Going long on insolvency as crippled UK businesses face dark days (MANO, BEG)

By Patricia Miller

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When I think of what the UK business landscape is going to look like for the next 18 months, two AIM listed firms come to mind. I’m talking about Manolete Partners (LSE:MANO) and Begbies Traynor (LSE:BEG). I reckon these insolvency specialists will see a huge uptick in cases. Both are the kinds of stocks best picked up on short-term weakness, in my view.

Even with the gov.uk support for small businesses it would be foolish to suspect that thousands of companies will not go under in the current climate. According to a 15 April study by the Corporate Finance Network (CFN), 1 in 10 SMEs have already had to close permanently and liquidate their assets.

If the lockdown lasts three months or more,” write CFN, “the situation looks even more dire, with accountants in the network reporting that 31% will have to close down their business by June.”

A further third of small businesses will likely not be able to access the cash they need to last another two weeks of lockdown.

Stark analysis on 1 April surveying 13,000 small companies suggested a massive 18% would be forced to close by the beginning of May. This represents 4 million UK job losses.

Fast forward to mid-April and the figures keep getting worse.

CFN founder Kirsty McGregor said: “This is now the third week of this, and we are not seeing any improvement for SMEs filter through the system. The announcements don’t translate into cash for businesses. I am really worried that the HMRC Job Retention grants won’t be received before their April payrolls are due to be paid.” 

It is a shoddy state of affairs for UK plc when the only businesses thriving are those that help shut down other companies, but we are where we are. So, I’ve already bought into these two AIM-listed insolvency players and I think they make for a solid long bid.

Big business

Coronavirus came at a point of significant structural weakness. The Red Flag Alert report published by Begbies Traynor, covering Q4 2019 and published in late January 2020, showed financial distress at record levels. Then, 494,000 small businesses were in a state of disarray.

This is an execrable environment for cash-burning startups, the research revealed, as the most recently formed businesses, those registered since 2014, are the ones in greatest distress.

And the numbers of real estate and property businesses — which are seen as a bellweather for the UK economy — rose at the highest rate, up 13% on the previous year to 53,000. Overall, the number of companies in significant financial distress has risen 81% since the start of 2016.

The two companies I am covering are highly profitable and best placed to take advantage of this situation.

Begbies Traynor

Manchester-based Begbies Traynor has long been a fixture of the insolvency scene in the north. The £119 million market cap firm has been operating since 1989 and has much of its original board in place, with namesake Ric Traynor still executive chairman. It does business turnarounds and restructuring as well as liquidations

In recent years as organic growth has slowed, Begbies has started snapping up profitable rival insolvency firms. Before the coronavirus crash, City brokers said they expected earnings to rise 18% in 2020 full year results, then 14% more in FY 2021. I would peg these numbers to breach 20% given the current climate. That would more than enhance a forward P/E ratio of 12.

On a market cap of £110 million, Begbies turns over £60 million a year, with a £3.5 million of pre-tax profit. The share price has repeatedly bounced off a resistance level at 88p but I see a short-term price target of 100p with a higher target of 140p by the end of the year. I am pretty confident investors will start seeing what I see.

Manolete Partners

Manolete operate in a slightly different but no less profitable field to Begbies. Manolete does not just fund insolvency litigation, it buys 90% of its cases from insolvency firms so works on much better margins than its rivals. This allows it to minimise losses and restrict costs.

Changes to UK law in 2015 and 2016 are highly favourable to this model: insolvency is the only area of the law where claims can be bought by a third party.

The London firm topped a strong 2019 for publicly-listed legal companies, with its share price near tripling for a 270% return for canny investors.

It is certainly more profitable than Begbies and as such represents a better opportunity, producing a pre-tax profits of £5.94 million in the last set of full year results.

It has a 67% market share of the third-party insolvency litigation sector in the UK, which means no other company comes remotely close.

CEO Steven Cooklin told the market at the start of April that the business was in a good place despite Covid. There have been some obvious delays to court proceedings because of social distancing but “very few of our cases go to court and we have been conducting mediations using video conferencing services”. A trading update showed a 131% increase in new cases, and gross revenues at £10.1 million for the full year.

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This article does not provide any financial advice and is not a recommendation to deal in any securities or product. Investments may fall in value and an investor may lose some or all of their investment. Past performance is not an indicator of future performance.

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