SIF Folio: Record's $8bn win could signal a return to growth

My Stock in Focus (SIF) buying screen is showing signs of life once more. The company I want to look at this week, specialist currency manager Record (LON:REC) is a stock I’ve kept an eye on for some years. 

I’ve always been attracted to Record’s high returns and generous dividends. But the lack of growth and fee erosion in recent years has left me questioning whether this niche firm might be losing its edge.

$8bn contract lifts outlook

The picture changed somewhat in September when the firm reported a major new contract win. 

Record has been selected for a dynamic hedging mandate of approximately $8bn in size. In this context, this figure represents the total value of foreign currency client portfolios that could potentially be covered by the hedging mandate. Record refers to this value as Assets Under Management Equivalent (AUME). 

Given that group AUME was $65.9bn at the end of September, it’s clear that this new mandate represents a significant level of new business. Indeed, I think the impact could be greater than these numbers suggest. 

Record’s largest business by AUME is passive hedging. This service generated £6m of revenue from $55.6bn of AUME during H1. 

My understanding is that fee margins are much higher for dynamic hedging, which is a more active approach. Dynamic hedging had just $3.2bn of AUME in H1, but this generated £1.9m of revenue. 

We’re told that fee rates on the new contract are in line with existing rates. My sums suggest this could equate to an extra £4.8m of revenue when the contract reaches full scale. That’s also the conclusion suggested by broker forecasts, which show revenue growth of £4.9m for FY22:

The new contract win clearly has the potential to drive a significant increase in profits. But it does also highlight the lumpy nature of Record’s revenue streams. I don’t think we can rely on a smooth progression upwards.

Perhaps coincidentally, this contract win has come just seven months after new CEO Leslie Hill had replaced 10-year veteran James Wood-Collins. Ms Hill has worked at Record since 1992 and was promoted to pursue “growth opportunities that Record is currently anticipating”. 

Ms Hill has made a flying start in the top job - I’ll be interested to see if this really is the start of a new run of growth, or just lucky timing. In any case, September’s news breathed new life into Record’s share price:

Should SIF buy Record?

Record’s $8bn win has created the kind of positive outlook and momentum that’s needed for a stock to qualify for my SIF buying screen. The shares now pass all of my screening rules. This gives me the option (but not the obligation) to consider adding it to the SIF folio.

One potential concern is that SIF already contains three financial stocks. Out of a total of 15, this represents quite a concentrated level of exposure: 

However, Record’s core proposition to its clients is that its products provide protection against volatility and adverse movements in foreign exchange markets. I don’t think that there’s likely to be too much correlation between Record’s business and the three financial stocks already in the portfolio:

• Sirius Real Estate: German commercial property landlord (added to SIF in March 2020)

• K3 Capital: Corporate broker, specialising in business sales (added to SIF in June 2020)

• Tatton Asset Management: Provides a range of services used by financial advisers (added to SIF in July 2020)

On balance, I’m still happy to consider Record. In my view, the financial sector offers some value at the moment. I’m not averse to being overweight in this sector.

Stockopedia’s algorithms are bullish on this stock too. Record boasts a StockRank of 97 and a style of Super Stock. I’m also encouraged to see that Record now qualifies for the Jim Slater ZULU Principle screen. This screen, modelled on the investing approach used by Jim Slater, has returned an impressive 440% since inception (2012). 

Let’s take a look at Record’s QVM factor scores to see if there’s anything else I should be aware of before deciding whether to invest.

Value: not bad

Record is highly profitable, pays generous dividends and has a strong balance sheet. Despite these attractions, Record’s recent lack of growth had left the stock looking cheap until September’s news came along. I estimate that the shares were trading on just 10 times trailing earnings prior to the contract win.

REC shares have risen by about 50% since then, but I’m still fairly comfortable with the valuation. Record’s earnings yield (EBIT/EV) is almost 10%, well above my 8% minimum. The stock’s trailing yield of 5% is also attractive to me, although it’s well below the level available earlier this year.

There’s no debt and net cash stood close to £19m at the end of September. The broader measure of shareholders’ equity was £25.7m at this time. Given the strong balance sheet, I believe the best way to value this business is relative to its earnings. On that basis, I don’t have any serious concerns.

Quality: high margins have slipped

There’s no doubt in my mind that by most conventional financial metrics, Record is a high quality business. The StockRanks agree, awarding the shares a QualityRank of 98. I believe there are two elements to this high score.

Firstly, this is a highly profitable business with excellent cash generation:

The second element that contributes to the quality score is the group’s Piotroski F-Score of 7/9. This fundamental health score looks at whether a company’s accounts are improving. This view is based on underlying trends in profitability, cash generation and leverage.

I don’t really have any concerns about the quality of this business. The only caveat to this view would be that recent years have seen margins fall, as you can see in the graphic above. My understanding is that this has been due to the group cutting its fees in response to pressure from clients.

This year’s big dynamic hedging win could reverse this trend if my analysis is correct. But maintaining this momentum will be key if the stock is to earn a growth rating.

Momentum: improving

The market appears to be optimistic about the outlook for Record. As the StockRank graphic shows, momentum has improved over the last 30 days, at the expensive of value:

My normal approach to understanding a stock’s MomentumRank is to break it down into its two elements.

Price momentum: Technically, Record’s share price performance has been strong recently:

There seems to be a strong uptrend in place, although I wouldn’t be surprised to see the price pullback a little in the short term.

Earnings estimates: The other element of the momentum score is broker forecasts. As you’d expect for a £90m company that’s quite closely held (founder Neil Record owns 30%), analyst coverage is limited.

However, the direction of travel has been positive recently, thanks to September’s contract win. The earnings outlook for next year has risen by 64% in the last three months:

My decision

As you’ve probably gathered, I have a favourable view on Record. Although the company has not yet proved it can deliver a sustained return to growth, the recent contract win seems likely to support profit growth of over 50% next year. 

I don’t think the FY22 forecast P/E of 12 and 6% yield look expensive, given Record’s strong balance sheet and high margins. 

I’ve decided to add Record to the SIF Folio and my personal holdings this week. As always, I’ll make the trade after this article has been published. 

Please let me know what you think about Record in the comments. Is this firm a class act with growth potential, or an ultra-niche business that’s too small to scale?