Weekly Market Commentary | 10/10/23 | BOO, PEEL, MTRO | Widening direct equity ownership

Attempts to widen direct equity ownership in the UK stock market are gathering pace, even as the high dividend yields on fund managers are signalling problems with that business model. Stocks covered BOO, PEEL, MTRO.

The FTSE 100 was up +0.3% to 7,536 last week. The Nasdaq100 rose +1.8% and the S&P500 was up +0.5%. The US 10Y government bond yield rose to 4.78%, now up almost 100bp in the last 3 months. When you see large moves like that in the bond market normally something breaks. I’ve been cautiously putting money to work into the market over the summer, but wouldn’t be surprised if we see another equity market sell-off.

New Financial, the city think tank, has published a report on how to increase retail investor participation in the UK equity markets. They say that the share of UK households that directly own stocks has been declining from just under a quarter 20 years ago to 11% now (see chart below).

However, there is now renewed interest from policymakers, regulators, think tanks and others in widening direct equity ownership. That’s because the less professionalised US markets (where retail directly owns 40% of the stock market by value) function better than Europe, where ownership by professional fund managers dominates.

Note too that the valuations of the UK fund managers are indicating that there is a problem with the business model of managing other people’s money. M&G, which has a third of a trillion pounds AuM, trades on a dividend yield of 10.5%. ABDN has half a trillion AuM and trades on a dividend yield of 9.5%. Premier Miton is on a dividend yield of 9% while Liontrust’s yield is approaching 13%.

Looking at ABDN’s Small Cap Growth Trust which has gross assets of £440m invests and in 56 companies, as an example shows the problems in the fund management model.

The fund is currently trading at a 12.5% discount to NAV and has an expense ratio of 0.95%. Abby Glennie and Amanda Yeaman who run the fund can’t take large, high-conviction ideas in smaller AIM companies, where many bargains and high-potential stocks can be found. Indeed, their largest shareholdings are Hill & Smith (mkt cap £1.3bn), 4Imprint (mkt cap £1.4bn), Diploma (mkt cap £3.9bn), Games Workshop (mkt cap £3.2bn) and JTC (mkt cap £1.2bn). All sensible investments, but these are hardly small-cap companies. The Abrdn fund is an Investment Trust, rather than open-ended fund, so shouldn’t be subject to liquidity concerns if they see outflows (which was the problem for Neil Woodford). The performance is below, down -39% in 2022 and -15% YTD. I am using Abby and Amanda as an example, but the same issue exists for all professional fund managers who are rewarded for growing AuM, rather than identifying sub £200m market cap companies with high potential.

I’ve suggested before, that amateur investors using a tool like Sharepad, enjoy significant advantages over professional fund managers. Now the powers-that-be are waking up to the fact that amateurs don’t just earn higher returns for themselves, they allocate capital in a superior way to the professionals and that helps the economy function better.

This week I look at Boohoo results, Peel Hunt’s trading update and a comment on Metro Bank’s capital raise.

Boohoo H1 Results to Aug

This online clothes retailer which also owns PrettyLittleThings, Nasty Gal, Karen Millen, Oasis and Debenhams brands announced revenue down -17% to £729m, (previous guidance H1 decline was expected to be between -10% to -15%). The company reported a loss before tax of £9m, versus £6m of PBT H1 last year. Net debt at the end of August was £35m, versus £10m in August last year.

Outlook: BOO management have updated their guidance for FY Feb 2024F, with sales now expected to decline between -12% and -17%. The previous forecast, given in mid-May at the FY Feb 2023 results had revenues at flat to -5% (Sharepad had the previous forecast a -3.5% decline).

Despite that revenue disappointment, they have kept their adj EBITDA margin guidance the same (between 4% and 4.5%), and they expect adj EBITDA to now be between £58m and £70m (previous guidance £69-78m). They have a medium-term aspiration to return to a 6-8% adj EBITDA margin, combined with revenue growth.

