The FTSE 100’s ‘secret’ growth share

3i Group (LSE: III) looks like a hidden star on the FTSE 100. The small and medium-sized private company investor reckons it runs a defensive portfolio of investee businesses with little exposure to the early repercussions of the Brexit referendum.

What’s more, around 70% of the firm’s assets are denominated in euros or US dollars and that has led to a translation benefit since sterling’s recent devaluation, which boosts the strong underlying performance the firm is reporting today with its half-year results.

With the business in such apparent good shape, net cash on the balance sheet and low gross debt, why is 3i Group’s valuation so low?

Too difficult?

At today’s share price of 615p or so, 3i trades on a forward price-to-earnings ratio of just over eight for the year to March 2018. The forward dividend yield runs around 3.8% and City analysts following the firm expect earnings to cover that payout more than three times. In today’s update, it says its net asset value stands at 551p per share — just 10% or so below the share price. The valuation looks attractive. Maybe too attractive, suggesting that investors might be worried about something.

I wonder if the firm’s business model might put investors off. 3i’s  history goes back to 1945 when it was set up to service a funding gap in Britain’s smaller enterprise sector. However, the company operates around the world these days, and a network of professionals apply their expertise towards developing the companies that 3i invests in. 

The firm targets what it calls mid-market companies with an enterprise value up to €500m, and new investment is focused on opportunities in Northern Europe and North America. It prefers to invest in the sectors of Business Services, Consumer and Industrial. On top of this private equity investment activity, 3i also invests in economic infrastructure and has a substantial debt management business.

Unlike straightforward trading companies, 3i is hard to see inside to judge how business might be going. Maybe that keeps the valuation low, or it could be that investors worry about cyclicality in the firm’s operations, or that currency advantages could reverse down the line if the pound strengthens.

An intriguing proposition

Yet 3i is upbeat about its forward prospects. Simon Borrows, the company’s chief executive, reckons it’s navigating the challenges of geopolitical and financial volatility from a position of strength. “Our diverse portfolio, rigorous investment processes and robust balance sheet underpin our confidence about the future success of the group,” he said.

3i like most companies has its challenges, with its Agent Provocateur investment currently suffering from slower consumer spending and unspecified accounting issues. But if the majority of its large and diverse portfolio of investee companies operate businesses that are truly defensive as suggested in today’s update, I think it’s an intriguing proposition selling at a modest valuation.

It’s hard for investors to diversify between several small companies on the stock market without building up trading costs. However, in 3i we have an opportunity to expose ourselves to the often larger upside potential of smaller firms while investing in a larger FTSE 100 firm that provides much better liquidity making it easier to get in and out.

A top growth share to research right now

If you like the look of 3i Group I think you'll also see the potential in a firm that one of the Motley Fool UK’s top investors has identified as A Top Growth Share

This British firm is spreading its international wings and could be on the cusp of gaining critical mass abroad, which could mean it powers forward to become one of the nation’s next great international success stories. Investors backing the firm now could do well in the years ahead

To find out more you can download this research, free of charge, right now by clicking here. 

Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.