Hargreaves Lansdown has proven itself in a tough economic climate

By Alec Hajinoff

It may be a challenge to imagine a company in a pretty bland business of investment management being widely lauded for its customer service. Yet London-listed Hargreaves Lansdown (HL.) is one such company and it does customer service well. Reading the company’s client feedback you would typically see “not the cheapest shop around, but great customer service”. There is no doubt that good customer service can only help retain clients in current economic turbulence. However, what I am intrigued to see is whether there is a link, direct or otherwise, between customer service and the very bottom line.

The twenty eight year old Hargreaves Lansdown (£973m Market Cap) is based in Bristol and in the last several years has turned itself into a fairly well diversified and managed fund supermarket. The 600 employee company runs a stock brokerage, manages its own investment fund (approx. £1bn under management), recruits clients for myriad of other funds and provides financial advisory services. Hargreaves is one of the leading financial service providers in the country and targets primarily individual investors.

The competitive edge of the company over other brokers is its in-house developed Vantage financial administration system (currently accounts for over 60% of annual revenues). Within Vantage investors can manage all their investments in ISAs, SIPPs, funds or equities from only one control panel, if you like. This admin system is underpinned by Hargreaves’ direct selling model under which the company sells funds direct to investors by-passing the customary IFA route, thus generating for itself a proportionately greater margin.

Assets under administration at end of ’08 totalled just a fraction under £10bn. Out of this Hargreaves managed to extract £65.5m of revenue for six months to end of ’08, an increase of 13.5% over previous reporting period. What is worthwhile noting is that 72% of this revenue is recurring (management fees, renewal commissions and interest). Over the last five years Hargreaves grew its revenues at a compound annual rate of 22.7%, a very acceptable rate indeed considering the company operates in a mature industry.

Operating margin has shown a sizable improvement to end up at 53% of revenue in ’08, from 47% in previous reporting period. This was achieved by strong control of administrative expenses, about 60% of which would typically comprise of staff costs. With effective tax rate of 30%, flat on last year, EPS for six months to end of ’08 came in at 5.5 pence a share. This is an improvement of 31% on previous reporting period.

With net income margin at almost 40% (improved every year since ’04) and pro-dividend management, Hargreaves paid out 85% of its earnings in last reporting period (4.7 pence a share, yielding 4.65% on adjusted annual basis).

The balance sheet shows very good liquidity and zero leverage. Current Ratio equals 2, cash and equivalents stand at £72.2m and Net Assets add up to £75m. This, coupled with Hargreaves’ profitability makes it crystal clear - we are looking at an incredibly profitable company with Return on Capital exceeding 69%.

The cash flow statement does not disappoint either. Good working capital management has ensured a £26m cash inflow from operating activities in six months to end of ‘08 (£6m in last reporting period). Because of no debt repayments and very low capital expenditure requirements (£1.1m in-house software development) Hargreaves Lansdown were almost printing money in ‘08.

The current share price of £2.04 fairly accurately reflects intrinsic company worth, however, assuming the management can sustain the current pay out ratio, earnings growth and low revenue volatility (current beta is 0.63) there may be some upside to be gained, although somewhat limited.

The main business drivers to consider for Hargreaves would be increasing assets under administration (requires innovative marketing, gobbled up £6m in costs last year) and solid control of personnel costs.

The company’s business model has proven itself in a tough economic climate, when the FTSE went down by 26% towards the end of ’08, Hargreaves’ assets under administration declined by only 11% with revenue managing to edge up by 13%.

So, whether it is a famed customer service or the fact that the founding directors have got a lot of skin in the business (around 60% of equity), Hargreaves management are doing a quality job.

www.proactiveinvestors.co.uk