Chief Executive’s Report
I am delighted to report on yet another year of continued progress for AFH in the financial planning-led wealth managent market. The year under review produced a sixth consecutive year of growth and improved profitability since joining AIM in 2014.
2019 was yet another year of continued progress for the Company in the financial planning-led wealth management market. Organic gross inflows of funds again exceeded 10% of our opening position and new business revenues from financial planning advice to both new and existing clients reached £15 million, a 25% increase above 2018 levels.
In addition, we successfully completed and integrated eight acquisitions with a combined capped value of £30.9 million, and continued to increase our profitability, as measured by Underlying EBITDA, by 65% for the year to £17.2 million.
AFH continues to focus on the long-term needs of its clients and to reducing their overall cost of investing. Our clients entrust us to help them meet their financial planning objectives and we recognise that over a period of 20 years or more the cost of investing can represent a material cost compared to the original investment. For this reason, AFH uses its size and buying power for the benefit of its clients and has, since IPO, demonstrated this strategy by consistently reducing third party costs for clients. In November 2018, AFH introduced a platform fee free proposition for those clients who chose our own platform and during the year the growth in our segregated mandates further reduced the fund management charges to our clients, resulting in a total charge for clients choosing this service, including ongoing financial advice, significantly below 2%.
The three new aspirational targets set out in January 2019, and mentioned in the Chairman’s introduction, provide clear and measurable targets for the Company and, while challenging, were set with confidence based on the Company’s record of exceeding its previous objectives that were set in 2016. I am pleased to report that during the year we have moved forward towards meeting all of these targets. In particular, our scale has enabled us to have taken a large step towards achieving our Underlying EBITDA margin target of 25%, with an increase to 23.2% (2018 20.6%), while continuing to build an infrastructure capable of achieving all three aspirations within the timeframe set.
The Group is underpinned by the culture that is encapsulated in our business model. The Board recognises the multitude of stakeholders served by the AFH community and seeks to balance the interests of all stakeholders in implementing its business strategy. This is particularly apparent in implementing the Group’s acquisition strategy, where an alignment of cultures has been proven to be fundamental to the successful integration and success of acquired businesses. As discussed above, there can be challenges when acquiring multi adviser businesses where a minority of advisers are vendors and the interests of all parties require alignment.
In the early summer months, the Board considered that, while attractive consolidation opportunities continued to exist, it was not in shareholders’ interest to raise further equity capital at the share price at that time. Having carried out a review of all options with our professional advisers, the Company issued £15 million five-year CULS and agreed with HSBC the terms of a modest debt facility. The combination of these instruments provided the Company with access to £27 million of available acquisition and working capital finance at a combined annualised cost below 4%. Since the completion of the CULS, the Company has completed four acquisitions with a maximum consideration of £9.75 million.
The acquisitions made during the year included our largest multi adviser transaction to date, CTL Three Limited, while continuing to focus on vendor adviser businesses and the assets of smaller retiring IFAs to whose clients we can offer the advantages of our discretionary managed proposition. However, our mantra, that clients’ assets will not be moved unless there is a clear benefit to them and that there is no commercial benefit to vendors of moving client assets, remains. In aggregate, acquisitions made during the year continued to trade at previous EBITDA levels through the integration period, retaining the clients, with many taking advantage of the enhanced AFH service proposition.
While the board continues to focus on the future opportunities for the IFA and Wealth Management Sector, 2019 was an exceptional year for our face-to-face Protection Broking business, which generated record levels of revenue while improving persistency rates for the second successive year since the acquisition of Eunisure Limited in 2017. During the year, the business expanded its operations into Wales, and since the year end, has further developed in Scotland through the recruitment of an experienced team of advisers. The success of the introduction of a non-indemnity model was greater than anticipated, requiring additional working capital to fund the growth, and as announced in September, this model has been re-balanced since the year end to retain the benefits of non-indemnity business while ensuring that the mix within the protection division does not require additional working capital in 2020.
The Group strategy to increase shareholder value through the expansion of the AFH community remains at the heart of AFH’s growth. This strategy continues to be driven by a combination of organic growth through greater productivity of our advisers and by value accretive acquisitions financed on an earn out model. The financial success of our strategy is monitored regularly by the Board against KPIs (detailed on page 16), by the Board and is measured against the three key aspirational targets set out in the Chairman’s introduction.
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 third-party 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 status as independent financial advisers, providing access for our clients to the whole of market, and to drive down custody and administration costs.
Our strategy has enabled the Group to enjoy annual double-digit organic inflows of Funds under Management and to maintain our low level of outflows in spite of the market pressures; to maintain our high levels of recurring revenue; and to maintain gross margins and to generate 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.
