STM still grossly undervalued

Working abroad and retiring to Florida or the Costa del Sol is no longer just a pipe dream for many Brits. More highly-skilled professionals are doing it than ever. But before they can they need someone to handle their pension in the most tax-efficient way. That's where AIM-listed STM steps in. Business is booming and forecasts are for a big increase in profits both this year and next. The shares, however, trade on anaemic multiples, with apparently no justification.

STM once made its money handling personal trust and corporate secretarial (CTS) functions. Now, it generates more income from pension administration - it handles Qualifying Recognised Overseas Pension Scheme (QROPS), an offshore pension scheme approved by HMRC and used by expats whose tax domicile can change as a consequence of employment. Sales of life assurance products to expats are rising fast, too.

And it is a company Interactive Investor has drawn attention to a number of times in the recent past. Nigel Green, who once owned a quarter of STM, is slowly selling down his stake to focus on his global IFA group, deVere. But we noticed there were plenty of willing buyers on the inside at STM - director of business and product development Alan Kentish and finance chief Therese Neish have both purchased shares at 18.5p and 23.5p respectively.

Since then, STM shares have risen by as much as two-thirds to 31p. A large part of that rally has been driven by interest in the run up to full-year results, which have more than lived up to expectations.

Revenue grew by 19% to £15.9 million in 2014, but pre-tax profit ballooned more than fivefold to £1.7 million as margins doubled to 15%, mostly because growth in admin costs slowed sharply. Pensions revenue soared by 36% to £8 million and life sales more than doubled to £1.4 million, while CTS revenue fell 5%.

STM has pumped a lot of money into the business over the past few years and has kept very much off the City's radar. Of course, it's still spending, and more business developers will be hired in 2015 to sign up new regulated IFAs. But the bulk of that investment is done and the impact on full-year results will become ever more clear in the coming years.

House broker finnCap has pencilled in an 11% increase in revenue for 2015 to £17.7 million, but adjusted pre-tax profit is tipped to surge by 53% to £2.6 million. In 2016, it's 5% and 38%, respectively, giving adjusted EPS of 3.9p and 5.4p.

STM is clearly throwing off lots of cash and ended 2014, £5.7 million. Yes, £3.5 million is tied up in the regulatory environment and the firm could repay £2.6 million of convertible loan notes, but the cash pile is set to grow and, with management telling Interactive Investor they have no plans for any acquisitions, the only option appears to be share buybacks, or a resumption of dividends. Certainly, finnCap thinks the latter is the most likely option.

Clearly, there is always the risk to STM of regulatory change, although STM is well-placed to weather any potential upheaval. But there seems little likelihood of this in the foreseeable future. In the meantime, the shares trade on just 8 times current-year EPS estimates, dropping to less than 6 times for next year. That looks cheap, especially for a company tipped to grow earnings by 95% in 2015 and over 38% the year after.

FinnCap is understandably bullish.

"A timing uncertainty surrounding the loan notes suggests a target price of 45p allowing for loan note conversion and 55p were the loan notes redeemed, based on a 10x P/E," says the broker. "This offers upside from the current price of 73% and 115%, respectively. Looking ahead, the strength of the balance sheet allows the group to contemplate re-introducing a progressive dividend policy.

"Without any obvious capex obligations, the pay-out ratio could be generous. Therefore the resulting potential yield relative to the current price could yet prove appealing."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.