Numis: The Downsides To A Dividend Up 17-Fold

13 May 2015
By Maynard Paton

Today I’m continuing my hunt for Watch List shares with a look at Numis (NUM).

Here are the initial attractions that prompted this research:

Appealing accounts: Recent results showed high margins and net cash
Dividend history: The payout has advanced 17-fold since 1999
Owner management: The directors control 21% of the business

As usual, I’m applying a question-and-answer template to help me pinpoint companies that match the criteria set out in How I Invest. I’m looking for as many Yes answers as possible.

Activity: Institutional stockbroker and corporate advisor
Website: www.numiscorp.com
Share price: 250p
Shares in issue: 113,196,019
Market capitalisation: £283m

Does the business boast a respectable track record?

Sort of.

NUM was established in 1989, joined AIM during 1996 and initially provided a range of stockbroking services to both retail and institutional clients.

By 2000, however, the private-client division had been sold and the business has since focused on supplying industry research, corporate advice and share-trading services to City funds and quoted companies.

My financial archives for NUM stretch back to 1999, when revenues were £4.4m and operating profits were £1.5m. By 2014, however, revenues had reached £93m and operating profits approached £24m.

The growth rates over time have been impressive:

	5 years to 2014	10 years to 2014	15 years to 2014
Sales CAGR	18.5%	11.0%	22.6%
Operating profit CAGR	n/a*	7.5%	20.1%
Dividend per share CAGR	5.6%	17.5%	21.0%

(*n/a due to losses reported for 2009)

NUM’s record is not perfect, though.

The 2008/9 banking crash caused revenues to halve and profits to turn into losses:

Year to 30 September	2005	2006	2007	2008	2009
Revenues (£k)	65,693	72,209	87,592	51,437	39,687
Operating profit (£k)	27,617	31,467	35,691	3,680	(13,228)
Profit from associate (£k)	1,388	1,500	1,469	803	-
Exceptional items (£k)	9.299	(200)	(2,196)	5,854	(138)
Finance income (£k)	1,604	2,926	3,836	5,756	2,847
Pre-tax profit (£k)	39,908	35,693	38,800	16,093	(10,519)
Earnings per share (p)	31.3	25.3	27.5	14.9	(8.4)
Dividend per share (p)	3.2	5.0	7.0	7.5	8.0

The business then suffered a rough time during 2010, 2011 and 2012, but has since recovered strongly:

Year to 30 September	2010	2011	2012	2013	2014
Revenues (£k)	51,999	54,891	52,893	81,208	92,911
Operating profit (£k)	(474)	1,818	3,968	22,058	23,893
Exceptional items (£k)	-	(2,208)	-	-	-
Finance income (£k)	649	570	181	561	477
Pre-tax profit (£k)	175	180	4,149	22,619	24,370
Earnings per share (p)	(0.1)	(0.7)	3.2	16.9	18.7
Dividend per share (p)	8.0	8.0	8.0	9.0	10.5

The dividend has made resilient progress, with the payout marching from 0.6p to 10.5p per share between 1999 and 2014. Encouragingly, shareholders received a static 8p per share handout between 2009 and 2012 despite minimal earnings and losses.

Exceptional items from the last few years have related only to moving to a new head office.

Has the business grown mostly without acquisition?

Yes.

NUM has not bought a business outright since at least 1999.

I should add that the firm has acquired sizeable minority stakes in other businesses as investments, but my records indicate such expenditure last occurred in 2005.

Has the business mostly self-funded its growth?

Yes.

NUM has consistently operated without bank debt.

However, the group’s balance sheet does show total shareholder equity of £112m that is represented by retained earnings of £59m and share capital of £53m.

Usually, such a significant share-capital figure would indicate a business having raised large sums from outside investors to expand.

But in NUM’s case, the £53m is largely due to the purchase of its own shares to reward staff — the cost of which has been borne by the group’s own cash flow.

Still, the balance-sheet entries should prompt a double-check of the share count — and sure enough, the number of total shares outstanding has grown by 20% between 2004 and 2014 and by 59% between 1999 and 2014. In fact, the share count has risen every year since at least 1999.

Does the business possess an asset-strong balance sheet? 

Yes.

At the last count, net cash and surplus investments were £74m or 66p per share.

Does the business convert profits into free cash?

Sort of.

Year to 30 September	2010	2011	2012	2013	2014
Operating profit (£k)	(474)	1,818	3,968	22,058	23,893
Depreciation and amortisation (£k)	615	466	422	459	461
Cash capital expenditure (£k)	(148)	(313)	(433)	(192)	(282)
Working-capital movements (£k)	(4,731)	(7,435)	(5,200)	19,327	(1,951)

The last five years have seen relatively small amounts spent on capital expenditure alongside somewhat large working-capital fluctuations. Notably, the aggregate cash movements of NUM’s working capital give a cash-neutral result for the last five years.

However, reported profits become a little suspect when evaluating NUM’s expenditure on shares for staff.

You see, since 2010 the business has spent £37m on buying shares that will (or probably will) end up with employees, but the associated ‘share-based payment’ charge set against earnings for the same period comes to £29m:

Year to 30 September	2010	2011	2012	2013	2014
Operating profit (£k)	(474)	1,818	3,968	22,058	23,893
Share-based payment charge (£k)	7,313	6,978	5,591	4,494	4,575
Share purchases (£k)	(13,058)	(5,697)	(3,221)	(4,691)	(9,997)

The figures for the last ten years show a greater discrepancy, with actual share purchases of £62m versus ‘share-based payment’ charges of £36m.

Within its results, NUM presents ‘adjusted’ earnings that ignore the share-based payments and the associated tax. This to me is highly cavalier reporting — those share-based payments reflect a true (and substantial!) cash cost to shareholders!

