Australian Ethical Investment (AEF)

[mark100]

This is a very illiquid stock and is only worth looking at for a longer-term investment. I already hold so this post could be considered a ‘ramp’

AEF is an ethical fund manager. It manages 4 ethical funds with Funds under Management currently standing at $470m.

It has 0.94m shares on issue giving it a market Cap of $29m ($31.00 share price)

The historical FUM are:

FY03 - $212m
FY04 - $267m (26% growth)
FY05 - $311m (16% growth)
FY06 - $417m (34% growth)
Sept 06 - $470m

Historical Earnings per Share are:

FY03 – 23.3c
FY04 – 52.9c (127% growth)
FY05 – 91.7c (73% growth)
FY06 – 145.1c (58% growth)

Historical Cost to Income Ratio is:

FY03 – 95%
FY04 – 89%
FY05 – 84%
FY06 – 79%

Historical ROE is:

FY03 – 4.4%
FY04 – 10.1%
FY05 – 16.1%
FY06 – 21.7%

AEF is trading at 21x historical earnings, which is line with its sector. However based on my estimated earnings for FY07 I think it is trading on a forward PE of around 13.2, which is a substantial discount to its sector.

This discount is probably due to AEF not being covered by any analysts. Also, they never forecast large increases in earnings until they are in the bag. For this reason, the share price tends to play catch up to the increases in earnings.

In my earnings estimate, I have assumed:
Average FUM for FY07 of $470m (may prove conservative)
Revenue as a proportion of FUM stays the same as last year at 2.65%.
Cost to Income ratio of 74.5% (decreasing at a similar rate to previous years)

This gives estimated NPBT of $3.18m and NPAT of $2.22m and EPS of 235cps.

I think AEF is good value at current prices but it takes patience to buy and sell a stake.

[steve fleming]

Hi Mark,

Just noticed your thread on AEF, and agree...am a big fan of AEF and of the fund management sector generally...the recurring management fees are essentially guaranteed, while the operating CF's and capex are minimal....the amazing growth of HHL over the last few years is testament to this.

I understand that a general rule of thumb to value funds management operations is roughly 10% of FUM...I am aware of several private Fund managements businesses that have transacted based on this valuation approach...In terms of ASX-listed pure fund managers you have HHL on a market cap/FUM % of 12%, and HFA on a market cap/FUM % of 13%....obviously AEF lacks the size and scale economies that HHL and HFA have, but as AEF is currently trading on a FUM% of just over 6% (29m/470m), shows the upside potential of AEF as they continue to grow their FUM, and acheive the "efficiency of operations" that AEF often refers to.

I see that HFA is now trading on a fwd PE of 23 which gives an indication of the sector's growth profile (no consensus forecasts that i could see available on Bloomberg for HHL)

AEF's FUM growth has been exceptional...certainly puts them in a strong position to emulate the growth of HHL....As you say, liquidity is an issue, while some will beleive that the payment of 10% of profits each year to community charities (as required by constitution) is contrary to growing shareholder wealth, AEF has, and will contine to, generate substantial year-on-year earnings growth.

As FUM gets closer to $1billion, then AEF will be up there with the likes of OFM and MCK and be seen as a decent size player in the FM industry, and will be re-rated accordingly.

Cheers

[Stranger_Danger]

Gee guys, keep quiet about this one, its hard enough to quietly buy already!

Agree with your comments though. Whilst the complete lack of liquidity means if things go wrong there is basically no way out, I view it as almost an "unlisted private company" investment and, accepting those risks, hold enthusiastically.

Interestingly, the FUM growth has NOT been driven by outsized returns to investors - frankly, their 5 years investment performance has been pretty crap (I'd rather own the company than the products).

Of course, AEF are completely out of the commodities/mining boom which is one of the reasons their returns compare badly. Should this boom at some stage reverse, their "deep green" stance (which unlike some so called ethical investors, they've actually stuck to) should mean they compare a lot better if mining stocks eventually go in the opposite direction.

However, as they've proved with their FUM growth, they are not reliant on this happening - it would just be a rather large cherry on the top, and if marketed correctly, I drool when pondering what they could get their FUM out to in a 5-10 year period.

Disc : Hold AEF.

[steve fleming]

Hi Strangerdanger!

Regarding your comments on liquidity, i can't think of any other company on the ASX with less than a million shares issued...these guys should really do a 1 for 10 split or something...however not really their style

Yep, as you say, recent returns have been average compared to the market, most probably due to the non-exposure to resource stocks....however the 5 year returns on their 3 equity products are all around 10% or higher, which is a pretty good effort.

their very strong anti-uranium stance won't impress too many here on ST, but there is no doubting a large chunk of the population (and media) agree with AEF's view...notwithstadning this, to double FUM in 3 years is outstanding and shows the strong support and interest from the public and sectors of the investment commnity in this sort of product...ethical investment considerations are important to a number of people i know.

Cheers

[mark100]

Hi guys,

As Steve Fleming has said, the rule of thumb for valuing pure funds management plays is 10% of FUM. Obviously AEF has only recently reached 'critical mass' which is why its being valued at only 6%.

If AEF can keep FUM growing at say 20% pa, a falling cost to income ratio should see them post earnings growth of well above this for several years.

My investment decisions are not based around ethical investments however I understand there are increasing number of investors who do take this into consideration. I would expect this market to increase with time.

I also note that HHL donates 10% of pre-tax profit to charity. Also, my Cost to Income ratio for AEF has taken these donations into account.

Probably the most important issue which I forgot to mention in my initial post is the potential for corporate activity. Last year Select Managed Funds (SEM) took a 15% stake. SEM soon after merged with AUW. There is always a possibility that AUW will launch a bid in the future.

cheers

[Stranger_Danger]

Hi Mark,

It is that 15% stake owned by AUW that worries me - I'd hate to see them make a bid of $35 or something in the short term.

My hope is that AUW either sell or ignore their stake - the profits from this share will come from (hopefully) watching a good management increase FUM whilst holding costs.

In this instance, corporate activity is a threat, not a positive.

[mark100]

Very true Stranger Danger. Plenty of growth to come from AEF over the next 5 years without having it cut short by on opportunistic takeover.

cheers

[mark100]

Well it doesn't look like AUW is a seller. I see they've been buying shares over the past few months to take their holding to almost 17%

[mark100]

FUM are now $500m, up 20% in the past 4 months

[steve fleming]

Hi Mark,

some pretty big re-ratings of Fund management stocks over the last couple of months - HHL has moved from a PE of 15 to a PE of 22, HFA is now trading on a fwd PE multiple of 25.

Based on a FUM% valuation, AED is way way undervalued compared to its peers, even allowing for its lack of scale.

Cheers

[mark100]

Hi steve fleming,

The latest update on FUM increases my forecast earnings for this FY making AEF very undervalued as you say.

In H106 the Cost to Income ratio was 81.8%
In H206 is was 77.3%

This ratio has been steadily trending downwards as they gain economies of scale.

Therefore I think the Cost to Income ratio for FY07 could be around say 73%.

Assuming an average FUM for FY07 of around $515m, AEF could earn EPS of around 275c, putting AEF on a PE of around 12.

Obviously its not easy to buy shares at the current price but a few do become available every now and then.

cheers

[Stranger_Danger]

Up to $45, but on the normal tiny volumes.

Have recently stopped buying for the first time in over a year, but very happy holding.

Any predictions as to what happens next? I suspect it settles in the low 40's until the next meaningful news - hopefully good news!