Stockwatch: This attractive share thrives on volatility

Is Record finally making music? For the last two to three years this FTSE Fledgling currency manager has traded sideways in terms of underlying financials and share price - significantly due to low volatility in financial markets while central banks have pursued exceptional monetary easing.

However, change is afoot following last January's 18% one-day movement in the Swiss Franc versus the Euro, and a 28% rise in the US dollar versus the Euro in the year to March 2015. Central banks don't want to delay normalising monetary policy (cutting back QE and raising interest rates), but there are still major risks to the system such as Greece, and rising US rates spell trouble for developing countries' debts as they are largely denominated in US dollars. Even if major crises are avoided, there is a shift in expectations underway that more currency volatility is the likely scenario in the years ahead.

This is attracting interest in the currency management services provided by Record plc, which aims to help clients with risk-reducing hedging or capital return strategies. This is mainly achieved through transactions in spot (present) and forward foreign exchange contracts, also a wider range of instruments to help achieve clients' objectives. Revenue generated is strictly fee-based, and there is no evidence the company is inclined to take a (leveraged) gamble on markets - possibly taking an exceptional hit - which is the usual risk to watch for in currency management.

Financials now improving after consolidation years

Latest results for the year to end-March 2015 show pre-tax profit up 18% to £7.7 million on revenue up 6% to £21.1 million, with basic earnings per share up 7.3% to 2.66p. The "assets under management" measures are a bit confusing to judge versus typical asset managers, because Record manages only the impact of foreign exchanges not the underlying assets. So revenue/profit is probably the better verdict of underlying dynamics; furthermore, management says the majority of its growth in clients and assets came late in the financial year, so the full benefit will be felt in 2015/16. There is always going to be some uncertainty as to the extent that engaging potential new clients translates into real business, but this activity is currently proceeding at a high level.

Earnings quality may also be improving with a more diverse spread of clients and products helping with currency issues irrespective of the economic cycle, A strong base of "passive hedging" clients has been built, which, although lower margin, accounts for nearly three-quarters of assets under management. At £8.1 million, its fee contribution has increased from 28% to 40% of total management fees, versus £9.4 million for dynamic hedging. That's down from £11.9 million as a result of cutting fee rates, with "currency-for-return" stable around £2.8 million. Performance fees only contributed £0.5 million, which only applied to two mandates in dynamic hedging - so you are not going to see volatility like in hedge fund performance fees.

Where the set-up is less "outside shareholder-friendly" is the 30% of original operating profit made available to be awarded to staff - a fairly typical city bonus scheme that management would probably argue is vital to attract and retain the best people. "High water marks" do not appear to apply though, e.g. where hedge fund managers must regain any losses before a performance element kicks in.

At least Record directors and senior managers are required to take a proportion of this bonus in shares, subject to a lock-up. On one hand it is a motivating factor, but on another, still a check on earnings growth and in principle also the P/E multiple - currently around 12 times anticipated earnings for the year to end-March 2016. In practice, listed asset management firms with such schemes can still become highly rated if the business does really well.

Dividend potential is likely more positive than conveyed

Notwithstanding quite a volatile record, the total annual payout is up 10% to 1.65p a share, i.e. an historic yield of about 4.5% with the stock currently at around 37p to buy. This is amply supported by £8.0 million of cash generated from operations with financial year-end cash at £12.0 million - last year's dividend payments cost £3.3 million. The board appears very cautious by way of stating it expects to maintain the total dividend at 1.65p, in a context where the business is improving and looks to be supportive. Indeed, the 30 April forecasts by Edison (see table, and which are sponsored by Record) could be conservative also.

Dividends will be set "at least covered by earnings and which allows for future sustainable dividend growth in line with the trend in profitability, such that the total dividend may be more or less than 1.65p a share." This is rather contorted and also contradictory in that "sustained dividend growth" doesn't equate with "more or less than 1.65p", but they probably just want to be prudent and ensure healthy earnings cover. If the business grows then it follows the dividend policy will be more expansive. There is already precedent of 4.6p per share in the 2010 and 2011 financial years.

Also in support of dividends, the table shows very low capital expenditure versus decent cash flow, i.e. the business profile is conducive for shareholder returns - and Record's priority has been genuine returns, which means ordinary dividends rather than buybacks. If earnings per share can recover to at least 4p (as previously achieved in 2010 and 2011) then a 2-3p per share dividend should be possible, implying a prospective yield up to 8% at 37p currently - in which case the stock will re-rate to price the yield more competitively.

So in conclusion, if currency volatility is set to rise in years ahead then Record's risk/reward profile looks attractive.

For more information see recordcm.co.uk