3i Group PLC (LON: III) – Maintaining dividend and lean cost base with a cautious investment approach

3i Group PLC (LON: III) is a FTSE 100 listed Investment Company. It was founded in 1945 with a capital of £15 million, and presently, it is operating as a leading international investment manager. It is engaged in two primary businesses – Private Equity and Infrastructure, which is specialised in core investment markets in North America and Northern Europe. The Private Equity division generally invests in Companies with enterprise value of €100 million – €500 million at acquisition, to generate capital returns. The focused sectors of investments comprise of Consumer, Healthcare, Industrial, and Business & Technology Services. Adjacently, the Infrastructure business invests to generate income yield and capital returns, by investing in economic infrastructure and greenfield project investments in developed economies, principally Europe. In FY20 (ended 31 March 2020), the Company conducted 13 bolt-on acquisitions and invested £1,062 million of proprietary capital.

  

(Source: Presentation, Company Website)

Key Fundamental Statistics



Industry Outlook Dynamics

The capital markets rallied in the calendar year 2019 despite political and economic uncertainty driven by the US-China trade war, Brexit, and signs of slowing growth in major economies such as China and Germany. However, the outbreak of the coronavirus pandemic and the resultant economic impact due to social distancing triggered sharp falls in pricing across global markets.

As per the recent publication from Research and Markets, the global asset management market was valued at approximately US$598.9 billion in 2020, and it is projected to reach US$788.8 billion by 2023. In 2019, the market size was $656.9 billion, and it declined in 2020 due to the Covid-19 outbreak and the measures to contain it.

Growth Prospects and Risk Assessment

The Private Equity portfolio consists of 32 Companies in four sectors across northern Europe, the UK, and North America. It reflects the geographic and sector diversification to provide resilience to the business. Adjacently, Scandlines division continues to yield a strong cash return for the Company since reinvestment in the FY19. Overall, 3i has a conservative balance sheet since the restructuring in 2012, which is underpinned by the availability of £845 million in gross cash (as of 31 March 2020) after returning cash dividends of £363 million. Moreover, it has a reputation of 75-year history as a responsible investor, with a global network of advisers and business leaders to identify opportunities and drive significant shareholders’ value. Furthermore, in FY20, the Company also completed 13 bolt-on acquisitions for the Private Equity portfolio, while the portfolio investment company – “Action” opened 230 new stores and generated LFL sales growth of 5.6%.

3i Group continues to have a conviction in the “Action” (portfolio company) growth story. The net sales, EBITDA and number of stores have grown from 2013 to 2019 on a CAGR basis by 28%, 27% and 25%, respectively. The Company has an exceptional track record of growth and attractive returns. In the financial year 2019, the action generated revenue progress of 21%, LFL sales growth of 5.6% and EBITDA increased by 20%. A discount platform primed to deliver outstanding growth for the long-term. In 2019, the Group showed good earnings growth in top 20 Private Equity investments. The Company is focused on managing the existing portfolio and is prudent in the management of liquidity and balance sheet.

 

(Source: Presentation, Company Website)

However, there are certain risks to business performance. The Covid-19 pandemic and wider economic downturn have been impacting the portfolio value of assets. Also, the investment rates and quality of new assets are lower than anticipations. Further, operational underperformance can impact earnings growth and exit plans. Moreover, the ongoing market volatility arising from geopolitical and economic uncertainties can dampen investor sentiments. Furthermore, the subdued M&A activity in the core sectors can reduce the investor appetite for the Company’s assets.

3i follows the conservative approach in managing capital resources and may have to raise long-term debt or use other financing options to manage realisation and investment flows. Any change in regulations by government, consumer behaviour and other business risks will impact the portfolio of the Company. The Group’s performance is also subject to liquidity risk, technology risk and uncertainties arising from exchange rate fluctuations.

