Record: High Margin, High Yield… And High Time New Clients Were Found

21 November 2016
By Maynard Paton

Quick update on Record (REC).

Event: Interim results for the six months to 30 September 2016 published 18 November 2016

Summary: If nothing else, REC’s results are consistent — once again this specialist currency manager revealed stagnant financial progress, a lack of new business and a dependence on a handful of major clients. Nevertheless, the group sports high margins and cash-flush accounts,  while the P/E could be as low as 7 thanks to the weaker GBP. Talk of potential special dividends unfortunately remains talk for now, but at least the ordinary payout yields 5.2%. I continue to hold.

Price: 32p
Shares in issue: 221,380,800
Market capitalisation: £70.8m
Click here for all my previous REC posts

Results:

rec-hy17-results

My thoughts:

* It appears $800m of client money was not earning any fees

REC used these results to amend how it discloses its effective assets under management (AUMe).

The group introduced ‘Multi-product’ as a new product classification, which covers clients whose mandates involve both currency hedging and “return-seeking” components.

What’s interesting is that client AUMe was previously declared at $55.8b, but under the new disclosure the figure is now $55.0b:

rec-hy17-aume-disclosure-change

REC claimed that Multi-product mandates are “generally remunerated on a different basis… and hence are not readily attributable into their component parts for AUMe and fee rate purposes.

The group added: “The new product category recognises such mandates separately and seeks to maintain the link between average AUMe and average fee rates for all product categories going forward.

However, deep in the small-print REC did admit (my bold).

AUMe for the Multi-product classification will be based on the chargeable size of those mandates, in order to maintain the clear link between AUMe, fee levels and management fees.”

So it appears that the $0.8bn reduction may be due to certain Multi-product AUMe not earning any fees.

Given REC’s stagnant financial performance throughout the last five years, I suppose I should not be too surprised to learn some AUMe was not generating any income.

At least this change to AUMe disclosure does not affect REC’s revenue or profit — past or future.

* Here are my fee-rate calculations 

REC’s first- and second-quarter updates had already indicated these results would not be spectacular.

Reported revenue gained 7% and operating profit jumped 23% — albeit due entirely to foreign-exchange movements and investment gains.

Excluding those non-trading items, underlying client fees fell 3% to £10.6m while underlying operating profit slipped 2% to £3.5m.

The lack of positive progress was due to clients withdrawing higher-margin Dynamic Hedging mandates, which could not be shored up completely by the extra money arriving into the lower-margin Passive Hedging strategy.

REC stated that its client fee rates had held up:

rec-hy17-fee-rates

 

But my own fee-rate calculations differed to those that REC presented.

Taking the average AUMe for each product classification, and the average £1:$1.37 exchange rate seen during the six months, I arrived at the following rates:

6 months to 30 Sept 2016Average AUMe ($m)Management fee (£k)Fee Rate (bps)
Currency for Return75046917.1
Dynamic Hedging5,9002,59612.1
Passive Hedging44,5005,6133.5
Multi-product2,6001,90720.1
Cash and other20000.0
TOTAL53,95010,585-

The differences may look small, but they do carry a sizeable impact on REC’s possible earnings. More on that a bit later.

* All strategies showing positive returns 

REC’s main profit-seeking strategies all reported positive performances during the first half, and are all now showing positive returns since inception:

rec-hy17-strategy-returns

If these positive returns can be sustained during the second half, the current year will be the first since 2013 during which all of REC’s strategies will be able to boast a successful year.

(I note REC’s underwhelming Currency Alpha product was closed during the half).

The positive returns — plus the implications of Brexit on currency markets — has apparently prompted a few extra discussions with potential clients:

We have seen a growing level of new business discussions, in particular towards the end of the period.  

This can be attributed to marked currency volatility on the one hand, and positive performance across all return-seeking strategies on the other. 

There is a welcome degree of diversification in the objectives clients are looking to meet.  Client and consultant engagement ranges across passive hedging, active hedging and return-seeking objectives, and in some cases combinations of these.  

This is the case across our core markets of the UK, continental Europe, and North America, and in markets we are exploring such as Australia.”

