Stockwatch: 30% upside on offer for this AIM-listed firm

Is Lighthouse Group, an AIM-listed national group of independent financial advisers (IFAs), poised for a fresh advance now its finance director is adding to his holding? On 7 and 10 April he bought a total of £14,500 worth at 14.5p a share. This is modest amount, although the normal market size for this £18.5 million company is around £1,000 equivalent.

It comes after the 2016 results showed a 119% advance in pre-tax profit to £1.9 million helped by higher-margin revenues and cost-cutting.

The group offers diversity across individual and corporate business on a broad spectrum of financial advice, having hopefully learned from a £2.4 million loss in 2011 linked to restructuring charges, then over 100 advisers leaving in 2012.

Yet the table shows good progress from 2014 and the stock has risen from 4.8p at the start of 2015 to 14.6p by mid-2016. The finance director is buying a post-results dip from 16p to 14.5p.

Modestly rated, albeit scope to improve

Assuming projections by company broker FinnCap, the forward price/earnings (PE) multiple falls from about 12 below 10 times, versus dividend yield around 2% covered up to 5 times by earnings.

As a snapshot that looks nothing special but compares, for example, with AIM-listed Mattioli Woods, another IFA group I have drawn attention to, its stock roaring ahead nowadays on a forward PE of 23 times and dividend yield of 1.8% with 2.4 times cover.

Mattioli has a stronger track record and much higher 15.0% operating margin (if declining annually since 2012) than the 4.0% Lighthouse achieved last year. But if Lighthouse can continue to evolve well then its rating offers scope to improve in relative context.

Looking more closely at the margin issues, cost of sales are stable taking 69.8% of revenue year-on-year, while other operating expenses were trimmed 7.2% to take 84.7% of gross profit instead of 89.1% in 2015.

Such extent of costs isn't what you ideally want to see but, given its significance in the value equation, it's intriguing how the finance director – with the best perspective over costs – is buying.

Within the gross margin mix, £1.5 million was lost after a "sunset clause" was introduced by the Financial Conduct Authority, offset by a 6% rise in average annualised revenue per adviser and more business on higher margin. The meteoric rise in pre-tax profit mentioned earlier was mainly helped by operating cost cuts from £13.2 million to £12.3 million and a lower depreciation charge.

Static revenue profile albeit growth elements

The five-year table shows revenue stuck stubbornly around £48 million; so while the recurring element has edged up from 48% to 50% in 2016, what scope exists for genuine top-line growth? At present it's more thematic than proven numbers: chiefly an extension of the marketing reach into "Middle Britain" to help with pensions and other advice.

There are three main operations: financial advisory linked to affinity relationships; wealth management under the Carrwood brand; and self-employed advisers operating under their own brands while accessing products available across the Lighthouse group. All three appear to show useful growth elements, promising for the medium term, albeit with 2016 numbers constrained by near-term complexities of the finance industry.

Thus, affinity-led revenues rose 16% to £6.8 million despite a £730,000 reduction in trail revenues (due to regulation change), its operating profit contribution expected to increase as advisory relationships become more effective.

Operating from long-lease modern premises near Brighton, this "Lighthouse Financial Advice" (LFA) side looks well-placed: contractual arrangements exist with 19 affinity groups representing over 6 million people making Lighthouse the largest UK affinity adviser.

Management cites an annual compound growth rate of 18% over the last four years, with the number of affinity partners up from 12 to 19; obviously easier to achieve in a sub-£7 million annual context for affinity revenue. Altogether LFA contributed £15.7 million, down on £16.1 million, implying other aspects not doing too well given the reduction links to the loss of trail revenues.

Similarly, wealth management is a curate's egg. Branded as Carrwood, this side has 45 contractual arrangements with accountancy firms to provide financial advice to their clients. It has seen a 5% fall in revenue to £8.4 million due to a non-recurring pension transfer in 2015, although average annualised revenue production per adviser is said up 10% to £215,000 – generated from advice across all product areas.

In context of 193 auto-enrolment company pension schemes as of end-2016, a further 54 wil be staged in due course, and up to a million small to medium-sized businesses have yet to achieve such schemes as required by mid-2018.

Lighthouse Advisory Services saw revenue slip by £200,000 to £23.8 million as a small number of member IFA firms became directly authorised or left the group, largely offset by annual revenue per adviser rising 7% to £107,000. The launch of in-house Luceo-branded investment funds has attracted £8 million from last September.

So performance is mixed but the modest PE arguably prices this in. More positively, the setbacks appear transitory and there are growth elements to drive better numbers.

Balance sheet offers scope for corporate development

There is no debt and £8.5 million cash (barely changed from £8.4 million at end-2015), albeit a regulatory element before "free cash": see £3.0 million short-term provisions and another £3.0 million longer term, on the balance sheet.

Note 17 in the 2016 annual report (you can download from the company's website) clarifies these provisions as relating to possible policy cancellations, cost of complaints and other commercial liabilities. So there should be at least £2 million for further investment where the cash flow statement shows just £214,000 deployed last year.

Management speaks of expanding the Luceo fund range "significantly" in 2017 "along with complementary offerings" albeit no word of acquisitions. Thus Lighthouse isn't a high-profile growth share like Mattioli Woods has achieved, but its risk/'reward profile tilts favourably versus a modest PE.

The finance director tucking stock away in his ISA looks apposite: target 20p and better as earnings and the rating improve.