Chief Executive’s Report
2018 marked an exceptional year of progress for the Company in the financial planning led wealth management market. We successfully completed and integrated 16 acquisitions with a combined value of £34 million during the period, completed two placings raising funds totalling £32.5 million and continued to increase our profitability, as measured by Underlying EBITDA increasing by 85% for the year to £10.4 million.
Of our three aspirational targets set out at the beginning of 2017, we achieved the first of these targets during the period with our underlying EBITDA margin exceeding 20%. Post period end we also reached our Funds under Management target of £5 billion, achieving the second of our mid-term aspirational targets. Considering our continued strong growth, we saw a sharp increase in our revenue to £50.7 million, the Board is confident that the final aspirational target of revenues totalling £75 million per annum will be achieved ahead of our original expectations.
As previously highlighted, the year under review produced our fifth consecutive year of growth and improved profitability since joining AIM in 2014. Increased revenues and improved margins resulted in a 43% increase in Earnings per Share to 16.0p after considering the dilutive impact of our successful fundraisings in 2018. Underlying Earnings per Share, excluding amortisation of our acquired client portfolios increased by 34% to 22.7p.
The success of integrating our acquisitions complemented doubledigit organic growth with productivity per adviser reaching record levels. Revenue for the 12 months ended 31 October 2018 of £50.7 million was over 50% above the corresponding period (2017: £33.6 million) and continues our progress to our aspirational revenue target.
The growing requirement of our clients for financial advice generated £20.4 million (2017: £12.2 million) of new business revenues, while recurring income of £30.3 million (2017: £21.4 million) continued to strengthen our revenue base, driven by our growing funds under management.
In addition to the organic funds invested, an additional £1.5 billion of funds were brought under management as the result of acquisitions made during the year.
Gross margins remain strong at 54% (2017: 53%). The gross margin of our core business remained at 55% (2017: 55%) while we were again able to utilise our growing purchasing power for the benefit of our clients and reduce third-party costs for them for a fourth successive year.
2018 was a year of further investment in our technology and infrastructure, as we continued to seek operational efficiencies and offer a streamlined experience to our clients. We are building technology solutions to support our advisers and provide greater flexibility and personalisation in our interaction with existing and potential clients and expect this investment to continue into 2019 and beyond.
Our marketing strategy continues to embrace the digital opportunities and challenges for the sector. Since 2016 the Company has invested heavily in establishing a marketing capability to support a growing national business and to extend beyond the traditional IFA routes to market. While we believe that face to face advisory remains the best model to serve clients’ needs, our evolving digital approach is expected to significantly expand our target market and to provide greater benefits to individuals and corporates who join the AFH community.
The significant growth of the Group has made it possible to finance these marketing and IT projects, which we believe will provide clear commercial advantages for our clients and drive further consolidation in the market while generating significant shareholder and client value in the future.
During the period we reported an 85% increase in underlying EBITDA and a further improvement to our underlying EBITDA margin, as the efficiencies and economies of scale we continue to target were reflected in our results. I am particularly pleased by the achievement of increasing our EBITDA margin above 20% (2017: 17%) as this is one of our key internal metrics and the first of our financial aspirations to be met.
The effective rate of Corporation Tax increased to 23.5% in the year reflecting the loss of tax relief for the amortisation of intangible assets purchased after July 2015. This resulted in an ongoing disallowable non cash expense of £1.4 million. The effective rate of tax based on Underlying EBITDA was 18%.
Profit after tax for the year of £6.0 million represents a 94% increase in the year (2017: £3.1 million) and after the dilution created by our successful fund raisings during the year has increased reported Earnings Per Share to 16.0p (2017: 11.2p). Underlying Earnings per Share, EBITDA plus non-cash sharebased payments as adjusted for tax, is a key measure used by the Board as it reflects the cash Earnings per Share generated by the business. As noted above, in 2018 this increased to 22.7p (2017: 17.0p), representing a 34% increase.