One day I trust the planets will finally align and REC will enjoy a notable influx of money from a broad spread of new clients. The last time such an influx occurred was 2007/8.

* No sign of a special dividend just yet

I can’t fault the fundamentals of REC’s accounts.

In particular, the H1 operating margin was an impressive 33%.

Cash conversion also remains terrific, with this half-year once again witnessing very modest sums spent on tangible assets and working capital.

Cash now stands at £36.1m, which after regulatory capital of £8.5m and third-party-owned investments of £4.2m comes to £23.4m or 10.6p per share. The balance sheet carries no debt and no pension complications.

Sadly there was no sign of REC returning any of its chunky cash pile to shareholders.

Back in June the group had said:

“The Board intends to continue its pragmatic approach; however it now considers the Group’s balance sheet and regulatory capital buffer sufficiently strong to support the consideration of returning at least part of any excess of future earnings per share over ordinary dividends to shareholders, potentially in the form of special dividends.”

But the narrative in this H1 statement simply declared:

The Board will also give consideration to returning at least part of any excess of the current year’s earnings per share over ordinary dividends to shareholders, potentially in the form of special dividends.

REC held the interim payout at 0.825p per share and projected the full-year dividend should be maintained at 1.65p per share.

* Two threats to future earnings

REC continues to be dependent on a small number of large clients (my bold).

“Account concentration risk has continued during the six months to 30 September 2016. The proportion of management fee income generated from the largest client was 14% for the six months ended 30 September 2016 (year ended 31 March 2016: 13%).  The proportion of income for the six months ended 30 September 2016 generated from the largest five clients was 58% (year ended 31 March 2016: 60%).”

Also worth considering are new regulations that involve “mandatory variation margin” — which I believe will require participants that use currency derivatives having to stump up extra collateral.

REC ominously used the term “committing significant resources” to cope with this new rule (my bold):

“Regulatory change continues to be a major theme in the foreign exchange markets.  This half year saw the first implementation of mandatory variation margin rules amongst bank counterparties, with the effects on our clients expected to be felt from the first calendar quarter in 2017.

As previously reported, we continue to be frustrated by differences in rules across jurisdictions.  We are nevertheless committing significant resources to managing the impact of these rules on our clients, and to seeking to mitigate any adverse consequences for our business.

In doing so we are also continuing to explore ways we can generate new business opportunities from these changes, by broadening our product offering in collateral management and in cash management more widely.”

Valuation

Using my own fee-rate calculations and the latest AUMe, I reckon potential management fees could now be running at £23.7m with £1 buying $1.24:

Year to 30 Sept 2017 (est)AUMe ($m)Fee Rate (bps)Management fee (£k)
Currency for Return90017.11,244
Dynamic Hedging5,70012.15,542
Passive Hedging45,6003.512,710
Multi-product2,60020.14,213
Cash and other2000.00
TOTAL23,709

These H1 results did not highlight any changes to costs, so I’m using the expenses I calculated in June:

Year to 30 Sept 2017 (est)
Management fees (£k)23,709
Less staff costs (£k)(6,800)
Less other costs (£k)(4,616)
Less 30% profit share (£k)(3,668)
Operating and pre-tax profit (£k)8,605

After standard 20% tax, my latest sums suggest earnings could be £6.9m or 3.11p per share.  Just before Brexit I was forecasting 1.88p per share  — which just goes to show the effect the weaker GBP may recently have had on translating REC’s substantial non-GBP income.

(Had I used REC’s own fee-rate figures, my sums would show management fees at a hefty £26m and earnings at a somewhat outrageous 3.72p per share.)

REC’s market cap at 32p is £70.8m, which adjusting for my aforementioned surplus net cash and investment figure of £23.4m gives an enterprise value (EV) of £47.4m or 21p per share.

Dividing that EV by my 3.11p per share earnings guess gives an underlying P/E of just 7.

Even if you assume all of REC’s cash is not surplus to requirements — and I must admit, the fact REC continues to hoard cash might suggest it is all needed to reassure clients — then the P/E remains modest at about 10.

Meanwhile, REC’s anticipated 1.65p per share dividend supports a 5.2% income.

