The Finance Ghost sheds light on Alexander Forbes as a business that is heading in the right direction. After all, a 33% increase in the interim dividend for the six months to September 2023 is a juicy reward for shareholders. The payout ratio is also pretty high, with a dividend of 20 cents per share on HEPS from continuing operations of 27 cents per share.
There’s growth. There’s cash flow. But what’s the back story and can the happiness continue?
Strategic acquisitions
Firstly, the correct name for the group is actually Alexforbes. From here on out, I’ll use the new name, especially considering that the new strategy is what is driving the current success. If you search for the listed shares though, you’ll need to use the full name Alexander Forbes Group Holdings.
The recent strategy has been all about building a more focused group. Now, that doesn’t just mean selling off non-core assets. It also means making strategic acquisitions to bolster the businesses that will be relevant going forward. For example, on 1 June 2023 Alexforbes acquired a majority (i.e. controlling) interest in TSA Administration, which is an independent provider of institutional group risk insurance administration services.
Sure, insurance administration is not the most exciting business model around, but do you really care when those dividends hit your account?
An acquisition that might resonate more with you is the purchase of 100% of OUTvest. This is the digital wealth platform in the OUTsurance Group that was launched in 2017. The business works, but was simply too small for OUTsurance and non-core to the group. Within the broader Alexforbes stable, the hope is that synergies will make the whole thing a lot more appealing (and bigger).
So, how do they make their money?
It’s tricky to look at these financial services groups and understand how they really generate all their income. We all understand that there are financial products involved and fees are earned on those products, but the details are what count. To learn more, we can refer to the results for the six months to September 2023.
The largest area of the business is the Investments segment, contributing 41.8% of operating income in the interim period and growing that income by 12%. Institutional blended margin improved in this business, but retail blended margin fell year-on-year due to product mix and a strategy to make retail products more affordable. Total closing assets under management and administration increased 10% year-on-year. The split is strongly in favour of institutional assets, coming in at R369.6 billion vs. R85.9 billion in retail assets.
The next largest division is Retirement Consulting, contributing 29% of operating income and growing by 19%, the highest growth rate in the group. Acquisitions are a big part of the group rate, as this is the area of the business that the TSA Administration business drops into. This isn’t the first acquisition either, with ongoing migration of “consenting funds” from the recent acquisition of Sanlam’s standalone retirement fund administration business. It’s worth noting that administration fee pressure in the retirement game is no joke. Although Alexforbes’ membership base is 20% higher year-on-year, administration fee income was relatively flat.
The rest of the business comprises Healthcare Consulting, Individual Consulting and Multinational Consulting. They are quite similar in size, though Healthcare is only growing at 5% whereas the other two managed 15% and 12% respectively.
What about margins?
Group operating income grew by 13% for the period, so your gut feel must be that profit margins moved higher thanks to such a strong income result. This is where you need to keep in mind that acquisitions are costly and that although a company might be buying revenue, it’s also buying the expenses that come with that revenue.
This is why operating expense growth comes in at 15%, driven by the corporate transactions and general inflationary pressures. Staff costs contributed 62% of the total expense base and they were up 15%, with business-as-usual contributing 12% and acquisitions contributing 3%.
Don’t underestimate technology costs either. Software licensing fees etc. are often denominated in US dollars, so a depreciation of the rand is unhelpful. Those costs were up 8% year-on-year, which is at least well below income growth and a decent display of cost management culture at the group.
The win was in property leases, with that cost down 6% year-on-year. The Sandton lease restructure helps with that.
Higher interest rates: a good thing
When you subtract operating expenses from operating income, you get to profit from operations before non-trading and capital items. The second part of that description makes all the difference, as you’ll soon see.
Before we get to the really volatile stuff, it’s important to understand that this metric is a really helpful way to judge the underlying performance in the group. Growth was 11%, impacted by growth in expenses being ahead of growth in income as discussed above. That’s still a solid performance and well ahead of inflation, so Alexforbes is delivering real growth to investors.
We then get to profit for the period from continuing operations, which was up by a whopping 66%. Before you think that headline earnings per share (HEPS) from continuing operations might adjust for the distortions, HEPS was up by 68%. Clearly, the “non-trading and capital items” make quite the difference.
The most important line item below profit from operations is investment income, which is earned from the regulatory capital and surplus cash position of the group. Higher interest rates are really helpful for Alexforbes, as excess group funds can be invested at a higher rate. Investment income jumped from R60 million to R111 million.
What are the immediate focus areas?
There’s quite a lot of regulatory change coming in this space. The two-pot system is going to drive significant changes in how the retirement industry works, with Alexforbes believing that there will be a positive net impact on group revenue over the long term. If nothing else, greater engagement with members will be required and that creates more selling opportunities for Alexforbes.
Operationally, the focus is on integrating OUTvest into the Alexforbes environment. In the second half of the financial year, Alexforbes aims to launch a discretionary fund management (DFM) capability as part of diversifying into the independent financial adviser market. They can use existing platforms for the DFM push, making this a potentially margin-accretive initiative at relatively low risk. We will have to wait for full-year results to see how this has played out.
If you’re going to hold SA financial services, this isn’t a bad choice
The Alexforbes share price is up more than 25% in the past year. Over five years, the return excluding dividends is 43.5%.
Those dividends are mighty important, as the current trailing yield is around 7%. That’s a strong dividend yield, underpinned by businesses that are highly cash generative and quite dependable in nature. To add to the investment case, there are areas of growth within the group (as evidenced by recent results) and Alexforbes has put a great deal of effort into building a more focused business.
Perhaps best of all, this is a way to gain exposure to the benefits of an environment of structurally higher interest rates, without the same credit loss exposure that is starting to plague the banks. Even with rates expected to start dropping this year, Alexforbes looks like a compelling choice for local financial services exposure.
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