The Company’s strategy to increase shareholder value through the expansion of the AFH community remains at the heart of our growth. This strategy continues to be driven by a combination of organic growth through greater productivity of our advisers and by value accretive acquisitions. At the start of the 2017 financial year the Board set itself three financial aspirations over a three to five-year timeframe:
- Funds under Management of £5 billion
- Revenues of £75 million
- Underlying EBITDA margin of 20% on revenue
In December 2018 we announced that the milestone of £5 billion Funds under Management had been met and, in this report, I am pleased to confirm that the EBITDA margin for the 2018 financial year was also achieved. The Company remains on target to meet our revenue aspiration.
As a result of these achievements the Board has set new milestones with the objective of meeting them within a three to five year timeframe.
- Funds under Management of £10 billion
- Revenues of £140 million per annum
- Underlying EBITDA margin of 25% on revenue
Culture is at the centre of any successful organisation and remains the driving force of both our internal growth and acquisitions. Our values and “brand pillars”, are set out in this Annual Report. These have been documented to ensure that we are able to measure and achieve both our vision and financial aspirations.
Central to our strategy is to put clients’ interests first to build a sustainable business that reflects our vision, including a drive to reduce the cost of ancillary services for our clients and to embrace them in the AFH community. During the year we continued to reduce fund-management fees while retaining our independent status, providing access for our clients to the whole of the market and to drive down custody and administration costs. During the summer we announced that platform fees would no longer be charged to clients on the AFH Direct platform in what we believe to be a unique proposition for clients of IFA businesses and one that will drive further growth for the Company as new clients and potential acquisition targets recognise the benefits of joining the AFH community.
Our strategy has enabled the Company to enjoy annual doubledigit organic growth in both Funds under Management and recurring revenue since we joined AIM in 2014 while maintaining gross margins and generating operating efficiencies to drive growth in Earnings per Share.
The Board remains committed to maintaining our existing strategy to meet our clients’ ongoing needs in order to fulfil our vision and expand our brand throughout the UK financial services sector.
The Company maintains an in-house acquisitions and integration team that allows us to undertake multiple acquisitions and to integrate them fully into the AFH model. During the year the Company completed 16 acquisitions with a combined value of £34 million, including two acquisitions with a target value in excess of £5 million (assuming performance criteria are satisfied).
In addition to the experience of the advisers who have joined through these acquisitions we added almost £1.5 billion to our Funds under Management as a result of the combined transactions. It is equally fulfilling to be able to report that once again prior-year acquisitions have traded successfully. The average deferred pay-out for those acquisitions reaching a performance milestone has again exceeded 90% of the target set at the time of the transactions, which as previously noted include growth expectations.
The acquisition of IFA businesses during the year again encompassed retiring IFAs, whose client portfolios have been transitioned to existing AFH advisers, as well as larger organisations whose clients and advisers have been absorbed into the AFH model. This approach allows investments to be retained on existing platforms and products where appropriate but enables clients to move to our cost-effective discretionary service where a clear benefit to the client can be demonstrated. Integration of acquisitions made during the year continues to be carried out successfully and I am pleased to report that overall the acquisitions are trading above target.
The year proved to be a difficult one for financial markets, as investors grappled with the headwinds of rising interest rates and growing tensions over trade. At the beginning of the year, hopes were high for a continuation of the synchronised upswing in the global economy, but these were soon dashed. Growth in the US accelerated, fuelled by the Trump tax cuts. However, most of the rest of the world slowed, as Beijing sought to clamp down on leverage and rebalance the Chinese economy, while political uncertainty and softer external demand weighed on activity into Europe.