Maynard Paton

Disclosure: Maynard owns shares in Record.

5 thoughts on “Record: High Margin, High Yield… And High Time New Clients Were Found

  1. Tabhair

    Congratulations, it looks like the market has finally started to see the value here. I had bids of 25p in for this one a few months back and got no shares at that price. I should have just paid up. The strong balance sheet and good cash generation give you some nice downside protection. Notwithstanding the stabilisation of the business, what is potentially interesting though is that there might be some potential rocket fuel under this one as well.

    You were speculating in your original post on whether the Currency for Return business might be coming back? With treasury yields spiking and a US rate hike inevitable this December, I imagine we are closer to this now than at any point in the last 2 years. It’s speculation naturally, but if I plug a $10b AUM for this business into your model, management fees balloon thanks to the operational gearing that’s inherent here. If we ever get to that position, remember my post and don’t sell too cheap, because you’ll have the momentum people piling in at that point! :)

    Reply
    1. Maynard Paton Post author

      Hello Tabhair,

      Thanks for the Comment.

      Yes, the price has risen of late. I think that is more to do with the weaker GBP and its effect on REC’s earnings, than any re-rating of the business.

      I think any of my past speculation about Currency for Return coming back is somewhat idle speculation :-) The division has been in the doldrums for years and client numbers are currently at a low of 11. Still, this could always be the bottom.

      There has been some life in currency markets during the last two years, with the CHF losing its EUR peg, the first US rate hike last year, and now Brexit. I think we will always be closer to the ‘great turning point’ for REC, but just how long we will have to wait is hard to say. In the meantime we can only hope REC’s larger clients do not jump ship.

      That said, REC’s currency strategies are all showing positive returns and the management narrative suggests growing interest in the group’s services. So there is hope that high-margin client money can be secured soon.

      Do not worry, if REC ever gets $10bn AUMe for Currency for Return, then I will be sure to remember your post!

      Maynard

      Reply
  2. Maynard Paton Post author

    Record (REC)

    Q3 Trading Update:
    http://ir.recordcm.com/regulatory-news-item.asp?newsid=2238697

    There were no major developments reported during the three months to 31 December 2016.

    Total effective client assets under management (AUMe) advanced by $1.6bn to $56.6bn, but in sterling terms gained £3.4bn to £45.8bn.

    At least clients decided once again to place extra money with REC —- this time they deposited the equivalent of $2.2bn during the quarter. Client numbers advanced by 3 to 64 to a fresh six-year high.

    However, today’s statement did admit:

    Since the end of the quarter, notice has been served to terminate mandates in respect of six associated Passive Hedging clients representing $0.7 billion AUME with effect from 30th January 2017, and also in respect of one Dynamic Hedging client representing $0.3 billion AUME, with timing to be determined.

    Although the mandates concerned are not too significant, it’s such a shame REC continues to lose business.

    Indeed, even though the management narrative in the statement said this:

    Such volatility and uncertainty in [currency] markets continues to provide opportunities for Record to discuss both its return-seeking and risk-reducing products with current and potential clients.

    …it seems clients are still happy to jump ship. Just when will REC decisively add new clients while at the same time keep its old ones?

    Anyway, I have adjusted the declared AUMe for the withdrawals and, assuming fee rates remain the same as those noted in the Blog post above, and using £1:$1.23, then:

    * Currency for Return AUMe of $1.0bn gives fees of £1,393k;
    * Dynamic Hedging AUMe of $5.8bn gives fees of £5,685k;
    * Passive Hedging AUMe of $45.6bn gives fees of £12,813k;
    * Multi-product AUMe of $3.0bn gives fees of £4,902k;
    * Total fees = £24,792k

    Less my guesses of £6,800k for staff costs and £4,616k for other costs as noted in the Blog post above, then less the 30% profit share (of £4,013k), I arrive at an operating profit of £9,364k. Taxed at 20% gives earnings of £7,491k or 3.38p per share.

    With the share price at 39p, the EV is 28p per share and my cash-adjusted P/E comes to 8.4. That 8.4x multiple assumes REC’s cash pile is surplus to requirements.

