Coming out of reporting season, an income stock we remain positive about is HFA Holdings, the parent of US-based Fund of Hedge Funds manager Lighthouse Partners.
With a market cap of $324m, HFA is on the small end of the spectrum, however it has a scalable business model and stable cash flows support a punchy 10% dividend yield.
HFA has flown under the radar in recent years as it recovered from the GFC by rebuilding Asset Under Management and Advice (AUMA) and paying down enormous debts used to fund its 2007 acquisition of Lighthouse.
Another reason is that AUMA growth plateaued from 2014 in the context of an ongoing fund of hedge fund (FoHF) industry contraction.
However, Lighthouse is differentiated in the FoHF industry by its ‘managed accounts’ accounts program, which allows it to collect real-time data on portfolios to assess adherence to mandates, providing more transparency, protection and stronger investment governance compared to traditional FoHFs.
This has driven consistent performance at very low volatility, which is attractive to institutional investors in the low rate environment.
The 1H17 result itself was lacklustre, with slightly better than expected fee income due to performance fees offset higher costs driven by a headcount increase. However, the second half looks better with January AUMA of US$8.9 billion above the US$8.7 billion mark reported at 30 December.
The value proposition remains: HFA’s $324m enterprise value (A$324m market value adjusted for net cash of A$31m) is only 8 times our forecast FY17 EBITDA of A$38m. Because the company has US$112m of deferred tax assets, no debt and minimal capital requirements, EBITDA translates strongly to free cash flow. Hence, why its dividend policy is set against EBITDA rather than reported earnings.
Presently the stock is trading at a free cash flow yield of about 13%. It has significant cash reserves for growth or capital management initiatives such as a share buy-back, which we think would be highly accretive for shareholders. We think the stock is worth closer to $3.
Originally published in The Australian newspaper on Tuesday March 14 2017.