Panmure Gordon & Co - Sector Discount Justified?

http://www.panmure.com/


With markets still trading near multi-year highs, it has been a good few years for stockbrokers. They have benefited from a raft of new initial public offerings (IPOs) and from the ability to raise funds for companies at attractive prices, meaning an uplift in top-line growth across the sector. Since stockbrokers are market-cyclical, it makes sense that most have advanced significantly over the past year in particular - however, that is not the case right the way across the board. Panmure Gordon (LSE:PMR) has underperformed its peers comfortably as a result of restructuring impacts, but also as a result of a lack of market awareness. Shares in the company currently change hands at 159.5p, which, with 15.55m shares in issue, values the company at £24.8m. Is the discount to the sector justified?


The technical picture over the past few years clearly shows that Panmure has failed to make meaningful progress despite very strong equity markets, and a return to economic growth. That has not been helped by a lack of liquidity, although liquidity has recently tightened up, most probably as a result of a stock overhang. Indeed, it was possible to purchase shares today below 160p, compared to the 159.5p mid-price. The likelihood of a share overhang was seemingly confirmed after the close of trading, as there were several large sell trades processed - for example, there was a sale for £227k, which explains the capped movement today despite healthy buying pressure. Whilst that is an issue, it will most likely be cleared in the short-term and pave the way to a recovery.

Whilst there are not material director shareholdings, a significant proportion of shares are held by institutions. QInvest (A major Qatar investment bank) holds over 43% of the issued share capital, with the Panmure Benefit Trust holding 7.6% and making fairly regular purchases. Four other notable institutions collectively hold around another 23%. A seller in the market is almost certainly one of the four other institutions (or a non-notifiable party) rather than QInvest or the trust. Before discussing the fundamentals of Panmure, it is important to recognise the sector performance, as that is likely to be a key factor in identifying potential upside. Indeed, I have chosen four comparator companies for this task: Arden Partners (LSE:ARDN), Cenkos Securities (LSE:CNKS), Numis Corporation (LSE:NUM) and WH Ireland (LSE:WHI). While there exist other companies within the sector, such as Charles Stanley, Canaccord Genuity and Shore Capital, the four chosen are the closest peers.

The chart on the right shows the relative performance of the companies over the past three years. As shown, Panmure has significantly underperformed its peers as it struggled to re-build profitability post-crisis unlike the other companies. However, as will become clear later, that is on the brink of changing. The strong price performances do show that investors are bullish on the sector, and in particular, Cenkos Securities has advanced strongly as it has guided towards beating market expectations numerous times - as it stands, Panmure has no market expectations, thus has no targets to surpass. Importantly, if Panmure's share price starts to gain traction, then it is easy to see investors in other peers transfer some of that cash back towards Panmure. On many metrics, it is the more undervalued option.

As per the activities of most large stockbrokers, Panmure's activities can be split up into two sections. The first is operating as a corporate and institutional stockbroker - this commonly includes IPO advisory and setup plus fundraising assistance and corporate advisory services.  The second is operating certain sales and trading investment banking activities - this involves the creation of research documents for clients and also 'market-making'. The nature of these operations differs with research document creation, corporate advisory and market making being three examples of highly recurring revenues, whereas IPO formation and certain large-scale fundraising schemes are not recurring. The latter two activities involve Panmure assisting with IPOs and then taking a small percentage as fees. All the work is done via staff, hence it is a labour intensive industry, and strong management is required. The company has offices in London, Liverpool and Leeds within the UK and has been operating since the late 19th Century.

Panmure itself has a very strong brand within the city, as it covered 130 clients in 2013 (versus 96 in 2012). Whilst that represents strong growth, the issue that Panmure has is that many of the clients are small in size, hence are less likely to generate significant revenues for the group. There are consequently two options for further building the business - to either focus upon higher market cap companies or to build a wider portfolio of small cap companies. In reality, it is a combination of the two strategies that is being followed, but the market is highly competitive so winning large clients is very difficult, especially since companies do not change brokers particularly frequently. New IPOs are met with a raft of broker pitches, and winning those clients is often difficult, especially for companies who do not necessarily have a track record of recently winning large clients. However, what is key is that Panmure is good at what it does - providing a high-quality service to its predominantly small cap and medium cap client base and that is reflected in the company's winning of the 2013 Small Cap Adviser of the Year award.

Of course, the core business is highly dependent upon the stock market and associated sentiment, hence why I described it as being market-cyclical earlier. When the market is strong, stockbrokers tend to perform strongly, and vice versa. Therefore you need to form an opinion on where the market is going to be able to confidently invest in the sector. Whilst that is not cast iron in Panmure's case (as I will detail later), it helps to be bullish on equity markets in general. Indeed, with a positive market backdrop it is hard to see UK equities falling back materially barring an external catalyst. Even in those circumstances, it is easy for retail investors to move ahead of major institutions and sell off those market-cyclical holdings if required.

