Questor share tip: Sell Hargreaves Lansdown it's overvalued

Hargreaves Lansdown
£13.45-152p
Questor says SELL

HARGREAVES Lansdown has seen its shares more than double during the past 12 months. However, Questor is concerned the shares are now looking overvalued as investors have priced in a very optimistic view of the future for the company.

The FTSE 100 financial advisory group reported record revenue and profits for the first half ended December 31. The strong start was certainly encouraging but even the company itself admitted it was an “exceptional start” and that the results were “a little unusual” given that they were boosted by the one-off event of the Royal Mail float.

Customers continue to flock to the service. Hargreaves said that client recruitment was stronger than expected, with 77,000 joining the service since the start of the financial year, bringing the total to 584,000. The company said around 27,000 of these new investors had focused their activity exclusively on the flotation of Royal Mail, which listed on the stock market in October. It said it expects “many of these” will become wider investors in future.

The growth in client numbers of about 15pc is impressive, but once the Royal Mail float effect is removed then the growth rate is reduced to 10pc. This double-digit growth rate has also been helped by the retail distribution review or RDR.

Customers seeking financial advice are finding that their traditional sources of expertise – individual financial advisers (IFAs) – are disappearing. IFAs will have to charge an hourly rate or declare fees up front after the RDR came into effect last year. Mr Hargreaves believes some IFAs have chosen retirement on existing pension packages built on previous commissions, leaving customers to migrate to Hargreaves Lansdown.

Revenue increased by 13pc during the period and pre-tax profits increased by 11pc to £104m. Assets under administration (AuA) increased to £43bn, a 43pc increase on the same period last year.

This is a very strong performance, the majority of which has been driven by demand for the service; however it has been flattered by external effects. Once money has found a new home, it tends to be “sticky”, meaning new clients will stay with the group, guaranteeing it a future revenue stream.

Hargreaves points out about 80pc of revenue is recurring from existing clients. This creates a snowball effect in revenue and profits, but what this also means is that the profits are exposed to movements in the stock market. Peter Hargreaves, the group’s co-founder and executive director, said the shares were operationally geared and would do worse when the market falls and outperform on the upside.

During the past six months, the FTSE All-Share has risen by 10pc, and if no new customers had joined Hargreaves at all, the AuA would still have increased by 10pc, tracking the stock market.

In practice this means that if we take the £3bn increase in the AuA that is attributable to the rising market, and apply Hargreaves’ 56 basis-point admin fee, that means about £17m in revenue and £11m in operating profit (taking a 65pc operating margin) during the past six months, or 11pc of the total, is due to the rising stock market alone. Stock markets don’t always go up.

Hargreaves shares currently trade on more than 40 times forecast earnings per share (see table). Questor thinks the shares need a more conservative outlook. Once adjusted for RDR slowing down, the Royal Mail one-off and a possible marked slowdown, then the pre-tax profits could struggle to advance by the forecast 16pc this year and 18pc next year.

For the long-term investor, Hargreaves is a successful, profitable company with a 2.1pc forecast dividend yield that was given an 11pc boost at the interim stage – ex-dividend March 12 and paid April 11. Questor last recommended holding onto the shares (£10.14, September 5) and they have risen 36pc since then, but the current price is looking far too rich. Sell.