Shares in financial services firm Sanne Group (LON:SNN) today sank by a third in early trading as a trading update revealed that reduced margins would see a reduction in profit for the full year. The share price movement has been very interesting over the past year: since 2019 it has surged from 500p to 750p. Today’s warning means that it has given that all back:
Sanne are a rather exotic company headquartered in Jersey. They offer financial firms an outsourced way to access financial markets overseas across a variety of asset classes. Clearly this has been a success. The company has been profitable and revenues have risen by a huge 6 times in the past 6 years, and more growth is still on the table as there have been plenty of acquisitions along the way.
With some of these being transformational in terms of profit, the company has always traded on very high multiples to reflect this growth. Even after today’s plunge in price and using a forward P/E, it still comes out at around 20. Not necessarily a deal breaker, but merits more investigation.
The warning comes in a trading statement RNS today. We start with good news: record levels of new business and cash conversion in excess of 100%, although strong trading clipped by weak European performance. We get into the meat of the warning as such:
The Group’s underlying operating margin in H1 2019 is expected to be approximately 26%, below our previous expectations for the current year. The margin performance in the first half was affected by a combination of items. We have seen a disappointing lack of delivery of operating efficiencies in the central operations teams that we highlighted in 2018, and some elevated overhead spend. We have already taken action to address these issues and continue to implement initiatives to improve the full year outturn.]
There is also a strong H2 weighting to this, which is a poor sign as often these do not materialise and could set us up for another warning:
Whilst we see good levels of revenue growth, the items impacting the underlying operating margin in the first half are unlikely to be fully compensated for in the second half. The Board therefore expects to report at full year underlying operating profit margin in the region of 28% to 30%, which is below our previous expectations.
A bad mark for no comparables: according to the annual report for last year this figure was 31.1% and 34.3% the year before, so we can see a really strong performance would be required to get this back up to that mark.
The very strong growth in our Alternatives business resulted in a Group blended tax rate of approximately 21% for the first half, higher than the previous period, which is indicative of a geographic mix effect where revenues were earned in higher tax rate jurisdictions. Assuming the continued strong revenue trajectory and business mix, we would expect a similar blended rate for the full year.
As a result of the changes to underlying operating margin and blended tax rate the Board expects to report underlying earnings per share for the full year below its previous expectations.
There are no research notes on Research Tree, but brokers are pricing a large jump in profits, on reduced margins this looks set to be missed.
There are a few things to like about the accounts. The company’s claims about cashflow are correct, and there is a very good cash conversion rate. In part this has been assisted in the last couple of years by very large amortisation charges, which is not matched by capital expenditures.
Profits have helped in part to pay for the new acquisitions, but mostly they have been fuelled by equity and debt. The IPO in 2015 was a green light for much larger scale acquisitions to take place. Sanne have spent £147.9m on these, and over the past few years £157.6m has been raised in both equity raises and debt, which almost cancels each other out.
Sanne pays a dividend, which is progressive, but also is eating up an increasing pile of that free cash flow, the payout ratio has increased from 32% in 2013 to 85% in 2018. Dividend payout was £18.4m last year so assuming everything works as planned, should still be sustainable.
These acquisitions have taken its toll on the balance sheet. Assets have increased almost tenfold over the past 5 years, but so have the intangible and goodwill columns. Net tangible asset value is negative.
There is no mention of debt levels in the last statement, but it appears that more acquisitions would require some reorganisation of liabilities. Debt stood at £86m from an available £100m at the time of the last annual report, although considering the large cash balance held and the cash generative nature of the business this does not appear to represent an immediate danger. With a market cap of still close to £800m, another raise is still an option.
The analysis may sound rather sit on the fence, and to be truthful it is difficult to get a good grasp of this business from a quick reading. This impacts on how we can process this profit warning, whether it is due to temporary factors or whether it is something more permanent. Without a greater knowledge of the industries it is difficult to know if other firms such as the larger banks may seek to compete in this field.
What is for sure is that Sanne have produced the goods for shareholders since their IPO, delivering both capital appreciation and dividends in the process and the work they do is at high margins, allowing a form of cushioning for a short-term disruption such as this. If we can believe in their story there may be a decent upside from here, without extra knowledge I would need a greater margin of safety. 3/5.