The withdrawal of the emergency monetary stimulus put in place following the financial crisis was a key focus for investors. Buoyant domestic demand and a strong labour market emboldened the US Federal Reserve to continue to wind down its holdings of government bonds and gradually push up interest rates. In turn, tighter US monetary policy served to lift government bond yields, contributing to periodic bouts of volatility in global equity markets. The trade policies of the Trump White House also unsettled markets during the period. President Trump’s first year in office was characterised by the introduction of market-friendly policies, including tax reform and deregulation. However, moving into his second year, the focus shifted to trade, where the president’s protectionist instincts are more contentious. In a bid to reduce the US trade deficit and safeguard American jobs, President Trump announced levies on imported steel and aluminium, and initiated a tariff war with China. Against this backdrop, global equity markets struggled. US equities delivered positive returns, as a reduction in corporation tax ushered in double-digit earnings growth, and the relatively closed nature of the US economy provided some insulation from the slowdown in global trade. However, in most other regions, including the Euro-zone and Japan, equity markets fell back. Emerging markets underperformed as concerns over the Chinese economy grew, and an appreciation of the US dollar during the second half of the year put pressure on economies with high levels of external debt, notably Turkey.
In the UK, ongoing uncertainty regarding Brexit continued to dampen sentiment. This said, the fall in UK equity markets was not as severe as that witnessed in many other countries. UK large caps were supported by the depreciation of the pound during the second half of the year, which boosted the sterling value of overseas revenues. In addition, the recovery in the oil price helped lift the energy sector. By contrast, retailers suffered, as sales shifted online and the World Cup induced pick-up in spending over the summer proved fleeting. The woes of the UK retail sector were also reflected in the commercial property market. Demand for retail property continued to ease, as a string of high-profile retailers either went into administration or announced store closures. However, with manufacturers benefitting from the competitive exchange rate, buoyant demand for industrial property meant that the UK commercial property sector as a whole continued to provide income and capital growth during the period. The performance of the UK bond market was negatively impacted by hikes in interest rates from the Bank of England during the year. Citing low unemployment and rising domestic inflation pressures the Bank of England hiked interest rates by 25 basis points in November 2017 – the first increase in 10 years – and followed up with a further rise in August 2018, taking the bank’s policy rate to 0.75%. This increase pushed up yields on short-term UK government bonds (Gilts) causing their price to fall back. The rise in Gilt yields weighed on sterling corporate bonds, although the sector did manage to eke out marginal positive returns.
Financial advisory and investment management
Financial advisory and the ongoing investment management of our client portfolios represent the core business of AFH. The ongoing management of our clients’ funds is driven by their attitude to risk on the basis of long-term investment, measured against the equivalent ARC Private Client Index (“PCI”) and reported regularly to our clients providing the opportunity for them to place our investment performance into the context of a range of discretionary investment managers. During the year revenue from our initial financial planning for clients and the ongoing management of their investments increased as a result of greater productivity and the increase in adviser numbers due to acquisitions that were made during the year.
The average discretionary client portfolio continues to be approximately £200,000 and based on their risk appetite is focussed on wealth preservation. However, for clients with larger portfolios who wish for a more traditional stockbroking service, AFH Private Wealth, with operations in Bromsgrove and Colwyn Bay, was established in 2016 and now manages over £150 million of client assets.
During the period the Company continued to invest in the strength of our investment team with additional senior appointments and in January 2018 AFH set up a series of segregated funds in a cost-efficient structure for our clients. During the year seven funds were established across a range of equity markets using independent fund management groups to manage the portfolio.
As set out opposite, the Company has a wide geographical coverage of the mainland UK market. While our acquisition strategy does not target specific areas, rather focussing on the quality of the business opportunity and the culture of that business, the acquisitions completed in the year encompass many regions and enabled us to extend our service proposition across the UK.
During the year our initial financial planning fees totalled £12.2 million, an increase of £2.2 million (23%) above our 2017 results, reflecting the increasing client requirements for financial planning driven by changing legislation, the changes to the UK pension market, with its associated opportunities and risks, as well as developing lifestyle needs.
