Stockwatch: Reassessing an old favourite

Our companies analyst made 200% profit and called the top of the market for this share. But what now? 

Is a £280 million all-share merger on AIM between Miton Group (LSE:MGR) and Premier Asset Management (LSE:PAM) driven by confidence – or more like a vital industry move, now that the bull market is fading and regulatory costs rising?

The formation of Premier Miton Group is so far chiefly propping Miton shares – up about 25% to 51p because the merger terms equate to 56.7p a share, including a 4.9p special dividend.  Meanwhile, Premier has drifted a few pence to about 168p and now back to its end-2018 low.

I've drawn attention to Miton various times on the buy and sell tack, including at 25p in January 2015, along a rationale that the maturing bull market would favour a specialist small cap equities manager and operational gearing boost its profits.  

This was verified by the table showing strong financial progress, although the stock wavered along the way, falling to 21p in mid-2016 then rallying to 76p by last October when I wrote it was time to lock in gains.  

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I haven't overlooked Premier on grounds it was less worthy, rather preferring to limit drawing attention to smaller fund managers given they can be more exposed if another financial crisis materialises.  Both these stocks falling back to where they started 2019, in line with fears for the global economy and domestic political chaos over a hard Brexit, shows it is hard to buck sentiment changes.  Moreover, I suspect it reinforced to the boards at Miton and Premier, a radical initiative is required.

On the face of it, a logical move

The combined group is expected to have £11.5 billion assets under management, revenue of about £76 million and pre-tax profit of £25 million after yielding £7 million cost synergies over three years (albeit a one-off cost of £10 million) by combining operating platforms.

Premier shareholders will be in two-thirds ownership.  The deal is promoted by "a compelling strategic and financial rationale" widening the product range, balancing it better between multi- and single-asset funds, achieving distribution synergies to sell those funds via complementary sales channels (Premier via IFA and online platforms, while Miton has strong contacts in wealth management) and greater scale to meet regulatory demands/costs instead of duplicating them. 

The hope has to be that there is no falling out at the top after positions get shared out between Premier and Miton directors, and the resulting culture means talent wants to stay (also join) not move away.  Such is always a risk with M&A in "people businesses". 

Miton's inflows have indeed consolidated

Last March when reviewing its 2018 results – earnings per share (EPS) soared 45% to 4.5p - I was wary that such momentum (helped by operational gearing) was sustainable:

"It's easy to fret, they represent the culmination of a 10-year bull market fuelled by central banks expanding balance sheets (now contracting) and a buoyant global economy (now in doubt)." 

Moreover, a 106% annual rise in net inflows over £1 billion had appeared to consolidate to ‘neutral' net flows for 2019 to date.  In July, Miton declared half-year closing assets-under-management up a respectable 8% during the period to £4.7 billion, however details of the release showed this chiefly due to rising markets.  Meanwhile, equity investors sat on their hands and multi-asset funds (sub 20% of total) saw a 9% outflow.

Quite whether calm before a storm or resumption of growth, only time will tell.

But, given listed companies are perennially expected to have growth initiatives, and it appears to me the consensus 2019 EPS forecast has softened to 4.1p from 4.5p achieved last year, management can hardly sit still.

My last call has recently been compromised

In March, I concluded Miton shares remained attractive at 58p given the cash generative nature of fund management (see the strong cash flow numbers in the table versus scant capital expenditure needs).  However, I underestimated the extent that small cap shares in particular are in the grip of market sentiment.

Miton rose to 62p in April but trended downwards thereafter as US/China trade tensions exploded, reaching 41p a few days ago where the implied yield was near 6%.  Although a short timescale, it's still saying Miton- as-it-stands, has run into challenges.  A radical revision of operating economics therefore makes good sense. 

Source: TradingView Past performance is not a guide to future performance 

Respecting how the environment and sentiment have changed however, no fund manager is likely to rebound soon.  I think broker Peel Hunt chooses its words carefully in saying that "assuming cost synergies are delivered, the scale of the group should help the rating of the enlarged group going forward."

Comparing price/earnings (PE) ratings, Miton and Premier both trade on forward multiples around 11 times, while £1.6 billion Jupiter Fund Management (LSE:JUP) is on 12 times with forecasts similarly expecting a modest slowdown in earnings this year.  And £0.9 billion Brewin Dolphin Holdings (LSE:BRW) is on 13 times as wealth management is expected more resilient than fund sales.

But recessionary fears mean a dour mood in financial stocks generally.  Jupiter and Brewin are priced for yields of 7.3% and 5.6% respectively, the market currently judging this as fair compensation for holding risks.

Let the merger bed down

I don't see this broad sentiment changing much in the near term and, with fresh money, it makes sense to see how the integration proves.  The market will quite likely suspend judgment until it sees results evolving, in terms of pricing for PE and yield.

The merged group's chairman, also chief executive, will transplant from Guildford-based Premier, the finance director being Miton's current chief operating officer in London – where group head office will be based - and non-executive directors will be a combination from both.  You’d hope they can avoid fireworks, but it may be wise to wait and see how this merger works for all employees.

Analysts at finnCap are enthusiasts for the deal, partly because it "mitigates key man risk" although unless Gervais Williams – the public face of Miton - fell under a bus he was unlikely to go elsewhere.  Owning nearly 9% of Miton as its managing director, he will be in charge of equity investment teams at the enlarged group.  I wouldn't regard Gervais seemingly not on the new board as a demotion, more like his sensibly focusing on stocks than plc issues, and, anyway, Premier will be in two-thirds equity ownership.

I'd also qualify this broker's claim about how enhancing fund distribution is "the golden rule for success in this industry": from a client perspective risk-adjusted fund performance is key, hence another reason to see how this pans out for the merged group. 

Yet, ultimately the crux for fund/wealth management stocks is people's appetite for the assets they offer, where sentiment is now cautious - and justifiably so.  I think patience may pay off here, with fresh money better-to-wait, while existing shareholders can take heart that the economics of fund management are being enhanced.  And, in the long run, it’s a nicely cash generative industry for dividends, with capital growth typically when markets rise. Hold.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.