In particular, I repeatedly point to the woeful performance of the mining sector, and recent lofty valuations being checked as being indicators that the market has not yet reached its high. The IPO and fundraising markets in particular have been hot, and I expect that to continue (especially the latter). To name a few examples, Panmure has participated in the IPOs of Kromek Group (LSE:KMK), MartinCo (LSE:MCO) and Eclectic Bar Group (LSE:BAR). These are all relatively small companies, but two of three are now comfortably above their IPO price, with Kromek less than 10% below. On the placing front, the company has successfully helped Faroe Petroleum (LSE:FPM), Johnson Press (LSE:JPR) and RPC Group (LSE:RPC) all raise significant amounts of cash over the first half of the year.

In the wider context, the IPO market still remains buoyant, although a few IPOs have been pulled in recent months. Over 2013, near to £3.9 billion was raised in AIM versus £3.1bn in 2012 - a material rise - and 2014 has started along the same lines with plenty of new listings making their way to the markets. AIM has continued to see a range of new listings from across the globe despite major recent weakness, and that bodes well for the future. However, other market participants have claimed that the IPO market is cooling and that the market will start to fade away. Is that really the case? In truth, a lot of the IPOs this year have been very poor value for their price with Boohoo, Just Eat, AO World and Pets at Home four examples that can immediately be listed off without much thinking. Each of these has fallen below their closing price on the initial day of trading, and it is fully justified. These companies were brought to market by private equity firms on ludicrously lofty valuations, and the market is sane enough to have seen through the inflated valuations. That itself is an indication that the market is not running away with itself. It remains the case that there is plenty of appetite if firms IPO on an attractive (or even fair) price, but many have listed on inflated valuations that were simply not going to attract enough investors. I therefore remain bullish on new listings and the move by UK giant AA to list on the main market is testament to that.

So where does Panmure sit in this recovery? The company has actually being undergoing a recovery of its own, and that is clear in the last two years' results. The change has been assisted through CEO Phillip Wake joining the company in 2012, and the eventual disposal of a loss-making US-based subsidiary. Along with the use of cash injected by QInvest when it took a large stake in 2009, the company managed to win further mandates and grow its client list over the past two years, which assisted in the company being able to raise more than £1.4bn for its clients in 2013 versus £373m in 2012.

As per the table above, revenues from continuing operations have grown rapidly over the past few years on the back of improving equity markets. That said, as it a theme for stockbrokers, who often tend to have plush offices in expensive locations, administrative costs are high and offset the vast majority of gross profits. A large part of the cost base is therefore fixed hence operational gearing can be prone to kick in, assuming that performance-related bonuses are not extreme. In Panmure's case, although admin costs are high, operating profit over £1m was achieved in 2013 for the first time in many years. There also appears to be a decent CEO incentivisation scheme whereby an increasing number of options vest at high pre-tax profit figures for the group in 2014 and 2015, but where none vest if pre-tax profits are only moderate.

Of the headline numbers, net commission and trading income (recurring) constituted £9.8m in 2013 versus £9.1m in 2012 and corporate finance and other fee income rose to £18.1m in aggregate, versus just over £12m in 2012. Operating profits for 2013 came in at £1.15m after share-based payments, which are probably best to include given that the business is reliant upon its staff. After tax, that fell to £832k. Despite that decent figure, it was further obscured by a £627k loss from discontinued operations, which can be categorised as exceptional and stripped out. Therefore, adjusted diluted EPS puts the company on a trailing price-earnings ratio (PER) of 30.2. That is hardly appealing, and most certainly is not cheap compared to other companies in the sector. There were other exceptional costs to account for though, which essentially means that the historic view of Panmure is not an entirely accurate assessment of future potential. However, 2014 will deliver a step-change in that department.

What bolsters the investment case in Panmure is the rock-solid balance sheet, which it is very difficult to find holes in. Net assets for the group total £31.48m, but that includes intangible assets that are worth excluding, yet net tangible assets still amount to £18.3m. Putting that into perspective, net tangible assets alone cover nearly three-quarters of the market cap. That provides excellent downside protection for investors and helps explain why the share price has been underpinned at current levels since early 2013. Within those assets, £6m is in cash with a further £11m in securities - there is also a material net receivables balance, so cash is not in short supply. It's interesting to compare Panmure's numbers to that of the four comparator companies using numbers, which are available.


As per the table above, Panmure is smaller than all of its comparators except Arden Partners who are valued at £18m. On the other hand, Panmure has had the worst one-year price performance by a substantial margin, rising just 14% whilst two comparators have managed triple digit rises and whilst Numis still rose by nearly a third - factoring in that Numis has only fallen recently as a result of weak indexes and that disparity is even more stark. The last current asset / total liabilities figure for Panmure stacks up well and is in-line with its peers, all who are well capitalised. Despite no earnings forecasts being available for Panmure, it is possible to construct these using figures announced by the company today. I shall cover that shortly. Lastly, Panmure covers a large number of corporate broking clients - 130 in total, but as mentioned, many of these are small hence don't generate sufficient revenues to offset the administrative costs. Note that the Cenkos forecast PER is shown as less than 15 as previous forecasts need to be updated in light of an 'exceeding market expectations' announcement.

