Hargreaves Lansdown: Growth Story

by The U.K. Income Investor

Hargreaves Lansdown (HL) stock has delivered great returns over the past decade or so. The investment services giant, well known for its integrated fund and share dealing platform, went public back in mid-2007 at 160 pence per share. My screen shows a current share price of circa 1,660 pence. Chuck in over 320 pence per share in cumulative dividend cash, and I have the total return here coming in at over 20% per annum on average since IPO. Impressive.

Clearly, this one has been a story of considerable growth. A quick glance at its FY08 annual report shows that the company had circa £11.1B worth of assets under administration at the end of that year. That figure had grown to £96.7B as of the end of April (its fiscal year ends in June). The company currently sports a combined total of 1.3 million ISA and SIPP accounts, plus around 324,000 general Fund and Share accounts.

Unsurprisingly given the above, profit growth has been strong as well. The company posted net profit of around £42.4M back in FY08 – equal to around 9 pence per share. Those figures have since increased to roughly £265M and 55 pence per share respectively on a trailing-twelve-month basis. A quick number crunch puts average annual per-share profit growth at around 17% over that period.

Commission Free Trading

Inevitably when discussing this type of business, the issue of commission free trading pops up. With upstarts such as Trading212 and Robinhood offering share dealing free of charge, won’t established players like Hargreaves Lansdown be forced to follow suit? I mean, the company charges circa £11.95 per trade at its most expensive level. At its cheapest, which kicks in at 20-plus monthly trades, commission still clocks in at £5.95 per trade. Hardly cheap, right?

On that face of it, it’s easy to see why that may be a problem. Two things make me think that this isn’t. Firstly, I’d bet that a lot of clients stick with Hargreaves precisely because it is an established name. It is a £7.5B company at time of writing, not to mention a member of the FTSE 100. It is incredibly profitable, with a rock solid balance sheet sporting a £320M net cash position. Debt is non-existent. Partly as a consequence of this, clients with tax-sheltered accounts, which between them account for the majority of assets under administration, tend to be particularly sticky. Even more so for those invested in unit trusts and OEICs. They also tend to regularly add to their accounts, which obviously increases the company’s assets under administration, revenue and, ultimately, profit.

Secondly, and more importantly, dealing charges don’t make up a particular big slice of the pie here in any case. I mean, Shares brought in revenue of £45.7M in 1H20. That was against total company-wide revenue of just under £260M. Indeed, its largest asset class by revenue – Funds – does not even levy dealing charges. It still generated over £100M in revenue for the company in 1H20. It generates revenue here via an annual service charge, the rate of which is tiered depending on assets under administration.

Valuation

With that said, I’m inclined to think that the biggest headwind here is the valuation. Last year, Hargreaves posted normalised earnings per share of 52 pence. My screen shows analysts FY20 profit estimates at around the 57 pence per share mark, which would put the stock at circa 29x earnings. Now, there’s no real reason to expect that figure to contract much right now. Interest rates remain at record low levels, and the company has delivered solid double-digit annual earnings growth over the past decade. It’s just something to bear in mind going forward.

To provide some colour to last that statement, imagine a scenario in which the stock trades at 20x profit ten years from now. Spread over the duration of that period, that headwind would amount to circa 3.6% per annum in total. If earnings-per-share growth averages in the high single-digit area in that time, well, you can see how that would eat into total returns. If we throw in low single-digits from dividend cash, then we get up to high single-digit stockholder returns overall.

Now, the above is just hypothetical. It is perfectly possible that Hargreaves stock continues to command a premium valuation versus the historical market average. It can also carry on growing its assets under administration via a combination of net new business, including from existing clients, and market movements. With that said, I’d be looking for the growth story to carry on at a double-digit pace in order to be comfortable here.

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