That's the yield on this small cap stockbroker.
A yield of 9% usually looks too good to be true. Alarm bells warn that a dividend cut may be on the cards, leading to a down rating of the shares.
That's the yield on Cenkos Securities (LSE: CNKS), the stockbroker to small and mid cap companies which is itself listed on AIM with a capitalisation of under £60m.
Though an idiosyncratic dividend policy means that the future payout is far from certain, the yield is covered 1.6 times and a lot of bad news is already priced in. With the shares down 27% over twelve months, the next move might be upwards.
Bread and Butter
Corporate broking and advisory services to small and mid cap companies is Cenkos's bread and butter, such as raising £120m for transport group Eddie Stobart (LSE: STOB) in May. It also has a strong position as a broker to investment funds, most prominently acting for Anthony Bolton's Fidelity China Special Situations (LSE: FCSS) which raised £0.6bn in its two issues.
Corporate broking generates over 75% of revenues and 84% of profits, with income coming from placing commissions, corporate finance fees, retainers and market-making. But the company does not undertake proprietary trading.
A 50%-owned fund management business in the Channel Islands and research-driven services for institutions make up the remainder of revenues.
Founded by Andy Stewart, the co-founder of Collins Stewart Hawkpoint (LSE: CSHP), in 2005, the company floated in 2006 to great fanfare, but has failed to grow to the scale originally envisaged. Andy Stewart left in June 2010, but retains a 12% stake.
Nevertheless Cenkos punches above its weight in league tables. It is one of only three brokers on the LSE with more than 100 clients, after Cazenove and Numis (LSE: NUM), according to the Hemscott rankings. It was the number one NOMAD on AIM by client market capitalisation in January, and number three in terms of client numbers after Seymour Pierce and FinnCap.
Overcapacity
It has been a tough time for the independent stockbrokers. The business is highly cyclical, geared to corporate activity in new issues and fund raising. Since the financial crisis the market has been dire, and there is severe over-capacity. The number of companies on AIM has fallen from a peak of 1,700 in 2007 to under 1,200. IPOs on AIM fell from £10bn in 2006 to £0.7bn in 2009.
In most industries this would lead to consolidation. But with much of the business depending on personal relationships companies are nervous of losing key staff in acquisitions. Some brokers have cut staff, others are seeking develop less cyclical fund management business, and some are specialising to underpin their market position.
With its prestigious rankings, niche position with investment funds, and strong balance sheet (with net cash), Cenkos should at least hold its own in this difficult market. But its shares have substantially underperformed. So what has gone wrong?
Management tension
There have undoubtedly been tensions in management over the direction of the business. Andy Stewart's departure left the business without a clear leader. More recently, CEO Simon Melling, who stepped up from FD two years ago, has decided to leave.
The company is searching for a replacement whilst, from the sidelines, Andy Stewart complains that the senior business heads frequently overruled the outgoing CEO. Non-exec Oliver Ellingham has also left after just a year in the job.
Then there's that idiosyncratic dividend. The policy is to retain only sufficient capital to meet regulatory and working capital requirements. The 2009 dividend was increased to 20p from 10p, including 10p from prior year earnings. 2010's dividend was cut to 8p (covered 1.6 times) and the shares naturally dropped on the news. The irony is that the payment from prior year profits could have been spread to show a progressive dividend policy.
And the results for 2010 disappointed the market. Revenues rose an impressive 31%. But a spattering of adjusting items makes analysis of profits more difficult. After accounting for £7.4m of one-off items in each of 2009 and 2010, operating profit either rose from £13m to £14m or from £6m to £7m. EPS fell, from 13.8p to 13.1p, or from 6.2p to 5.2p.
Staff costs, which are three quarters of recurring costs, rose 20% (with a 13% increase in headcount), so margins fell from 28% to 24%. The company's aim is to make as much remuneration variable as possible whilst remaining competitive.
A contrarian play?
So it may be a contrarian view to see value in the company. But the PE of 6.7 undervalues its franchise and sticking power, which should see it through this extended down-cycle. Amongst the 62% of the shares which are tightly held, three senior managers have 20%. It's those senior managers who generate the business.
It's a speculative, risky share, but one with significant upside.
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