Comparisons: I’ve used Sharepad’s compare feature to compare BOO with Asos, Superdry and Next. The latter is the quality player in the sector and seems to have sailed past the problems that competitors have experienced. When we do begin to see a return to Like-for-Like sales growth across the sector, the lower-quality brands are likely to see much greater upside though. As an aside, Superdry was up +15% last week, after it announced that it would receive £28m proceeds for 75% of its South Asian (ie mainly India) business. That removes any near-term risk of failure in my view, and has bought valuable time.

Valuation: The shares are forecast to return to profitability in FY Feb 2026F, which puts it on a PER that year of 44x. On a price/sales multiple they are trading on 0.2x FY Feb 2024F sales.

Opinion: I think the story for the investment case in retailers is more nuanced than disposable incomes coming under pressure from inflation and higher interest rates. Judging by my own eyes, pubs in London seem to be doing well and last week Greggs reported LfL sales +14%, so people are spending money, just not on items to wear. Rather than higher interest rates, I think that there has been a shift in preferences following the pandemic, with consumers preferring to spend money on eating and drinking, rather than physical goods like clothes. Eventually though, people will have to start buying clothes again. I’ve been too early with my badly timed Superdry purchase, but on 0.1x to 0.2x revenues these retailers are priced for failure.

Peel Hunt H1 Sept Trading Update

Another bombed-out sector that I am keeping an eye on is UK stockbrokers. That is partly because it’s a cyclical industry which may present opportunities where conditions improve. Deutsche Bank bought Numis and Japanese bank Mizuho bought Greenhill earlier this year, so the idea of a recovery is not entirely far-fetched. Cenkos merged with finnCap to form Cavendish, and of course, UBS bought Credit Suisse, so the broking sector is slowly consolidating and the survivors may enjoy better economics. But the other reason I read brokers’ RNSs is to vindicate my decision to leave equity research over a decade ago.

Peel Hunt announced an “in-line” update, with revenues +3% to £42m for H1 to September. They were joint bookrunner for CAB Payments, which raised £335m, making it the largest IPO of the year in London (so far). They say that costs have increased with inflation, which I take to mean that they will be loss-making FY Mar 2024F, as last FY to Mar LBT was £1.5m.

The chart below shows that revenues peaked in FY Mar 2021 at £197m, versus £90m forecast for FY March 2024F. It’s not easy to run a business when you have that sort of cyclicality.

PEEL now act as an adviser to 154 companies. Brokers have an annoying habit of trumpeting client wins, but not revealing client losses. Last October Peel Hunt had 164 companies, which implies they’ve lost 19 clients but won 9 new clients to produce a net loss of 10 this year. They don’t give a detailed update on the balance sheet, except to say that long-term debt stands at £15m (down by £6m) since June, and they have a £30m RCF with Lloyds. At the FY Mar NAV was £93m, and total assets were £594m. Most of that is from market making in stocks, with £526m of securities funded by £469m of current liabilities.

History: Peel Hunt was founded in 1989 by Charles Peel and Christopher Holdsworth Hunt. They listed on AIM in 2000 but were then bought by KBC bank. The Belgium bancassurer lost money during the financial crisis and staff organised a management buyout in 2010. At the time they were 75% owned by staff and 25% owned by external investors. They re-listed on AIM in 49m shares at 228p, in September 2021. That raised £36m for the company, and £69m for selling shareholders, giving them a market cap of £280m on admission. The principal selling shareholders were management and other insiders. Steve Fine, the Chief Executive still owns 4.5% of the company and Darren Carter who is a non-exec owns 8.3%. The largest institutions are Gresham House 6.6% and Unicorn AM 3.6%.

Valuation: The shares are trading on a PER 13x Mar 2025F and EV/EBITDA of 1x sales that year. That is assuming revenue grows at +10% this year, then +20% Mar 2025F, so clearly scope for a wide variance in outcomes.

Opinion: I think at some stage the brokers will do well. But it does not seem like it will be in the next six months. My view is that they are worth following, but too early to make a strong investment case. I prefer Cavendish to Peel Hunt because I have more friends who have worked at Cenkos and finnCap, which gives me a feel for how those firms operate.

