A late profit warning saw Cenkos Securities shares (LON:CNKS) fall almost 30% towards the end of business yesterday as it revealed that revenues for this year would be significantly second half weighted. The share price has since pulled back a little:
The bigger picture shows massive price declines: in 2014, a share was almost 250p. But this reflects a couple of things about the company: revenues are erratic and lumpy and vary heavily. For instance, turnover in 2014 was £88.5m, just two years later in 2016, that dropped to £43.7m. The effect on operating profit was even harsher, dropping from £26.8m to £4.98m. Additionally, dividend payouts have been generous and most of the profits are paid back to shareholders.
The nature of the business perhaps dictates this, as reinvesting funds may not guarantee any extra returns. There are only so many businesses to cover, after all. Cenkos will be a familiar name to most who trade shares, as they are one of the few brokers who produce research for small and mid-cap companies. In addition, they offer other services such as consultancy, research and corporate broking.
The warning was not well-timed, coming out in the afternoon at 3pm. Quite why this is done is not known, but they have form for it, with the previous trading updates coming out in market hours.
We start with some director news: a new CEO comes in. There have been some musical chairs going on at boardroom level, with both CFO and CEO now being replaced in the last year.
On to the warning:
As reported in our AGM Statement in May, the first quarter of 2019 was disappointing as market volatility had a significant impact upon investor sentiment. Although a slight improvement was recorded in the second quarter, the Company’s revenues in the first six months have been lower than the first half of last year. The Company’s revenues are anticipated to be substantially second half weighted.
The dreaded second-half weighting comes into play, and the drop in revenues is not quantified here.
We are currently working on several transactions and our potential pipeline gives us optimism for the rest of the year. The Board expects that the second half performance will be much stronger than the first half. The execution of our pipeline will likely be influenced by the evolving political and economic outlook and the consequent impact on our corporate and institutional clients.
This seems a long way of describing ‘Brexit’, although certainly we can see it have an impact. Potentially we may see another warning if things do not turn out as planned.
The Board also confirm that a number individuals within the Company’s Investment Companies Team have tendered their resignations. These individuals will continue to operate normally during their notice period and consequently these resignations are expected to have a limited impact on the revenues and net contribution of the Company for the full year ended 31 December 2019.
This seems co-ordinated and perhaps they are being poached to work elsewhere? In any case, this seems to be part of one of the biggest part of the business (Corporate Broking).
Cenkos is quite an interesting business. Their narrative talks up the returns for shareholders in terms of dividends, and it is correct in this sense, that a large amount of cash has been returned, certainly many times in excess of the market cap currently, although a longer term holders overall return would still be negative: Total Shareholder Return sat at -27% in the last report and is probably even further down today.
With corporate finance heavily dominating the revenues here (£32.7m out of £45m in the last annual report) it is not a surprise that things can vary. Big events such as mergers or IPO of large companies do not happen that often, and are very lucrative for companies such as Cenkos. Large equity raises are also a good source of income, although this measure has approximately halved from 2017 to 2018 and can be distorted by very big transactions.
Unpredictability is of course a bad thing, but it is not as if Cenkos are going to disappear overnight. They are extremely liquid: they carry no net debt, and the current cash position is in excess of the market cap, which is quite remarkable. Current price is underneath book value of equity, which must be quite reliable as assets comprise of cash and investments Their focus seems tight: there is negligible intangibles on the balance sheet and capital expenses are very low. As a result, cash conversion here is very clean which has filtered through to dividends.
The management and ownership structure is interesting: the founders still retain large stakes in the business. Until this year, the founders have stayed out of the firing line and employed others for the CEO/CFO job. Remuneration is quite variable here, with low basic salaries and very high bonuses, which help act as a bit of a cushion to maintain profitability when things go bad.
All in all, despite a profit warning, there is no real immediate danger.
A lot of this screams out ‘value’ to me. It is fair to say that profits have declined massively from a peak of 2014, but then again this type of profit decrease is quite structural within the industry and Cenkos have little control over the big ticket transactions. A bigger bear point may be the impact of new EU regulations which may limit fees it receives.
Another divisive point may be governance and whether too many founders might stifle everyone else. Activist Crystal Amber were quite vocal in opposed the return of the old CEO Jim Durkin and demanded an outside appointment. There is also the issue of close ties to Neil Woodford and the association with Quindell, for which it was fined £500,000.
The short-term future may not be so good, as Brexit might cause a pause in the market, the track record of profitability and flow of dividends should hold up. Even though this is not a growth company, there does seem to be a great chance that shareholder returns will not be negative from this price and that there is a decent discount built in. 5/5.