The brighter outlook for Panmure was signalled initially in May when the company reported on "encouraging progress" and favourable market conditions. In addition, the company announced its plans to recommence dividend payments following a long break (last was during the crisis in 2008), and this could prove to be a catalyst in the future. "Since the start of the year, the Company has enjoyed strong growth in revenues in both the primary and secondary markets, in particular leading a number of high quality transactions for corporate clients. This has had the desired positive effect on profitability."

That profitability will ultimately boost net tangible assets further, providing yet additional backing to the current share price. Ultimately, it is profitability that will re-attract investors to Panmure. That is why the announcement today was vital. The company commented upon "significant growth" and investment across all business lines. Crucially, profit before tax for H1 alone is noted by the company to come in at approximately £1.8m, which is very significant compared to historic figures. Applying a 23% effective tax rate (to form a clearer underlying picture even though there is a deferred tax asset), we are left with £1.386m in post-tax profits for H1, and that equates to 8.9p/share in earnings. We can use this to form three basic pitchfork (high case, mid case, low case) forecasts for 2014.

Using a PER of 15 and a tax rate of 23%, a purely symmetric result for H2 would give a further 8.9p in earnings, or 17.8p for the full-year. That would mean the shares are trading on a PER of 9.0 currently and that a PER of 15 would extrapolate towards a price of 267p, which is appreciably higher than the current share price. I have penned the low case (conservatively) as being a £0.8m post-tax profit for H2, which would give a further 5.1p, or 14p for the full-year. That would mean the shares are trading on a PER of 11.4 currently and that a PER of 15 would extrapolate towards a price of 210p. I have penned the high case as being a £1.75m post-tax profit for H2, which would give a further 11.3p, or 20.2p for the full-year. That would mean the shares are trading on a PER of 7.9 currently and that a PER of 15 would extrapolate towards a price of 303p. Each of these scenarios is very favourable compared to the current share price and hints at there being an attractive opportunity for upside. Even factoring in an even more conservative PER multiple of 12 and using the same low case, mid case, high case markers, largely covers the current market valuation. Indeed, at current levels, it would not be unsurprising to see corporate action within the sector that involves Panmure, although the large stake of QInvest may act as a deterrent or a hurdle at the least.

I suggest that a price-earnings ratio of around 15 is suitable for Panmure Gordon, given that its balance sheet is particularly impressive and that it has a strong brand with a large client base. Whilst the CA/TL number is in-line with peers, Panmure's net tangible assets amount to around 74% of the market cap. That is higher than:
- 19% for Cenkos
- 41% for Numis
- 54% for WH Ireland
- 64% for Arden Partners
Combined with the boosted earnings numbers for 2014 and lack of price movement over the past year, a PER of 15 is credible in my view, especially if the company re-commences a dividend. The disparity between comparators is likely to narrow over the coming months, especially when the company posts its half-year results in September.

On the above basis, it is becoming increasingly evident that the company is succeeding with its turnaround plan, albeit on the back of a stronger stock market. Of course, there will always be concerns about the level of administrative expenses, but with a balance sheet that provides exceptional share price backing (plus growing earnings), there is scope for very material upside from current levels. The company is currently being valued at a low level relative to both forward earnings and asset backing, and that provides downside resistance from current levels, which means Panmure has a very good risk/reward at current levels. Unlike its peers, it has not yet re-rated significantly, but with an improving pipeline of opportunities and confirmation today of a much better profit performance, it appears that Panmure has finally turned a corner, even if it is many months later than its peers. I have therefore put a Buy tag on Panmure Gordon at 159.5p targeting 210p in the low-case scenario. The current sector discount is not justified.

UPDATE (08/10/14) - Despite the significant sector discount and balance sheet strength, the weak markets are likely to mean that H2 activity is subdued. For that reason, I have moved Panmure from Buy to No Rating at 140.00p for a circa 12% loss

3 comments:

  1. Fantastic review and it is nice to see some numbers put forward to value Panmure on. It has been like holding a dead rat for the past year. I agree with not allowing for tax losses but could that happen? I havent looked into it. A cautious approach is always advised

    IMHO, DYOR etc..

    Anon

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  2. Top notch :0). Panmure Gordon retweeted it :0)

    Solooiler

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  3. Net working capital is £17.2million (93.9% of market cap). They propose to recommend dividends next year. There is no debt. New ceo has driven the first decent profit in years though I'm sure there's risk that the performance might not be repeated in the latter half. I'm very tempted, but alas I'm an amateur unlike Elite. Price is now 117p, will see when the markets reopen :-)

    Thanks for this report el1te.

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