Hargreaves Lansdown (HL) first appeared on the site back in late June. Shares of the investment platform provider traded for around 1,660p back then, which is around 12% higher than last week’s closing price. They started the year at over 1,905p apiece. Although that performance does not look very good, the firm has actually not had a bad year at all. Assets under administration (“AUA”) increased 5% to £104b in its fiscal 2020, which ended in June. Underlying profit before tax rose 11% to £339.5m in the same period.
The company has also recorded a strong start to its FY21. AUA clocked in at £106.9b at the end of its first quarter, around 3% higher than at the end of FY20. That led to quarterly revenue of £143.7m, a 12% rise year-on-year. For a notionally cyclical business, Hargreaves has not had a bad COVID experience by any means. I can’t say that I would have predicted that back in March.
Recent financial results aside, there is a lot more to like about this company. The historical growth record is something that was mentioned in the prior article and so does not need repeating. Suffice to say, both profit growth and shareholder returns have been excellent here since the company listed back in 2007. Hargreaves is also a staggering profit machine in its own right. Its average return on equity stands at somewhere in the 70% region over the past ten years, which is an almost absurd level of profitability.
A Moat (Of Sorts)
It is worth zooming in on that last sentence since it is an important part of the growth story here. The great thing about ridiculously profitable businesses like this is that they don’t need much funding in order to grow profits. Put another way, it means that they can payout most of those profits to shareholders without compromising future growth. To use Hargreaves as an example, it has generated cumulative net income of circa £1.15b over the past five years. It has paid out circa £825m in the form of regular and special dividends in that time. Despite the nominally high implied payout ratio, profit still increased by 75% over that period.
Usually, such high levels of underlying profitability attract competition. Wide-moat stocks, to coin a Warren Buffett phrase, have durable competitive advantages that shield them from this. That said, Hargreaves is not really a business you would typically expect to sport such a moat for very long. I mean, it makes much of its money by levying fees on client assets. Since folks tend to be cost sensitive, why wouldn’t they simply switch to another firm offering lower charges? That is a question that crops up a lot here, and it is a fair one.
For what it is worth, my guess is that the firm benefits from scale advantages as well as inertia. The latter speaks for itself – a lot of folks simply can’t be bothered to move accounts, especially ISAs and SIPPs, for reasons touched upon in the last piece. Client retention stands at circa 94% here as a result. As for the former, while it is true that Hargreaves charges higher fees, it has also negotiated discounts on the ongoing charges levied by funds. For instance, the popular Lindsell Train Global Equity Fund sports an ongoing charge of 0.65%. At Hargreaves, its discount brings the figure down to 0.50%. This does not quite offset the higher platform charge, which stands at 0.45% per annum, but it is something. You can run the overall numbers against the likes of AJ Bell and Fidelity.
The big question: can the firm sustain this moat well into the future? Well, it has managed to so far, so it would not exactly be a surprise if it did. What is clear, and assuming the underlying business does indeed continue to display extraordinary profitability, is that its shares should trade at a premium valuation to the wider market. Again, that is simply due to its ability to payout most of its profit to shareholders without compromising profit growth. The average firm does not enjoy that advantage.
Given the share price decline, the valuation is more attractive now than back in June. I have the current 1,465p share price equal to around 25x FY20 underlying net profit of 57.8p per share. All other things being equal, long-term EPS growth in the 8% per annum region would lead to double-digit returns. This seems doable from long-term AUA growth, but it still depends on the company sustaining extremely high levels of underlying profitability. All things considered, Hargreaves stock looks like an okay deal right now.
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