Stockwatch: time to reconsider this litigation finance stock?

After a stock price slump, Burford Capital has been moving onwards and upwards – though two short sellers still target the firm.

Is it reasonably secure to consider reinvesting in Burford Capital (LSE:BUR), the AIM-listed litigation finance stock?

Its price slumped from about 1700p to 600p in August 2019 after short-seller Muddy Waters embarked on searing attacks of its accounting and corporate governance. 

The price managed to recover to 900p that November but drifted from early 2020, and the March sell-off saw it down from 600p, briefly below 300p. 

It has however since been in a steadily firm uptrend. Despite brief profit-taking after another rise following the 1 October interim results, the uptrend continues – yesterday up 9% to 690p and starting today around 700p.  

Buyers appear to be regarding the coast as clear, as if Muddy Waters has thrown in the towel since last criticising a January update. I suspect it is hard to argue with the results showing a jump in realised gains to $186 million (£143 million) in the first half. Moreover, including cash management and receivables (money due from successful cases), cash generation was $262 million.

Additional to such fundamentals, a dual listing in the US has been confirmed, with Burford due to start trading on the New York Stock Exchange from 19 October. 

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The sense is this is providing additional demand. Time will tell according to wider sentiment on Wall Street, but investors there are shrugging off the possible demise of Trump – embracing the prospect of a Biden administration with a $7 trillion debt-fuelled spending spree – as more than compensating for reversing Trump’s corporation tax cuts.  

A subjective element to profitability remains

Muddy Waters repeated – far louder and being wider in its critique – the concern I developed after initially drawing attention to Burford’s potential at 135p in April 2014. 

Management expanded its portfolio of cases aggressively, with cheap debt finance alongside equity raises. This helped reported profits soar, but a rigorous outsider was quite lost as to whether the strategy was genuinely accumulating value. A critic could say they were confusing the possibility enough cases would not pay out as hoped by ramping up the portfolio. Auditors are not in a position to judge expected case outcomes, hence there was no real external check. Burford was printing its own profits to some degree. 

The table shows a very high operating margin, although returns on equity and capital employed moderated to mid-teen and barely double-digit percentages respectively. The cash flow trend has been negative, usually a glaring warning sign if earnings purportedly soar. 

In March 2018 I cautioned about being too positive, as “it is difficult to pin down when many new case-investments are being made”. I was ridiculed as the stock soared on – breaching 2000p in August 2018. 

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But a year later the weight and aggression of Muddy Waters have smashed Burford’s halo. It has taken time for results reporting to show better disclosure plus consistent performance.

Bear in mind there will always be some opacity to profit. Also, the demand for greater transparency has made its financial statements an even more complex read.  

Cut to essentials rather than fret over detail 

I cut to the essentials: how at around 700p per share a capitalisation of £1.4 billion is a slight premium to £1.3 billion equivalent net asset value as of last June. 

While it is impossible to be sure of underlying value where legal cases are involved rather than hard assets, the premium is nothing like the multiple it was when the stock traded at 1500p to 2000p. 

Meanwhile the current environment of business disruption due to Covid-19 should now be conducive to higher levels of litigation. Burford flourished after the 2009 recession. 

Yes, many defendants will declare “force majeure,” but in enough situations claimants will have a genuine case and see virtue employing litigation finance – and let legal specialists drive the case - rather than tie up their precious capital and time.  

The lockdown did impact financial commitments to new cases by 74% to $195 million, and cash deployments were 42% down at $258 million. 

However, a cash position up 39% to $260 million positions Burford well to capitalise on this. Management says the litigation environment has stabilised, with the investment pipeline improving.

Source: Company REFS

Two disclosed short sellers still target Burford 

I am not sure quite what Gladstone Capital (NASDAQ:GLAD) is doing: its short position trading has seemed erratic, last edging up to 1.23% of the issued share capital as of 3 August. 

I have seen enough short sellers get badly cornered with conviction trades at the lower turning point of a stock’s fortunes, although the other disclosed one over 0.5% quite puzzles me. 

Kuvari Partners increased their short by 0.11% of the issued share capital to 0.63% as of 1 October i.e. in reaction to the latest results, which the market is interpreting positively. 

Kuvari is astute, having foreshadowed the need for Kier Group (LSE:KIE) to raise capital two years ago. It initially disclosed a 0.54% short position in Burford last 4 February when the stock traded at 690p (but might have begun shorting at higher prices).

It then raised this to 0.82% as of 9 March but has since trimmed back, as if this is more a trading position than serious conviction.

In early trading today the stock reached 710p, before settling back around 700p. Personally I would not want to be short in what appears a new bull phase, both on fundamentals and the chart, despite empathising with parts of Muddy Waters’ critique.

Consensus looks for resumption of growth in 2021

For what brokers’ views are worth – most likely reflecting a chief financial officer’s guidance – the sense is for earnings per share (EPS) of over $130 in 2021 after a dip to $85 this year. 

That equates to EPS of about 100p after two years of decline, hence a low prospective price-to-earnings (PE) ration of 7x, which is attractive relative to so many overvalued growth stocks nowadays.  

The dividend payout is also projected to re-rate to 43 cents per share in 2021, and though I would take that with a dose of salt it would imply a prospective yield of 4.7%, thrice covered by earnings. 

I incline to think the market got over-enthusiastic towards Burford, then quite similarly jaundiced, but a steady-state view recognises genuine scope for litigation finance.

It also has an international dimension, where Burford is particularly strong, with offices in the Far East besides the US and London. The directors were justifiably rapped on aspects of accounting opacity and a cosy board. Yet the situation is moving onwards, and I suspect upwards, again.

There is easily a chance that US investor sentiment destabilises again in the short term, if President Trump suffers a resurgence of Covid-19 – next Monday being the crux, relative to when he first tested positive. 

But the US market appears now to be embracing the prospect of a Biden majority. Burford’s joint US listing could therefore indeed prove well-timed. ‘Buy’. 

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