VALUE INVESTING
Garban-Intercapital

By Stephen Bland (TMFPyad)
June 16, 2000

Garban-Intercapital (LSE: GBN), one of the world's largest money and securities broking businesses, has just announced preliminary results for the fifteen months to 31 March 2000. The company has changed radically over the last couple of years because of mergers, so historical comparisons are not very meaningful. Its primary interest, as far as securities and money broking is concerned, is in electronic trading systems for the professionals in these areas but it is not an IT company selling systems as some have seen it; the company is itself a broker.

Not a pyad share because it trades at above book value, but nevertheless it has certain strong value features.

Market cap is around £200m at 210p per share.

The full figures are not out yet, but as far as I can judge, net assets per share are around 137p and "liquid funds" in the chief executive's words, which I take to mean cash and near cash, are about 103p. The net debt situation seems to be nil, with a surplus of cash.

The yield is high, probably in the region of about 8% plus. A guess, because of the fifteen-month accounting period following a change of accounting date from 31 December to 31 March.

The price to earnings ratio (P/E) is again difficult because of the changes and long accounting period. There seems to have been a loss in the fifteen months after exceptional items. The adjusted figure pre-exceptionals as stated by the company itself is 29.9p. Annualising this gives 23.9p for a historical P/E of around 9. Pretty low. There is only one recent earnings per share (EPS) forecast, from house broker Merrill Lynch, giving 34.0p for 2001 for a forecast P/E of 6. However I would expect this to be updated in due course following the results announcement. Which way they will play it I don't know.

According to the chief executive, the current figures are much more representative than the historical ones. He refers to a "very solid start" being made in the current financial year. Pre-tax profits for the first three months are £16.8m. Based upon this, on a 30% corporation tax charge and assuming a similar rate of profit is maintained, the theoretical forecast EPS is 46p for a forecast P/E of under 5. But this is just my extremely crude extrapolation which is not reliable.

So on my figures a strong value share, missing only price to book value (P/BV) under 1 to be a pyad.

So what does it smell like? Not that great. Money broking has a poor investment image. In fact any company that makes its money from dealing in stuff will tend in the main to attract a low rating in the market. This is because the quality of earnings from such companies is seen as less reliable than many other industries. And with good reason, because there will usually be a very patchy earnings history, demonstrating that the profits are not easily sustainable, that they are at the whim of the markets in which the companies operate and thus they may have very limited control over their own profitability. Lack of repeatable earnings, in effect an unreliable source of EPS, will therefore take its toll in the form of a low P/E, high yield share. Investors in such companies are reluctant to give them the benefit of the doubt.

Looking at Garban's EPS record you can see this picture of normalised figures:

1995             15.2
1996              3.0
1997              2.5
1998             15.4
2000 (15 months) 29.9

These are the amounts for 1995 through to 1998 for the first four years and 2000 for the fifteen month period to 31 March. You could argue, I guess, that a pattern has set in for the latest three periods but before that it was poor.

The shares, in their present incarnation following the mergers, have been trading only since around the end of 1998. In that time the high has been 313p and the low 180p. Thus they are around their low at present, hence the value attractions.

The question of course, as with any value share, is: how likely is the market to rerate it? I have my doubts because of the perceived unreliability of a broking company. Value is about perception. It's no good the investor perceiving his share to be undervalued if the market never changes its mind to agree with him. Successful value shares require that sufficient numbers of other investors come to share the purchaser's perception about undervalue.

There is no "real" value of shares, as some investors think; you often see this meaningless expression used by some people. There is only the perception at any particular moment and that changes every time the price moves up or down.

So with Garban, my belief in the almost perpetual low rating afforded by the market to this sort of business militates against a likely change in perception that must take place if money is to be made in the share. However, there is low and there is low. Even a company traditionally rated at the bottom of the heap has a range below which it may become too cheap. And an indication of too cheap is strongly rising EPS against exceptionally cheap fundamentals, the critical factor I believe that is a prerequisite for any good value share.

Consequently at the current price of 210p, and assuming (a massive assumption) that my ultra-crude EPS forecast is somewhere near the mark, this may be a good, but quite risky, short-term value play, because low-rated Garban may just be too low-rated right now. But this presumes that nothing goes wrong. Be warned that broking businesses are perhaps more likely than other businesses to get hit by profit warnings and unforeseen circumstances, for the reasons I mention above: that they are exposed to the sharp end of volatile markets.

If anyone goes in, I'd say don't hang around if you start to show a decent profit; dump it quick. Equally if it goes wrong, same thing.

Related Links

• Value investing discussion board
• Garban-Intercapital discussion board