning of softer market conditions in September.

I expect free cash flow to remain strong and could be tempted by the group’s 4.6% dividend yield. However, with the shares trading on more than 15 times forecast earnings I feel the shares are probably fully valued at current levels. I wouldn’t be surprised to see some further weakness over the coming months.

Sabre Insurance (SBRE)

  • Share price: 280p (-1.6%)
  • Market cap: £700m

Trading update

Sabre Insurance specialises in high-risk drivers such as boy racers, who attract very high insurance premiums.

Q3 highlights: I covered this stock in July and remain impressed. Today’s update confirms that management expect to achieve a combined ratio for this year of “slightly better than its mid-70%’s target”.

I explained combined ratios in more detail in July, but in short a lower figure is better, as it indicates a greater surplus from premium income after paying for claims and operating costs.

What’s impressive here is that an insurer competing in a tough market is able to remain so profitable. Most mainstream motor insurers are targeting combined ratios in the high 90%s this year.

As I commented in July, Sabre’s specialist focus and its pricing discipline appear to enable the firm to deliver impressive profits.

However, pricing discipline has affected volumes. Gross written premiums (GWP) for this year are expected to be 7% below last year’s figure of £210m. Broker forecasts suggest that this should result in a flat adjusted profit performance for the year.

Although claims inflation is said to remain high, CEO Geoff Carter says that recent regulatory changes have been reflected in competitor pricing. Mr Carter says that Sabre has been able to raise prices accordingly without suffering any further hits to volume.

My view: I see this as an income stock and would be seriously tempted if I didn’t already have a sizeable shareholding (for me) in mainstream rival Direct Line.

In today’s update, the company confirms that capital generation remains strong and should support “an attractive full-year dividend”. Obviously this is in lieu of growth, but as an income investor that wouldn’t bother me. Brokers are forecasting a full-year payout of 20p per share, giving a 7% yield.

My main concern remains that Sabre’s profitability will attract more competition, driving down margins. However, the firm has a long track record in this sector. Perhaps I’m underestimating the company’s specialist expertise? Maybe underwriting high-risk drivers is difficult niche in which to operate profitably.

I’d be interested to hear from readers with knowledge of this sector. But in the absence of evidence to the contrary, I continue to view Sabre Insurance favourably at current levels.

That’s all for today, thanks for reading.



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