As previously highlighted, the year under review produced a sixth consecutive year of growth and improved profitability since joining AIM in 2014. Increased revenues and improved margins resulted in a 59% increase in statutory Earnings Per Share to 25.4p while underlying Earnings Per Share, increased by 45% to 32.8p.
The double-digit organic growth in Funds under Management, together with productivity per adviser reaching record levels and our protection division again reporting record levels of revenue, was augmented by our acquisitions to generate total revenue for the 12 months ended 31 October 2019 of £74.3 million, 47% above the corresponding period (2018: £50.7 million).
The growing requirement of our clients for financial advice and protection insurance generated £28.3 million (2018: £20.4 million) of new business revenues, while recurring income of £46 million (2018: £30.3 million) continued to strengthen our revenue base and earnings quality, driven by our growing Funds under Management.
As noted above, our retention of clients and their investment funds continued to be high while outflows, including pension drawdown were less than 3% of opening funds under management. Alongside to the organic funds invested by our clients, an additional £1.17 billion of funds were brought under management as the result of acquisitions made during the year.
Gross margins, after absorbing the cost of platform fees for those clients on our own platform, remain strong at 53% (2018: 54%), with the benefits of the non-indemnified model for our protection business enabling this division to report gross margins above 50% during the year.
Gross margins, after absorbing the cost of platform fees for those clients on our own platform, remain strong at 53% (2018: 54%), with the benefits of the non-indemnified model for our protection business enabling
this division to report gross margins above 50% during the year.
As previously reported to the market, we see increased technology supporting our face-to-face advisory model and, since IPO, have consistently invested in technology both operationally and for the benefit of our clients. 2019 was a year of further investment, with over £1.5 million expensed as we targeted long term operational efficiencies and a streamlined experience for our clients. We will continue to build on these technology solutions in the future in order to support our advisers and offer a cyborg service providing greater flexibility in our interaction with existing and potential clients.
Our marketing strategy continues to embrace the digital opportunities and challenges for the sector. Since 2016, the Group 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 year, we reported a 65% 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 growth in our Underlying EBITDA margin above 23% (2018: 20.6%) which confirms our ability to invest further in the business while achieving our aspirational targets in the timeframe set.
The effective rate of Corporation Tax was 21% in the year, reflecting the loss of tax relief for the amortisation of intangible assets purchased after July 2015. The effective rate of tax based on Underlying EBITDA was 17%.
Profit after tax for the year of £10.8 million represented an 82% increase in the year (2018: £6.0 million). After the full year impact of dilution created by our successful fund raisings in the 2018 financial year, statutory Earnings Per Share increased to 25.4p (2018:16.0p). Underlying EBITDA adjusted for tax per share, being Underlying EBITDA less a current tax charge at 19%, is a key measure used by the Board which reflects the cash-based Earnings Per Share generated by the business. This increased by 45% to 32.8p (2018: 22.7p).
As previously reported to the market, our working capital has been impacted by the cash profile of policies sold by the Protection Divisions under Non-Indemnified terms, which has given rise to significant debtor balances. Although this has generated enhanced gross and EBITDA margins, we have seen an £8.5m net decrease in our Group’s working capital, being the movement in trade receivables in respect of these policies. These debtors are due from blue chip insurance companies and will be recovered over a four-year period, generating additional secured cash flow for the division.
As previously advised to the market, from 1 November 2019 the Board have rebalanced the volume of Non-Indemnified and Indemnified policies to eliminate the need for additional working capital in the division in the future.
The balance of the net decrease in working capital reflects the organic growth of the Group. Debtor days for both the Wealth Management division and the Indemnity business written by the Protection division remain in line with previous years.
The Group maintains a dedicated 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 Group completed eight acquisitions with a combined capped value of £30.9 million, including one acquisition with a target value in excess of £10 million (assuming performance criteria are satisfied). In addition to the experience of the advisers who have joined through these acquisitions, the acquisitions added almost £1.2 billion to our Funds under Management. While integration of several of the larger transactions has taken longer and required more management involvement than in past years, it is equally fulfilling to report that most acquisitions have traded successfully. The average deferred pay-out for those acquisitions reaching their final performance milestone again exceeded 90% of expectation based on the trading of those businesses prior to acquisition.
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.
Review of the markets
The year was a volatile one for investors, with global equity markets falling sharply during the last two months of 2018 only to then stage a marked recovery during 2019. The slowdown in global growth, which started in 2018, continued throughout the period, as ongoing uncertainty regarding Brexit and the US-China trade war negatively impacted business sentiment and curbed investment spending. The industrial sector bore the brunt of the slowdown, and countries where manufacturing makes up a large share of the economy were hit hard. However, buoyant household spending meant that the picture for most developed economies was one of slower growth rather than outright contraction.
