We recently assessed the fundamentals for Pinnacle Investment Management Group (ASX:PNI), given that the shares have declined from a recent high of $6.19 in early May. This is despite steady growth in Funds Under Management and the addition of new firms underpinning an outlook for strong revenue growth.
Even down here there is still reason to be cautious.
About Pinnacle Investment Management Group
PNI holds minority equity interests in 13 boutique investment management firms (‘Affiliated Firms’). The business model is to enable high-calibre investment teams to establish a boutique firm and gain access to services provided by PNI. These services include distribution, access to capital, infrastructure, and support services. An attractive aspect of the business model is that while there is some outflow risk from the trend to in-house management by large superannuation funds, PNI has diversity across affiliates and mandates.
The Company’s ownership interests (typically 23-49%) in these boutique investment managers is the key driver of profitability. This is because it diversifies the exposure to any one manager/fund and gives PNI’s earnings exposure to various levels of ‘maturity’ of the underlying businesses. Further, PNI’s profit is leveraged to the profit generated by each manager, which in turn is a function of growth in FUM; performance fee generation; and improving margins (which typically occurs as the manager achieves scale).
Assessing the Key Fundamental Drivers
Growth Strategy Supported by Strong Balance Sheet
The Company has a strong balance sheet position, which supports the strategy of acquiring two new affiliates each year, investment in growth activities and funding support for its affiliates (including by seeding new products) and make dividend payments. The number of affiliates has grown from five in FY13, to 13 in FY19, with gross FUM over this timeframe growing from $10.8b in FY13 to $54.3b in FY19.
Profitability Impacted by Cost Investment
In FY19, PNI’s cost growth (+37%) outstripped revenue growth (+32%), with the high cost growth underpinned by two factors. Firstly, PNI is investing heavily in order to support growth of current affiliates, with increased investment in distribution channels (e.g. international and listed markets). Secondly, investment in/seeding new affiliates where management teams have a strong track record and growth potential. Finally, as PNI bears the cost of providing space for its affiliates until they reach profitability, the Company is also incurring high property costs, including the cost of acquiring additional office space, ahead of further growth.
While investment in affiliates will continue, the rate of cost growth in FY20 (based on Company commentary) is expected to moderate and be below the rate of revenue growth in FY20.
Factors Impacting Fund Flows
Retail inflows (which account for the majority of group FUM) were lower in 2H19. This in turn led to lower than anticipated fund flow and revenue-based fees. While PNI continues to generate net inflows, the quantum is decreasing as inflows fell to $1.5b in 2H19, which has slowed from $5.0b in 1H19 and in excess of $5.5b in both 1H18 and 2H18 per half-year period in 1H18 as fund managers approach capacity.
One reason for the decline in retail inflows in 2H19 (compared to 1H19) relates to current market conditions for value-biased global funds for affiliate Antipodes Partners. Despite the Antipodes Global funds remaining ahead of benchmark since inception (1 July 2015), market strength lately has been driven by growth stocks (as opposed to value stocks). This has meant that underperformance against the benchmark has deteriorated. In particular, the 1-year underperformance for the Global Fund and Global Long Only Fund was -7.49% and -6.72%, respectively.
A second reason is that fund performance more recently has been disappointing. While 94% of managers are outperforming the benchmark on a on 5-year basis, a number of affiliate funds strategies are underperforming benchmark on a 1-year and 3-year horizon.
Outlook for Fund Flows
PNI has identified a strong pipeline of FUM prospects (both retail and institutional) going into FY20. In particular, the Company is confident on the Institutional mandate pipeline and expect to continue to bring LITs/LICs to market in FY20. In context, of the $2.9b in retail inflows in FY19, $1.0b came from Listed Investment Companies (LICs) and Listed Investment Trusts (LITs). Notwithstanding these factors, fund flows in FY20 are expected to slow.
Fundamental View of Pinnacle
Pinnacle is currently trading on a 1-year forward P/E multiple of ~22x. This is at a premium to consensus EPS growth forecasts of 17% and 20%, respectively.
We consider that the current multiple reflects the long-term value in PNI, underpinned by future leverage from short-term investment undertaken to support affiliates and a strong distribution network. However, we consider that there are a number of short-term factors that are likely to limit any re-rating in the shares. These include:
i) General market volatility,
ii) Fund flow uncertainty (in particular institutional net flows have dried up), and
iii) The underperformance of funds within key affiliates (i.e. Firetrail Investments, Antipodes Partners, Hyperion Asset Management) on a 1-year and 3-year basis.
Further, earnings growth over the course of FY20 and FY21 are reliant on moderating cost growth, as well as the on-boarding of new affiliates to drive continued FUM growth (given that organic fund inflows have slowed).
Accordingly, we take a cautious view on PNI at present.
Charting View of Pinnacle
The chart for PNI has looked ugly ever since it gave us a reversal signal last October. At the moment though it does look as though it should head higher in the short term. A few weeks ago we saw PNI retest the low from December, and reverse off that quite strongly with the candle for that week looking particularly bullish. The real test for it will be resistance up near $5. If it can clear that then we can assume that it won’t head lower. Otherwise it may at risk of continuing on with the downtrend.
Michael Gable is managing director of Fairmont Equities.
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