Edmond Jackson's Stockwatch: Cenkos Securities

Much better-than-expected 2012 results from Cenkos Securities, an AIM-listed broker specialising in growth companies, reflect a calibre operation alongside improved UK stockmarket conditions and business confidence.

While a price/earnings (P/E) rating of 12 (based on continuing operations) looks fair enough given the markets' uncertainty, with the shares at 90p to buy, a yield over 8% suggests further upside.

At first sight a full payout of earnings looks unrealistic to sustain, however Cenkos is well backed by cash and a high payout policy might be the best way to maximise value for shareholders in a focused business. If the directors engage ambitious acquisitions, for example, they could end up overpaying for employees who don't integrate and leave in due course.

Cenkos did well last year in volatile markets, helped by the rally from autumn 2012 which encouraged smaller companies to tap fund managers' new appetite for risk. Comparing the 2012 interim results with 2012 prelims, revenue was down in the first half from £25.1 million to £20.2 million and pre-tax profit on continuing operations from £5.0 million to £3.5 million. A post-tax profit of £3.5 million from the sale of a Channel Islands operation boosted interim results, otherwise the underlying trend was unexciting - hence the shares' drift to as low as 46p mid-year. Management did not update investors until the latest 5 April prelims, which have surprised on the upside.

For 2012 as a whole, revenue rose 16% to £43.2 million and pre-tax profit from continuing operations jumped 37% to £7.0 million - quite regaining performance in 2009-2010 when the shares were priced at 100p to over 200p, if enjoying a P/E multiple over 20 times in those years. The P/E de-rating most likely followed from the market realising a "growth" rating was optimistic, then overdoing the "cyclical" view in trading the price down to 46p. Profits have recently shown very good recovery, but the trend is more resilience than growth.

Integral to Cenkos's success has been a relatively low fixed cost base and remuneration structure geared to performance, which should help attract and retain high-calibre employees; the success of a broker like this being largely a result of good, cost-effective service. Since its founding in 2005, Cenkos was ranked last March as the leading AIM adviser by clients' market capitalisation and second for its number of clients.

AIM may benefit from the abolition of stamp duty although overall risk appetite among investors remains the key consideration for this market's health; also whether companies regard the listing and maintenance costs as worthwhile to raise capital and maintain a public financial profile.

It is interesting to consider the extent to which UK quantitative easing policies have forced investors to switch from interest-free cash (losing value to inflation) into riskier assets such as smaller company shares, thus helping firms raise money. This could have a wider effect on the UK economy. The stockmarket looks forward when pricing shares and is likely to consider whether capital raisings are gaining some degree of momentum, although sentiment can still change. More important for the market trend than last week's poor US jobs figures will be company earnings reports.

So there tends not to be much revenue visibility in this industry; witness the Cenkos chief executive's limited remarks on the outlook: "Whilst not immune to events in the general economy, our pipeline remains strong and we have made an encouraging start to 2013." Note also, under the risk factors: "The continued uncertain economic outlook may lead to a continuation of the slowdown in primary and secondary fundraising seen in 2012." This latter remark is part of a deliberate attempt to clarify risks however, rather than an all-considered view.

From the 2012 income statement, the operating margin has improved from 12.9% to 15.0%; it remains to be seen if this can improve further. The balance sheet is strong, with no capitalised goodwill or intangibles, net assets of £22.2 million reflecting a similar cash balance which is up from £14.0 million - the cash-flow statement showing £16.2 million net cash flow from operations after interest and tax. There are also nearly £10 million "other current financial assets" although capital resources over regulatory requirements, after share buybacks, are put at £5.8 million.

Trade payables have edged up from £23.5 million to £24.3 million however, compared with trade receivables dropping from £21.8 million to £15.5 million. It looks as if Cenkos is being a lot more diligent chasing up its debtors while creditors are left in limbo; something which sharp-eyed readers of accounts might question if profit/cash is benefiting this way.

With 12.3% of the issued share capital bought back last year, such a "return of capital" should assist earnings growth, however fundamentally I would regard Cenkos as a yield share because it makes sense to keep the business focused and substantially pay out earnings to shareholders.

The management's own substantial shareholdings, for example two directors including the chief executive with about 9.5% of the company each, aligns interests well with outside investors.

The high yield/modest P/E is also a function of the shares' illiquidity making it harder for larger investors to trade shifts in the market, if useful for small investors.

For more information see cenkos.com.