Numis Corporation — Diversification mitigates market downturn

Exhibit 1 puts the FY22 profit and loss result in the context of the FY18–21 figures, showing how revenues have changed over a five-year period. This reflects fluctuations in market activity and the benefits from investment in diversification that has included development of M&A advisory, the international private markets team (Growth Capital Solutions within investment banking), the international equity capital markets activity, debt advisory and, within equities, an electronic trading platform and the event-driven team. Numis notes the M&A and private markets activities together accounted for more than half of investment banking revenues in FY22, while the electronic trading platform contributed 14% of institutional commission income. Our comments on the profit and loss analysis below relate to the changes between FY21 and FY22 unless stated.

Group revenue was 33% lower and unsurprisingly the main source of weakness was in capital markets (-62%) where macroeconomic and geopolitical concerns had a chilling effect on activity and a lower average deal fee in the absence of large transactions. Positively, this was partly offset by strength in M&A advisory (+26%) limiting the decline in investment banking revenues to 39%. The equities performance was relatively resilient in the circumstances, with a revenue decline of 18% against a 20% fall in the Numis Smaller Companies Index and reduced activity among institutional clients. Within equities, good contributions from the electronic trading product and the event-driven team helped mitigate the impact of the difficult trading background.

A comparison between the second-half year-on-year revenue decline of 30% at Numis and the 42% H123 reduction for Peel Hunt (also covering the six months to end-September) demonstrates the impact of the differences in activity mix. Peel Hunt also seeks to diversify, but at this point two of its three main activities (investment banking and execution services) contributed to the sharper revenue decline.

The year-end number of retained clients at 176 versus 182, was affected by acquisitions of clients. This, together with other departures, more than offset the addition of 15 new clients. Numis’s clients have an average market capitalisation of £1bn.

The other operating income line shows a net loss of £1.4m on the investment portfolio, which was valued at £18.4m at the year-end (vs £21.8m FY21). Two disposals during the year raised £8m, including the remaining holding in Oxford Nanopore Technologies (where Numis invested 13 years ago and acted for the company in its IPO at the end of FY21). The proceeds were partially reinvested in three new investments. Remaining legacy investments are being progressively sold, with the aim being to have a broadly stable number of holdings through reinvestment.

Total administrative expenses were 16% lower, including a 25% reduction in total staff costs mainly reflecting lower variable remuneration. The compensation ratio increased to 56.4% from 50.4% as revenue fell and the average headcount increased by 11%. The year-end headcount was 5% higher at 336, with staff additions mainly comprising junior and mid-level roles to support growth. Non-staff costs increased by 8%, some of which related to establishment of the Dublin office.

This left operating profits 75% lower and the operating margin, before other income at 7.4% vs 31.4%. Net finance income was positive in part because of net foreign exchange gains of £3.4m and pre-tax profit was 72% lower. The tax charge at 34% was boosted by a number of factors, including increased tax exposure on share schemes related to the lower Numis share price and tax on investment portfolio disposal gains. As a result diluted EPS was down 76%.

The board has proposed a 7.5p final dividend giving a total of 13.5p, in line with the prior year and a level that the board sees as sustainable across market cycles while still investing in the business.

The group remains committed to mitigating the dilutive impact of share awards and during FY22 £8.2m and £3.4m were spent in buying back shares for treasury and the employee benefit trust, respectively.

The group has continued to pursue its five strategic pillars, which remain in place.

Here we briefly review the market background for Numis. The first two charts show the very subdued level of equity issuance on both the Main Market and AIM markets for most of calendar 2022. Numis suggests that market uncertainty and unfavourable macroeconomic conditions are likely to affect the investment banking industry for some time, but we note that the period of reduced activity is already quite extended and that a return to greater stability could prompt quite a sharp recovery in activity based on prior market cycles.

Trading activity (Exhibit 4) previously peaked with the onset of the pandemic in March 2020 (Main Market) and subsequently on AIM when there was a rotation into higher risk/small-cap stocks. That rotation was also evident in the relative performance of the CBOE All-Companies and Small-Cap indices. Recent activity levels have been subdued, particularly for AIM. The equity indices (Exhibit 5) fell in reaction to the attack on Ukraine and its economic repercussions. More recently there has been some recovery but further volatility seems quite likely given the continuing macroeconomic uncertainty. In these circumstances, Numis’s consistency in pursuing its strategy and willingness to invest selectively to hire key staff when market conditions are difficult seem likely to support growth through market cycles.

Exhibit 6 gives headline figures for the actual result versus estimate for FY22 and revised estimates for FY23. The changes for FY23 are modest. We have factored in higher interest income reflecting the increase in base rate and expectation of further increases and also allowed for a higher facility fee for a larger credit facility (see below). We adjust for the reintroduction of a 25% corporation tax rate during the year and this is the main reason for a 4% reduction in our EPS estimate.

A segmental breakdown of our revenue estimate is given in Exhibit 7. Here we have a virtually unchanged estimate for total revenue but have assumed a larger contribution from advisory than before and less from capital markets. Given the current market background, we assume the first half for capital markets will remain subdued while the strong advisory pipeline suggests that at least the first half will remain strong. The second-half outlook is less certain, but we have assumed some improvement in capital markets which accounts for the increase for the year as a whole in that activity and for group as a whole.

At the end of September, cash stood at £105.7m vs £111.5m at end-H122 and £134.1m at the end of FY21. The average daily cash position in FY22 was £110m with a variance between high and low cash positions of £106m. The £28.2m reduction in cash in FY22 reflected an operating cash inflow of £23.8m before a negative working movement of £22.6m (working capital items are typically volatile subject to movements in trade receivables and payables and timing of fee receipts and variable compensation payments). Net of this, the operating cash inflow was £1.2m. Dividend payments and share purchases absorbed £27.1m and other items a further £2.3m. To provide a longer-term view, in the last five years net operating cash flow has averaged £33.7m per year, share purchases and dividends £28.0m and cash has increased by an average of £2.1m.

Numis has refinanced its revolving credit facility, increasing it from £35m to £50m at a lower margin and with greater financial flexibility. The company expects this to remain undrawn for most of the year but it does provide scope for normal business activities that generate substantial variance in cash balances, as highlighted above.

Numis continues to operate with capital significantly in excess of its regulatory requirements. A new regulatory capital regime applied from January 2022 and Numis indicates that its Pillar 1 requirement will be lower under this regime but, for a transitional period, the requirement remains unchanged until the Financial Conduct Authority has completed its review of Numis’s internal assessment.

The chart below shows a 10-year history of the price to book ratio for Numis. The current value is 1.1x, compared with the 10-year average of 2.1x. The implied ROE required to match the share price at the time of writing (185p) would be 10.6% (using a ROE/COE model with a discount rate of 10%). This is above the depressed FY22 level of 7.4% but significantly below longer-term averages (five and 10 years, 18% and 19%, respectively) and highlights the caution built into the current valuation.

Exhibit 9 shows a peer comparison table including UK investment banks/brokers and US and European investment banks and advisory firms. Comparisons are heavily qualified by the differences between the activities of the companies, the absence of consensus estimates for the UK companies and inconsistent year-ends. Nevertheless, we note that Numis offers a yield of 7.3%, and its P/E ratio for the year to September 2022 is lower than the consensus current year P/E for US/European investment banks and advisory firms, almost all of which have December year-ends. Most companies in the peer table have price to book values below 2x.