Ongoing management fees increased to £29.3 million (2017: £20.6 million), reflecting the increased Funds under Management which, as noted above, grew to £4.4 billion during the year as a result of net organic inflows together with assets attached to acquisitions completed during the year. This increase was reflected in the ratio of recurring income within this division which rose to 71% (2017: 69%).
Gross margins in our core business remain at 55%, reflecting the level of business generated centrally relative to that self-generated by our advisers.
The division generated EBITDA of £10.1 million (2017: £6.6 million), representing a 24% margin on revenue (2017: 22%), again demonstrating the benefits of scale that was highlighted in my last report.
Our protection broking division, established in 2017, performed strongly during the year, generating £9.1 million of revenue at a 45% gross margin (2017: 35%). The increase was due, in part, to a move from indemnified to a non-indemnified model with selected providers under which AFH receives revenue on a monthly basis, in line with the premium received by the providers rather than as an initial commission, in exchange for an increased share of the overall commission.
During the year the division extended its channels of distribution to a telephone-based operation which the directors believe to offer significant growth opportunity in the future. Further investment has been made in this operation after the year end to scale the business during 2019.
In assessing its appetite for financial gearing, the Board considers the deferred consideration outstanding on acquisitions as a component of the Company’s financing structuring, providing cost effective and unsecured leverage for the benefit of our shareholders.
The Company remains free of secured debt, with the exception of a mortgage held on the freehold property acquired in 2015 and maintains a capital structure that the Board believes provides an appropriate level of gearing through the deferred consideration outstanding on acquisitions and through Unsecured Corporate Bonds. The Company continues to maintain a net cash position and all regulated subsidiary companies reported significant margins above their regulatory and stress-tested capital requirements as at 31 October 2018. At the year end the Company had £28.5 million of deferred consideration outstanding, contingent on the achievement of certain growth targets, together with £2.9 million of corporate bonds. Following the year end £2.1 million of the corporate bonds were redeemed in accordance with the relevant Trust Deed.
In December 2017 and October 2018, we concluded equity fund-raisings of £17.5 million and £15 million respectively. I thank our major institutional investors for their continuing support and was pleased to welcome a number of new institutional investors to our share register. The funds were raised to finance the initial cost of our acquisitions and during the financial year £16 million was used for the purchase of sixteen businesses. A further £7.6 million has been used for the acquisition of an additional four businesses, with a potential value of £19 million since the year end.
Current year trading
Trading in the current year has continued to follow the trend set in 2018 with high levels of new business generated by our advisers and initial integration of our recent acquisitions proceeding in line with expectations. Since the beginning of the financial year we have acquired 4 businesses, including CTL3 which added 26 advisers and over £530 million of additional Funds under Management to the Company.
The turbulent markets since October 2018 have impacted our total Funds under Management but the balanced strategy that we adopt on behalf of our clients has mitigated the full effect of the equity market falls. Our outlook for the equity markets remains cautious.
The Company retains strong cash balances in excess of its regulatory requirements and our increasing adoption of technology and focus on digital marketing is generating new opportunities to deliver organic growth. The Directors believe that the demand for a professional financial planning-led investment service will continue to grow and that the scale of AFH will enable the Company to benefit from the regulatory and economic change anticipated in 2019.
While the Company continues to actively seek high quality businesses to acquire and enhance the Company, the Directors remain focussed on ensuring that only Earnings per share enhancing transactions are undertaken. While the commercial benefits of growth through acquisition are clear, the financial model is based on a suitable arbitrage differential being maintained though an effective public equity market. In view of the current uncertainty in the public markets, the Directors believe that the pace of additional acquisitions will be determined by the availability of additional equity funding at appropriate values.
Trading remains strong and in line with the Board’s expectations and the activity of the first quarter of the year underpins the Directors’ confidence for the continued progress of the Company in the current year and thereafter in line with its new aspirational targets.
Chief Executive Officer
18 January 2019
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