A sharp turnaround in the stance of central banks was a key driver of financial markets over the period. Against the backdrop of historically low levels of unemployment, the US Federal Reserve raised interest rates in December 2018, continuing its policy of dialling back the emergency stimulus put in place during the financial crisis. However, concern that global economic activity was cooling and the US monetary authorities were tightening policy too quickly contributed to elevated levels of market volatility during the final months of the year, prompting policymakers to change tack.
The Federal Reserve adopted a more dovish position at the beginning of 2019 and, ultimately, went on to cut interest rates in August, September and October, thereby reversing three of the four rate hikes introduced in 2018. Other central banks followed, with the European Central Bank (ECB) announcing it would cut interest rates deeper into negative territory and restart its programme of quantitative easing (QE, or buying bonds) in September.
The dovish pivot on the part of central banks helped fuel a rally in government bonds, as interest rate expectations were pared back. From the end of October 2018 to the end of August 2019, the yield on the benchmark 10-year US Treasury bond more than halved, falling from 3.2% to 1.5%. Negative central bank policy rates in much of Europe and Japan, along with quantitative easing and safe-haven flows pushed the global stock of negatively-yielding debt to a record US$17 trillion in August.
Gilts delivered strong returns over the period, with the 10-year yield falling to a record low of 0.4% at the start of September, as political uncertainty and ultra-low rates in the Euro-zone enhanced the appeal of UK government paper. In turn, lower rates on Gilts and the ongoing hunt for yield meant that the sterling corporate bond market had a good run.
Equity investors had to contend with a series of challenges during the year. Slowing global growth and subdued oil prices weighed on corporate earnings, and the ups and downs of the US-China trade spat produced bouts of volatility. Nevertheless, lower interest rates proved a powerful tonic for equity markets and, with US-China trade tensions easing somewhat over the autumn, the MSCI all-country world equity index notched up gains of around 12%. US equities led the rally, with the S&P500 hitting a record high in October.
In the UK, ongoing uncertainty over Brexit weighed on the performance of both the domestic economy and Sterling risk assets. During the third quarter of 2019, annual GDP growth slowed to just 1.1%, as consumer spending cooled and concern over the UK’s future relationship with the EU held back business investment. Similarly, with Brexit uncertainty making global investors wary of UK equities, the FTSE100 was one of the worst performing major stock markets over the 12-month period. This said, the index still managed to return over 6%.
Brexit also cast a shadow over the UK commercial property market. At a time when online shopping continues to take its toll on high street names, lacklustre consumer confidence compounded the woes of the retail property sector. Although industrial property was a relative bright spot, there were some indications towards the end of the 12-month period that tenant demand was softening. With political uncertainty plaguing UK markets since the referendum, the hope is that greater clarity regarding Brexit will, when it comes, unleash pent-up demand for sterling risk assets.
The UK IFA sector anticipates further demand for professional financial advice driven by the demographic profile of the UK’s mass-affluent population and legislation, that continues to transfer the responsibility for pensions and long-term healthcare onto the individual. This creates significant opportunities for organic growth across the market whilst increasing the long-term relationship of a client with their IFA. This is particularly noticeable in the pension market where clients are, in general, no longer purchasing annuities on retirement but managing their own funding through investment and drawdown and as a result requiring ongoing advice and investment management services from the IFA community.
The Office for National Statistics (ONS) suggests that over 85% of total UK personal wealth is concentrated in the hands of savers over the age of 45 who, between them, hold over £2 trillion of investable assets. While there has been a proliferation of technology driven propositions in recent years, the IFA market continues to see a growing demand for personal, face-to-face advice, in many cases from individuals who, in the past, have not felt the need for, nor sought, professional financial advice.
The client and adviser relationship, together with the likely demand for greater financial guidance throughout the growing mass affluent community, suggests that the IFA remains well positioned to benefit from the social and political changes impacting society as a trusted adviser, and in many cases friend, with a detailed knowledge of a client’s financial aspirations and needs.
IFAs are traditionally small businesses or sole traders, providing advice to clients and distribution to the traditional wealth managers and platforms as, generally, the investment needs of their clients are outsourced. The FCA suggests that there are over 13,000 regulated businesses, the majority of which engage less than five advisers per firm. Furthermore, a recent survey suggests that up to 30% of the principals of these firms are likely to retire within the next five years1. Continuing regulatory pressures, together with the ability of large IFA groups to use their scale for the benefit of their clients, are expected to combine with the demographic profile of the market to require greater efficiencies to serve the growing client population and to drive further consolidation within the sector.
