Mention of investment bubbles or the phrase irrational exuberance immediately brings to mind speculative fads such as tulip mania, the original dotcom boom or even the current cryptocurrency craze. But what kind of strange bubble is it that could have wrapped up within it a south-west London brewer, an industrial floor manufacturer and a retro-friendly luminescent so drink manufacturer?
To give you a clue, all of the above – in turn, Young & Co’s Brewery plc, James Halstead plc and Nichols plc (which makes Vimto) – are AIM-listed and each qualifies for business property relief or BPR, meaning investors in these companies receive relief from inheritance tax (IHT). Add in the government move to allow AIM shares to be wrapped in an ISA in 2013, and it led to a relative explosion of IHT solutions and the popularity of BPR-qualifying companies soared in sympathy.
Hence, James Halstead, which has grown revenues at a steady if unspectacular rate of an average of just 2.7% a year for the past five years, trades on a trailing p/e ratio of 25x.
Or the brewer Young & Co, which with a similar revenue growth profile of 7% on average for the past five years, has a trailing p/e ratio of nearly 21x. And Nichols, where growth stalled between 2013 and 2015 before putting in a 7% rise in 2016 and 13% in 2017, all of which is apparently worth a trailing p/e ratio of just over 24x.
“We would agree that some stocks, popular with IHT investors, have high valuations that do not seem to be wholly justified by the outlook for the company’s revenues and earnings, particularly when compared to similar stocks that are not AIM-listed,” said Anna Wilson, fund manager at Amati Global Investors.
A classic bubble, then; albeit one focused on a discrete area within the total universe of AIM and what turns this into an area of concern for investors is the potential for the government to tinker with, or even scrap altogether, the BPR rules. Indeed, the Office of Tax Simplification (OTS) is currently undertaking a review of the rules around IHT and is expected to report at some point this autumn.
A fork in the road
“The phrase I use is that some AIM stocks are ‘pregnant with BPR risk’,” said Stephen English, head of AIM at Liverpool-based investment managers and stockbrokers Blankstone Sington and manager of their AIM IHT portfolio.
It is hard to quantify what might happen to some of what he calls these ‘AIM blue chips’ if the government were to pull the rug from under BPR – or even what might constitute those changes – but the general assumption is that there would be substantial falls in some share prices.
“The question of a valuation ‘floor’ is a difficult one to answer as there are surely different ways in which BPR support might be taken away,” said Wilson.
“It may not be done retrospectively, but for future AIM issuance. The withdrawal of BPR support might be reserved for specific sectors, leaving more speculative or unprofitable investments covered. Looking at each stock on its individual merits is therefore key – some companies have the underlying growth to protect their valuations, others might not.”
This parting of the valuation ways would mean, as English pointed out, that should the worst happen and all AIM stocks suffer a share price reverse in the immediate aftermath of any announcement then a quick reckoning will occur of winners and losers. “You will see a bifurcation where some will gap down and stay down and get lower,” he said. “Others will go down and then will quickly rebound because there is an investment case there, irrespective of BR qualification.”
With most IHT portfolio services containing between 30 and 40 stocks, the maths of BPR mean that as Brian Moretta, head of tax enhanced research and investment analyst at Hardman & Co, said: “There is scope for [providers] to do something different.”
“This is all about constraints,” he added. “AIM as a whole has a reasonable diversity. The opportunity is that AIM is a bit less efficient but with associated greater upside potential.”
The further down the market cap ladder, the less research will be available – a trend that has been exacerbated by the imposition of MIFID II on the division of analysis and execution. “That means there is less coverage and we have to work harder,” said Gervais Williams, fund manager at Miton who manages among other funds the Miton UK Smaller Companies fund and the Miton UK Microcap Trust. “As a growth team, we prefer companies which are out of the limelight and overlooked.”
English is fishing in similar waters, albeit through an IHT lens, looking for more embryonic companies in terms of listing with a sub £150m in market cap sweet spot. He said these types of company o er investors “twin kicker” of performance. “First, they are smaller, they are under-owned, and their price is lower so your price/earnings ratio is lower,” he added. “Second, they are generally offering you much stronger earnings growth.”
popularity of AIM, making the point that active managers have moved away from “an exclusive focus” on FTSE 350 stocks.
“Until recent years funds were closely aligned with the mainstream indices,” he said. “But over the last three to five years that has become less popular. This is partly due to the rise of index funds. Active managers have sought to increase exposure elsewhere and quite a few have moved over to AIM stocks. There is more money going into growth stocks.”
English agrees which is why he believes the way some IHT managers manage in this space makes for a robust investment proposition regardless. And as Wilson put it: “AIM stocks are increasingly bought by institutions that are not investing for BPR relief, as the market has become a destination for high growth tech, media and pharmaceutical companies.
This flow of money has an additional political dimension. It might be argued the last thing the current government would want to do would be to upset the AIM applecart. Indeed, the latest from the Treasury is that it remains “fully committed to supporting AIM” which it sees as a vital cog in the UK economy.
As English pointed out, the IHT portfolio providers are not the only ones with a dog in this fight. The London Stock Exchange will also be keen to wield its lobbying power. “There has been some fantastic success stories on AIMs; AIM is worth over £100bn by market cap now,” he said.
“HMRC appreciates the job AIM does in terms of fostering growth capital for the fastest growing companies, and they understand that SMEs are grist to the mill from a job creation view.”
Yet as English concluded: “You can never say never. The bigger risk would be a change in government.” But that is an argument for another day.
Avoiding the crush – Stephen English’s AIM micro-caps
Park Group plc
Market cap: £142m
If anyone is looking at a Christmas savings club, then Park Group is their likeliest provider with over 190,000 customer accounts and total customer numbers at over 436,000 in the year to June 2018. As English said, the company accumulates savers’ cash during the course of the year and distributes it from September onwards. “That cash is earning next to nothing at the moment because interest rates are very low,” he said. “But if interest rates normalise, Park Group will be one of the few companies to enjoy a signifi cant boost to profits, driving the share price appreciably higher at a time when more indebted companies are likely to falter.”
Market cap: £232m
Having floated on AIM and raised £11.8m in April 2017, the corporate foreign exchange specialist Alpha FX demonstrates English’s willingness to invest in an IPO. He explained that a lot of his IHT portfolio peers will avoid any new issue and he is careful to point out that he will only invest in a very small percentage of AIM floats. “The acronym ‘It’s Probably Overpriced’ is pretty apt for the vast majority of them, that is why we are ultra careful,” he said. Of those he has gone for, though, the share price rises since debut had in the main been very impressive, including Alpha FX which, having floated at 195p and with a market cap of just £64.2m (below the level where many of English’ peers can get involved), recently hit an all-time high in early October of 700p.
Curtis Banks Group plc
Market cap: £152m
With over £12bn of assets under administration Curtis Banks is one of the UK’s top providers of SIPPs and SSASs. While not insubstantial at a market cap of £152m, Curtis Banks is still too small for many larger BPR investors to consider, a quirk that English actively seeks to exploit. Size alone gives little indication over quality and English said Curtis Banks ticks a number of boxes for IHT-driven investors. “Profits are growing at double-digit rate, the balance sheet is very strong and by charging fixed fees rather than ad valorem, it will be largely insulated against any fall in the value of assets that it administers,” he added. “Operating margins should expand to a very attractive 30% and investors are set receive a dividend yield of over 2.6%”