    I mentioned in the Blog post above that perhaps all the cash is needed to reassure clients and therefore is not surplus to requirements. If the cash is needed, then the possible multiple rises to 11-12.

    At least my 3.38p per share guess easily covers REC’s anticipated 1.65p per share dividend, and can now probably fund a special payout that the group has mentioned within its recent results. A 1.65p per share payout offers a 4.2% income at 39p.

    All told, the elusive wait for some substantial client wins continues for at least another three months.

    Maynard

    Reply
  3. Maynard Paton Post author

    Record (REC)

    Q4 Trading Update:

    This update was a tad disappointing, with client withdrawals — some previously announced, some not — emphasising how this business continues to tread water at best.

    Total effective client assets under management (AUMe) advanced by $1.2bn to $58.2bn during the 3 months to 31 March 2017, and in sterling terms gained £0.8bn to £46.6bn.

    The preceding Q3 update had admitted:

    Since the end of the quarter, notice has been served to terminate mandates in respect of six associated Passive Hedging clients representing $0.7 billion AUME with effect from 30th January 2017, and also in respect of one Dynamic Hedging client representing $0.3 billion AUME, with timing to be determined.

    This Q4 update said:

    During the quarter, six associated Passive Hedging clients representing $0.6 billion AUME terminated, and one client reduced its Multi-Product mandate by $0.9 billion. The impact of these AUME reductions was offset by a new Passive Hedging client (+$0.2 billion) and inflows of +$0.8 billion to existing hedging mandates. Record has been notified of the termination of a Passive Hedging mandate of $1.2 billion expected during the current quarter.

    It appears the six Passive Hedging clients with $0.7bn AUMe did leave, but took $0.6bn. Meanwhile, the Dynamic Hedging client representing $0.3bn AUMe who was planning to leave “with timing to be determined” is still to leave.

    Sadly this Q4 update revealed a Multi-Product client has also withdrawn $0.9bn AUMe, and a $1.2bn Passive Hedging mandate is about to disappear as well.

    At least an extra £1.0bn AUMe of Passive Hedging money was placed by clients during Q4, although Passive Hedging is by some distance the group’s lowest-margin division.

    As I wrote three months ago, it’s such a shame REC continues to lose business.

    Indeed, even though the management narrative in this Q4 statement claimed:

    The environment of political uncertainty that has prevailed since the middle of 2016 looks set to continue… This backdrop continues to support discussions on how Record is able to assist clients and potential clients in achieving their investment objectives. As a result good engagement continues across Record’s diversified range of strategies.

    …it seems clients are still happy to jump ship. As before, just when will REC decisively add new clients while at the same time keep its old ones?

    Anyway, I have adjusted the declared AUMe for the withdrawals (including potential and prospective) and, assuming fee rates remain the same as those noted in the Blog post above, and using £1:$1.28, then:

    * Currency for Return AUMe of $1.0bn gives fees of £1,339k;
    * Dynamic Hedging AUMe of $6.0bn gives fees of £5,651k;
    * Passive Hedging AUMe of $47.0bn gives fees of £12,690k;
    * Multi-product AUMe of $2.5bn gives fees of £3,925k;
    * Total fees = £23,605k

    Less my guesses of £6,800k for staff costs and £4,616k for other costs as noted in the Blog post above, then less the 30% profit share (of £3,657k), I arrive at an operating profit of £8,533k. Taxed at 19% gives earnings of £6,911k or 3.12p per share.

    With the share price at 40p, the EV is 29p per share and my cash-adjusted P/E comes to 9.4. That 9.4x multiple assumes REC’s cash pile is surplus to requirements.

    I mentioned in the Blog post above that perhaps all the cash is needed to reassure clients and therefore is not surplus to requirements. If the cash is needed, then the possible multiple rises to almost 13.

    At least my 3.12p per share guess continues to easily cover REC’s anticipated 1.65p per share dividend, and can now probably fund a special payout that the group has mentioned within its latest results. A 1.65p per share payout offers a 4.1% income at 40p.

    All told, the elusive wait for some substantial client wins continues yet again for at least another three months.

    Maynard

    Reply

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