Strategic Business Model
Financial advisory and investment management
Financial advisory, and the ongoing investment management of our client portfolios, represents the core business of AFH. Likewise, the management of our clients’ funds is driven by their attitude to risk on the basis of long-term investments that are measured against the equivalent ARC Private Client Index (“PCI”) and reported regularly to our clients providing the opportunity for them to measure our investment performance in 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. This was as a result of greater productivity and the increase in adviser numbers due to the acquisitions made during the year.
The average discretionary portfolio managed on behalf of our clients continues to be approximately £200,000 of investable assets, the construction of which is primarily based on a clients’ risk appetite and focused on wealth preservation. However, for clients with larger portfolios who wish for a more traditional stockbroking service, AFH Private Wealth was established in 2016 and now manages over £125 million of client assets operating from Bromsgrove and Colwyn Bay.
During the period, the Group continued to invest in the strength of our divisional management team with additional senior appointments made. These external specialists bring valuable experience of larger financial services businesses and complement our continued commitment to develop staff, promoting from within where possible.
As set out below, the Group has a wide geographical coverage of the mainland UK market. While our acquisition strategy does not target specific areas, rather focusing on the quality of the business opportunity and the culture of that business, the acquisitions completed in the year encompassed many regions and enabled us to extend our service proposition across the UK.
Through our acquisition strategy, we have grown our employed adviser base to complement the already established self-employed adviser model. This strategy has allowed us to broaden our appeal in the IFA market and recruit in a challenging market where demand continues to exceed supply.
During the year, our initial financial planning fees totalled £15.1 million, an increase of £2.9 million (23%) above our 2018 results, reflecting the increasing client requirements for financial planning highlighted in previous reports. This is being driven by the changes to the UK pension market, with its associated opportunities and risks, as well as developing lifestyle needs.
Ongoing management fees increased to £45 million (2018: £29.3 million), reflecting the increased Funds under Management which, as noted above, grew to £6.2 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 to new business within this division, which remained stable at 69%.
As noted above, the division invested heavily in IT and marketing initiatives during the year and deployed additional management resource to the integration of the larger acquisitions made in 2018 and early 2019. Notwithstanding this increased cost, the division generated an increased Underlying EBITDA of £14.2 million, 41% above the 2018 level of £10.1 million, representing a 24% margin on revenue (2018: 24%).
Our protection broking division, established in 2017, performed strongly during the year, generating £14.2m of revenue at an improved 54% gross margin (2018: 44%). The increase was due, in part, to the full year impact of the move from an 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 policy premium.
The division generated Underlying EBITDA of £5.4 million (2018: £2.7 million), representing a 38% margin on revenue (2018: 30%), demonstrating the benefits of scale highlighted in our last report.
In assessing its appetite for financial gearing, the Board considers the structure of the AFH acquisition model with over 50% of the maximum consideration to be deferred and subject to performance criteria as a component of the Group’s financing structure, providing cost effective and unsecured leverage for the benefit of our shareholders.
During the year, the Group successfully raised £15 million of funds through the placing of 4% CULS, with a five-year conversion price of 420p. At year end, the Group remained free of secured debt, except for a mortgage held on the freehold property acquired in 2015. As previously reported, following the year end the Company signed deal terms with HSBC for a £12 million secured debt facility which can be used to fund working capital and future acquisitions. No amount has been drawn down on that facility to date.
Over 65% of the funds raised from the CULS were used to make new acquisitions during the fourth quarter, which are expected to drive future Earnings Per Share.
The Group continues to maintain a strong cash position and, furthermore, all regulated subsidiary companies reported significant margins above their regulatory and stress-tested capital requirements as at 31 October 2019.
At the year end, the Group had a maximum £37.9 million of deferred consideration outstanding, subject to performance criteria, together with £15.7 million of CULS and corporate bonds. Based on past performance approximately 90% of the deferred consideration would expect to crystallise over the next three financial periods.
Current year trading
Trading in the initial months of the current year continued to follow the trend set in 2019, with consistent levels of new business generated by our existing advisers in spite of the political uncertainty during November and December.
The Group retains strong cash balances, in excess of its regulatory requirements, and its increasing adoption of technology and focus on digital marketing is generating new opportunities for organic growth, which remains the base on which the business has grown. The Board believes that the demand for a professional financial planning led investment service will continue to grow and that the scale of AFH will enable the Group to benefit from the regulatory and economic climate anticipated in 2020.
Trading remains strong and in line with the Board’s expectations and the current levels of activity underpins the Directors’ confidence for the continued progress of the Group in the current year and thereafter in line with its aspirational targets.
Chief Executive Officer
17 January 2020
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