Segment Analysis

In FY20, the Company segmented the business into three divisions – Private Equity, Infrastructure, and Scandlines. The Scandlines division was previously reported as Corporate Assets. The Scandlines comprises of investment previously managed in Private Equity and Corporate Assets.


(Source: Presentation, Company Website)

Synopsis of Recent Developments

5 June 2020: 3i Group PLC issued a 20-year £400 million bond (coupon of 3.75%), to further strengthen the balance sheet to withstand Covid-19 scenario.

2 January 2020: The Company announced the appointed of Alexandra Schaapveld as a non-executive Director, which came in effect from 1 January 2020.

Key Shareholders

Trading Update for the Period Q1 FY2021

On 30 July 2020, the Company provided a performance update for the three months to 30 June 2020 (Q1 FY21), with a strong start to the financial year 2021. Despite the significant economic and social disruption caused by the Covid-19 pandemic, the Private Equity portfolio demonstrated resilient performance in Q1 FY21. Strong performance was observed in sales, EBITDA and cash generation, as all stores reopened in mid-May 2020. In July 2020, it also delivered a strong performance, with a cash balance of more than €631 million by the end of July 2020. LTM (last twelve months) sales are higher than the total sales in FY2019, while LTM EBITDA to the end of July 2020 has recovered to €539 million. In the seven months to the end of July 2020, 48 new stores were opened. Also, it is on track to meet the target to open 152 new stores in 2020.

In April 2020, the Company has completed the £20 million of equity injection in Hans Anders. It invested a £17 million in Basic-Fit to provide expansion capital during June 2020. Further, in July 2020, the single-use Bioprocessing platform acquired Sani-Tech West, Inc. This acquisition will significantly expand the combined 3i Group’s global footprint and market-leading product portfolio. Overall, the Infrastructure portfolio was performing as expected earlier. It witnessed a good share price recovery from 3i Infrastructure Plc (3iN), with generating value growth of £121 million. In the first quarter of 2021, Scandlines demonstrated resilient performance, supported by stable freight volumes.

Led by the euro and US dollar strengthened against sterling, the Company recognised a net £144 million gain on foreign exchange in Q1 FY21. The diluted NAV (Net Asset Value) per share surged to 858 pence at 30 June 2020 against the 804 pence at 31 March 2020, while a total return of 6.8% for the three months to 30 June 2020. On 30 June 2020, the gross debt and net debt was £975 million and £146 million, respectively. At the start of July 2020, the Company had received an amount of approximately £159 million from the sale of Kinolt and ACR.During the first quarter of 2021, the 3i Group Pension Plan Trustees completed a £650 million buy-in transaction with Legal & General. On 30 June 2020, the IAS 19 surplus stood at £148 million.

Financial Highlights (FY2020)


(Source: Company Website)

On 14th May 2020, the Company announced the results for the year to 31 March 2020, with a resilient performance for the year in these unprecedented times of major social and economic disruption. In FY2020, the Company generated a gross investment return of £318 million (2019: £1,407 million) and operating profit before carried interest of £215 million (2019: £1,295 million). The total return for the financial year 2020 stood at £253 million (2019: £1,252 million), representing a 3% of the profit on opening shareholders’ funds (2019: 18%). On 31 March 2020, the diluted NAV (Net Asset Value) per share tumbled 1% to 804 pence (31 March 2019: 815 pence). Total dividend per share was 35 pence for FY2020. Since the restructuring in 2012, the Company had a conservative balance sheet strategy, with gross cash of £845 million as at 31 March 2020 and generated an operating cash profit of £40 million.

Financial Ratios

Reported profitability metrics for the financial year 2020 stood higher than the Industry Median, reflecting higher revenue generated and better control over expenses. On the liquidity front, 3i Group Plc’s current ratio was higher than the industry median, which showed that Group has sufficient current assets to pay short-term obligations. On leverage front, the debt-equity ratio was 0.08x, which was lower as compared to the industry median of 0.16x, reflecting that the company is less leveraged as compared to the industry.

