FTSE 100 investment company 3i Group (LSE: III) has long been a favourite of ‘smart money’ investors, in my experience. This is money controlled by major financial organisations, including investment banks, hedge funds, and pension funds.
For other investors, the seeming complexity of private equity businesses can be off-putting, I think.
But essentially what 3i does is invest in mid-sized companies headquartered in Europe and North America. It earns fees from the money invested in these businesses and from a share of the profits that they generate.
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Set for Action
Eighty-seven percent of 3i’s investment portfolio is focused on the value-for-money, infrastructure and healthcare sectors.
But by far its single-biggest investment is a 57.6% holding in Action — Europe’s fastest-growing non-food discounter.
This investment generated a gross return of £3.718bn over 3i’s full-year 2024 ending on 31 March. It delivered annual revenue growth of 28% compared to 2023, sales growth of 16.7% and EBITDA growth of 34%.
Overall for 3i, full-year 2024 saw a total return of £3.839bn. This equates to a 23% return on opening shareholders’ funds.
Action’s financial year runs from January to December. Over its first quarter of 2024, net sales jumped 21% (to €3.004bn) against Q1 2023, while operating EBITDA rose 28% (to €397m).
The key risk here for 3i in my view is that Action’s business growth slows down. However, it opened 119 new stores in H1 2024 and plans to open 330 overall this year.
Moreover, consensus analysts’ estimates are that 3i Group’s earnings will jump 15.6% each year to end-2026.
Weighing up the stock price
On the back of this growth, 3i’s shares have risen 61% from their 31 October 12-month low of £19.27.
This might cause some investors to avoid the shares, thinking they have risen too far already. Others may think that they need to jump on the bandwagon simply to avoid missing out.
Neither of these approaches is conducive to making good long-term returns, in my experience as a former investment bank trader.
The only thing I want to know is whether there is any value left in the stock. If there is, I would then decide whether it is right for my stage in the investment cycle.
Is there value left in the shares?
On the first point, 3i currently trades on the key price-to-earnings (P/E) ratio measure of stock valuation at just 8.
This is the lowest of its peers, which average 34.5, so it is very cheap on this basis. The group comprises Intermediate Capital Group at 13, Partners Group Holding at 31.6, Bridgepoint Group at 37.8, and CVC Capital Partners at 55.4.
To find out how much of a bargain the shares are in cash terms, I ran a discounted cash flow analysis. This shows the stock to be 65% undervalued at the current price of £30.95.
So a fair value would be £88.43, although it may go lower or higher than that.
Will I buy the shares?
Aged over 50 now, I am focusing on high-yield shares only, and 3i’s 1.9% dividend return is not enough for me.
However, if I were even 10 years younger I would buy the stock for its high growth prospects and extreme share price undervaluation.