Does the business enjoy a competitive advantage?

I don’t think so.

True, NUM will cite client service and staff expertise as differentiating the firm from its rivals. What’s more, operating margins were a cracking 26% during 2014 — indicating some operating strength.

However, it’s difficult to have that much faith in any sustainable NUM ‘moat’ when the banking crash caused a sizeable loss and depressed profits during the following three years.

My impression of NUM is that its profits simply look great in the good times (margins topped 40% during the 2005-07 credit boom), but then turn awful in the bad times when business dries up.

For what it is worth, the average operating margin for the last five years has been a middling 13% and for the last ten years has been a useful 16%. (These margin figures may be flattered somewhat by the calculation of the aforementioned share-based payment charges.)

Does the business produce a respectable return on equity?

Sometimes.

Return on average equity for 2014 was £20m/£108m = 19%. Stripping out the group’s cash and surplus investments from the equity base gives a figure of 44%.

However, the super ROE figures occur only in the good years. Between 2008 and 2012 for instance, the annual result never topped 13%.

Does the business employ capable executives?

Yes.

Chief executive Oliver Hemsley established what became NUM in 1989, has been in charge ever since and can therefore claim responsibility for the group’s expansion.

Mr Hemsley is in his early 50s, so I trust a succession plan is not an obvious requirement at present.

Does the business employ good-value-for money executives?

Sort of.

Mr Hemsley’s current wage is £250k, which seems very reasonable for running a business that made profits of £22m in 2014.

It’s also pleasing to see that, during the last ten years, Mr Hemsley’s basic wage has advanced at an annual average of about 5% — some way below the comparable 17.5% income growth enjoyed by shareholders through their dividend.

However, executive bonuses can be chunky — Mr Hemsley took home an extra £1m or so last year (and during the boom years of 2006 and 2007).

That said, he did waive his bonus during 2010, 2011 and 2012 — although I suspect that was to make up for the fact he collected bonuses for 2008 and 2009, when NUM’s profits fell heavily.

Does the business employ owner-orientated executives?

Sort of.

Mr Hemsley boasts an 8%/£23m stake, while three fellow executives enjoy a combined 13%/£37m holding.

(I should add that Mr Hemsley has sold about a third of his stake since 2011, with the latest disposal taking place last year at 270p.)

The drawback to NUM’s executives is their liberal granting of options and share awards to staff. The 2014 annual report declares 11 million outstanding options and share awards, which represent about 10% of the current share count.

Reflecting past awards to staff, NUM’s share count has grown by an average of 2% per annum during the last ten years. That dilution would have been a lot more had NUM not counterbalanced the awards by spending £62m on purchasing shares in the open market.

Does the business enjoy reasonable growth prospects?

Possibly.

Interim results issued last week reflected how NUM can be affected by rough stock markets. “Somewhat volatile” conditions during the Autumn of last year led to revenues dropping 12% and operating profits diving 28%.

However, the board’s outlook was upbeat:

“The second half of 2015 has started strongly with the completion of a number of transactions including equity and bond issuances for Provident Financial, Clinigen, Unite and Cambian, amongst others.  Our deal pipeline remains strong and our market share in issuance and M&A activity continues to grow, evidenced by our recent advisory and underwriting role for Kier on its proposed acquisition of Mouchel.  

At the same time, we are increasingly involved in helping early stage and growth companies access capital where we see significant innovation and opportunities to disrupt existing business models.  The UK is very well positioned to benefit from revolutionary technologies emanating from universities and elsewhere. Numis is building a leading position in attracting capital to help these companies develop and achieve their potential.”

Ultimately NUM’s progress should be be correlated to the health of the stock market. Rising share prices will lead to greater corporate activity and higher demand for advisors such as NUM. On the other hand, another slump could see NUM’s profits collapse once again.

Does the share price stand a good chance of becoming a bargain?

Maybe.

Possibly the best indicator of value here is the resilient dividend.

Back in 2012 for instance, the lack of NUM’s recovery from the banking crash caused the shares to drift to less than 80p — and offer a yield of 10%-plus. The group’s 2013-2014 revival then sent the shares as high as 350p.

Right now the 11p per share trailing dividend supports a 4.2% income

On a P/E basis, operating profits are currently £20m and after applying a standard 20% tax rate, I get possible earnings of about 14p per share.

Subtract the aforementioned 66p of cash and surplus investments from the 250p share price, and NUM’s enterprise value comes to 184p per share. The potential P/E on that EV is 184p/14p = 13. Not an obvious bargain for a business where profits can fluctuate so significantly.

Is it worth watching Numis?

I’m not sure.

Granted, this business offers cash-rich books, persistent dividend payments and directors with 21% of the share count.

But there’s no escaping the fact that profits here are dependent heavily on the direction of the wider stock market. In the good times, the figures look great — in the bad times the figures look awful. I get the impression over a full market cycle, NUM’s margins and returns on equity might be somewhat average.

The other downside to this business is the relentless share dilution. The share count has increased every year since at least 2000 and I can’t see that reversing anytime soon.

Indeed, NUM’s employees are rewarded very handsomely and — given the amounts spent on shares for staff have outweighed the sums spent on dividends — I do wonder if this business can ever be run with shareholders as the priority.  The fact NUM presents ‘adjusted’ earnings that ignore the substantial cost of staff shares does not fill me with confidence.

Anyway, as ‘geared plays on the market’ go, I do prefer the financial economics of fund managers such as City of London Investment and Ashmore. They too offer cash-rich books and high insider ownership, but profits at such firms have proven to be less volatile and they do seem to generate much more cash for dividends to shareholders.

Maynard Paton

Disclosure: Maynard does not own shares in Numis.