Small-cap financials that add up

Several diversified financial stocks have been darlings for fund managers … here they are.

PORTFOLIO POINT: Certain diversified small cap financial stocks have been delivering hot returns in the current climate. Here’s a list of fund manager darlings.

Sentiment is now at its highest level in 15 months, according to CoreData’s latest quarterly Investor Sentiment Index.

In other words, Australian investors are regaining their appetite for risk. CoreData suggests that Australian investors are becoming more optimistic about the economy, business conditions and the sharemarket.

Amongst the diversified financial services sector, which typically offers lightly geared leverage to stockmarket recovery, there are a limited number of companies with proven track records and strong management teams that most small-cap fund managers are willing to invest in when the risk play is on.

Last Friday, Austbrokers (ASX code: AUB) went ex a 21.5 cent dividend but still managed to post a 4% gain in its share price for the day.

Shares in Austbrokers, a darling of small-cap fund managers for some time, are up 36% over the past year.

Austbrokers invests in general insurance brokers and underwriting agencies. Its revenues are derived from commissions and fees generated by selling insurance policies and therefore it offers leverage to growth in premium rates, sums insured and the general level of economic activity.

For FY2012 it reported 20% growth in net profit after tax to $25.6 million, having completed seven acquisitions during the year.

Austbrokers is forecasting further premium increases in FY2013 driving ‘moderate’ profit growth.

In its annual report released last week, the company said it expects further acquisition opportunities to emerge despite new entrants to the market.

Austbrokers trades at just over 15 times FY2013 earnings, with the market expecting the company to post 10% EPS growth over the next couple of years. The stock is offering a prospective yield of just 4%. This compares with a less than 14 times multiple for the broader small-cap index. Its market cap now stands at $462 million.

Another market darling has been salary packaging house McMillan Shakespeare (ASX code: MMS). Its stock has risen 46% over the past year and now trades at 14.8 times FY2013 expected earnings, despite also offering a yield of just 4%. McMillan’s market cap now stands at $906 million.

Funds management group Magellan Financial Group has also enjoyed a stellar year to date.

Magellan Financial Group is a funds management business focused on global equities for high net worth and retail investors in Australia and New Zealand, as well as a limited number of globally-focused investment funds for institutional investors

By its own description its investment strategy is straight forward.

Its portfolio is made up of big-name US brands that are household names around the globe and which any retail investor can obtain direct exposure if they choose.

To build its portfolio Magellan has created a team of 17 investment professionals marketed to financial planners and the like by a 12-strong distribution team.

In the year to June, Magellan posted a 136% improvement in net profit to $13.7 million, built on the payment of $9 million in performance fees during FY2013. Employment expenses rose 60% to $11.5 million.

The question is, just how high are the barriers to entry for Magellan’s line of work? It has achieved enormous support from the financial planning community for its suite of global products in a market dominated by locally focussed fund managers.

Shares in Magellan have been on a wild ride since a capital raising at $0.98 in April 2007. The global financial crisis hit hard, and shares in Magellan bottomed at about $0.34 in March 2009. They were to start a gradual recovery before skyrocketing 145% so far this calendar year to $3.38. Its market cap now stands at $515 million.

The share price increase has made the investment bankers that founded the business even wealthier than they were before they started the business.

Chairman Chris Mackay is sitting on stock with a valuation of about $60 million while managing director Hamish Douglass is sitting on stock worth about $70 million.

Cavalene Holdings, an entity associated with James Packer, is sitting on stock worth $46 million.

Those waiting for at least a partial recovery in the broader stockmarket before resuming their buying may well have left their move a little late – at least when it comes to the best known names in the diversified financial services sector.

I believe better value is to be had amongst the smaller financial services stocks including accountancy group WHK (ASX code: WHG), trustee company Equity Trustees (ASX code: EQT) and financial planning group Centrepoint Alliance (ASX code: CAF).

Including these names, I research eight financial services groups that possess an average FY13f P/E of 10x and a dividend yield of 6.7%. These figures look attractive relative to the S&P/ASX 200 Diversified Financials industry group, which is priced on a P/E of 12.6x and a dividend yield of 5.6%.

Hugh Robertson is an executive director of Investorfirst Securities.

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