Share Price Performance Analysis
 

Daily Chart as on 17 August 2020, before the market close (Source: Refinitiv, Thomson Reuters)

On 17 August 2020, at the time of writing (before the market close, at 9:37 AM GMT+1), 3i Group Plc shares were trading at GBX 924.20, up by 0.15% against the previous day closing price. Stock 52 week High and Low were GBX 1,189.00 and GBX 529.80, respectively.

Bullish Technical Indicators

From the technical standpoint, the shares were trading well above the short-term support level of 20, 50 and 100-day simple moving average prices, which reflects an upward trend in the stock. Also, 14-day RSI is currently in an oversold zone, which means there is a good potential for a short term rebound in the stock price. MACD line is placed above the central line, indicating a bullish setup. The Company’s stock has delivered a positive return of around 14.46% in the last three months.

3i Group Plc Vs FTSE 100 Index (3 Months)

 

(Source: Refinitiv, Thomson Reuters)

In the last three months, 3i Group Plc share price has delivered 14.36% return as compared to the 0.78% return of FTSE 100 index, which shows that the stock has outperformed the index during the last three months.

 Valuation Methodology

Price/Book Value Approach (NTM)



To compare 3i Group Plc with peers, Price/Book Value multiple has been used. The peers are Tikehau Capital SCA (Price/NTM Book Value was 0.97x), Catella AB  (Price/NTM Book Value was 1.20x), Leonteq AG(Price/NTM Book Value was 0.99x), Union Financiere de France Banque SA (Price/NTM Book Value was 1.57x), XPS Pensions Group Plc (Price/NTM Book Value was 1.67x)  and Burford Capital Plc (Price/NTM Book Value was 0.94x). The Average of Price/NTM Book Value of the Company’s peers was 1.23x (approx.).

Business Outlook Scenario

The Group made a solid start to the financial year 2021 and achieved a total return of 6.8% with NAV per share of 858 pence. Despite the social and economic disruption caused due to Covid-19 pandemic, the Group delivered a strong performance in Q1 FY2021 from the majority of Private Equity portfolio. With the reopening of all stores across locations, the Company witnessed resilient sales, EBITDA and Cash generation. 3i completed bolt-on acquisitions for Bioprocessing platform investment and Evernex in July 2020 and provided the capital of £37 million to Hans Anders and Basic-Fit for business support. The Company issued 3.75% bond for the 20-year period for £400 million to strengthening the balance sheet to tackle the impact of Covid-19. The Company also witnessed a decent recovery in share price for 3iN (3i Infrastructure Plc). During the lockdown period, the Company continues to work remotely across the US, Asia and Northern Europe. Overall, the Company shall be able to navigate through the short-term uncertainties since it has a diverse and resilient portfolio, strong balance sheet position, expertise in geographic and sector profile.

The Company entered FY21 with the most uncertain outlook. However, the management is confident that 3i’s portfolio is quite resilient and diverse to provide substantial strength to the balance sheet. It has a strong balance sheet and lean cost base with no pressure to realise assets in the portfolio. It expects the investment rate in FY21 to be lower than the previous year as the focus during the pandemic is to grow the existing portfolio. However, it will continue to build an interesting pipeline to explore investment opportunities. Therefore, it should emerge from the crisis with renewed strength.



 (Source: Presentation, Company Website)

Over the course of 4 years (FY16 – FY20), the Company’s dividend surged from 22 pence per share in FY16 to 37.50 pence per share in FY20. Compounded annual growth rate (CAGR) stood at 14.26%.

Based on the decent growth prospects and support from the valuation as done using the above method, we have given a “BUY” recommendation on 3i Group at the current market price of GBX 913.20 (as on 17 August 2020, before the market close at 8:22 AM GMT+1) with lower double-digit upside potential based on 1.23x Price/NTM Book Value (approx.) on FY21E book value per share (approx.).
 
 
*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.
*Dividend Yield may vary as per the stock price movement.

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