Metro Bank rescue capital raising

Metro Bank announced that it had raised £150m of new equity at 30p per share and refinanced £600m of debt. The bank is also in talks to sell £3bn of mortgages, which represents 14% of total assets. That mortgage sale hasn’t happened yet, but would boost the core tier 1 ratio to above 13% (on a proforma June 2023 basis) that the capital raising produces. The bank is expected to deliver a RoTE in excess of 9% in 2025 and low double-digit to mid-teens over the medium term according to the RNS (see my opinion comments below though). The shares were down -22% last week but then rallied +26% on Monday.

The biggest shareholder is currently Colombian billionaire Jaime Gilinski Bacal, who is backing the current capital raising, and his vehicle Spaldy investments will become a 53% shareholder, contributing £102m of the £150m equity raise. The FT reports that the Bank of England had contacted lenders to see if they were interested in buying Metro.

History: The history makes an interesting case study in what to avoid. MTRO bank was founded in 2010 by Vernon Hill III, who had done well building a Commerce Bank in the US. He was fired from there in 2008, and Commerce Bank was sold several months later to Toronto Dominion Bank for $8.5bn, which turned out to be very fortunate timing just before the GFC. Hill then founded Metro Bank, which positioned itself as allowing owners to bring dogs inside branches and customers were called “fans”. Several UK fund managers I spoke to at the time refused to look at Metro on principle, because of related party transactions between Hill and his wife, who had been paid millions for designing the branches.

MTRO were backed by the Reuben brothers, Steve Cohen, and Ken Moelis as well as institutions like Fidelity and Wellington. Some of these wealthy backers exited at the IPO stage, but Steve Cohen sold out in 2020 after the shares had fallen -90%.

In 2016 MTRO IPO’ed raising £400m and valuing it at £1.6bn. The shares rose +7% on the first day of trading, to £21.64, suggesting a “first-day pop” is not always a guide to subsequent share price performance. Profits did not arrive until 2018, partly because the backers had underestimated how competitive the UK mortgage market is, and partly because MTRO expanded via a costly branch network (they currently have 76 branches and 2.8m customers).

In May 2019, Metro Bank raised a further £375m at 500p per share, following accounting mistakes (they calculated their Risk Weighted Assets and capital requirements incorrectly) and governance concerns involving Vernon Hill. The mistakes triggered a -39% fall in the share price and a £10m fine from the FCA because the bank had misled investors.

Valuation: Sharepad’s NAV calculation is now out of date, given that the bank has raised £150m at 30p per share. The new NAV is 166p (down from 562p at June).

Opinion: During the financial crisis banks had a nasty habit of raising capital (HBOS, RBS) and then announcing large losses, but that isn’t the case here and a large bad debt impairment doesn’t seem likely with MTRO. Credit quality in the UK mortgage market has been resilient in 2023. Instead, the bank’s problems come from regulators (PRA and FCA) refusing to approve the bank’s Internal Ratings Based Approach (IRBA) models which would have reduced Risk Weighted Assets (RWA) in the lending book.

Metro Bank has already raised money at 500p in 2019, so I can understand investors feeling some revulsion at a 30p capital raise. However, that is now sunk cost, IF the double-digit RoTE is achievable, then the shares look very good value. At a share price of 60p, the 0.3x NAV and 0.2x revenue is undoubtedly cheap.

That said, I doubt that the RoTE target can be achieved. MTRO have refinanced their tier 2 debt with a new coupon paying 14% and issued a £175m senior note paying 12%, so the bank has to operate with more equity and also has a higher cost of capital than competitors. But maybe a value of 0.5x NAV (which would imply 80p price target) is justifiable? That said, Metro Bank has had 13 years to prove that its business model is viable, it hasn’t done so yet, and it is unlikely to get a third capital raising away.


Bruce co-hosts the Investors’ Roundtable Podcast with Roland Head, Mark Simpson and Maynard Paton. To listen you can sign up here: privateinvestors.supercast.com

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This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.