MIA Ratings: AJ Bell
Wealth management platforms at scale can be incredibly profitable. Hargreaves Lansdown (HL), the UK’s largest Direct to Consumer (D2C) platform, consistently achieves operating margins above 60%.
AJ Bell (AJB) is less than a quarter of the size of Hargreaves Lansdown by market cap, but its margins are also impressive, and it is scaling its online platforms quickly. Assets Under Administration (AUA) at AJ Bell grew by 23% per annum between 2015 and 2020, significantly outpacing the wider online platform market growth of 11% per annum over the same period.
Here’s the MIA Ratings scorecard for AJ Bell:
The MIA ratings are based on a specific set of criteria, which will allocate higher scores to quality growth stocks. The scores may be interesting to consider as part of wider research, but of course shouldn’t be relied upon to make any investment decisions.
AJ Bell’s scorecard looks pretty good, so let’s take a look at some of the analysis behind the scores for each of the categories.
The financials score is determined from an average of scores across three sub-categories: efficiency of returns, growth, and stability. These are the scores in each category for AJ Bell:
AJ Bell’s aforementioned high operating margins contribute significantly to both the efficiency and growth scores. The chart below shows AJ Bell’s reported operating margins over the last 5 years:
AJ Bell’s operating margin is not only now approaching 40%, but is increasing as the company scales. The scalable IT systems used by online platform providers have a high but relatively fixed cost base, providing operational gearing, and enabling profit margins to increase as the number of customers and, more importantly, AUA increase.
Strong Growth Metrics
The key drivers of AJ Bell’s business are customer numbers and AUA. Wealth management platforms generate a significant portion of their revenues from charges based on the value of customers’ holdings. AJ Bell is not only growing both customer numbers and AUA but is also driving increasing levels of operating profit from each of them, as the charts below show:
This growth in customers and AUA has translated into strong revenue and profit growth over the last few years with revenue CAGR of 18% between 2016 and 2020, and (note the operational gearing here) operating profit CAGR of 31% in the same period.
Valuation and Sentiment
AJ Bell’s share price has been in a consolidation phase since an initial surge following it’s IPO in 2018. With the exception of the market crash in March 2020, the shares have traded in the fairly tight range between 370p and 460p. The shares are currently trading towards the bottom of that range at just over 400p.
The sideways movement of the share price along with increasing reported earnings has resulted in AJ Bell’s trailing price to earnings ratio steadily falling since its peak in 2019. It is now close to its historical low, although the company is still highly rated with a trailing P/E of about 36 times.
Wealth Management Market
The UK wealth management market has several long term structural growth drivers. People are living longer, staying active for longer, and there is increased recognition of the need to save more to be able to afford longer retirements. These drivers are supplemented by Government policies including pension scheme auto-enrolment and tax free ISA accounts. Technology has also made it much easier for consumers to set up and manage investments through online platforms, although these still only account for around 30% of the total UK wealth management market.
The online platform market also has high barriers to entry, initially requiring significant investment in technology to create the scalable and robust systems required to support large volumes of online transactions. New entrants then have to achieve sufficient scale to become profitable. The difficulty in doing this is compounded by the critical importance of having a trusted and recognisable brand.
These dynamics have resulted in the sector being dominated by a handful of companies, with the market leaders (Hargreaves Lansdown in the Direct To Consumer market and Aegon in the Advised Platform market) significantly ahead of the others.
Customer retention rates tend to be high across platform providers (AJ Bell’s retention rate is 95%), which implies that competition is mostly for new customers. How do those potential customers choose between providers? Well, very often they don’t. The recent market study on investment platforms conducted by the FCA found that fewer than half of potential customers research more than one platform, emphasising the importance of reputation and brand awareness.
The study also found that the choice of platform is often a secondary decision, driven initially by the choice of investment product required. Also for those customers that do research different providers, both the range of investment choices and platform charges are considered equally important.
A look at AJ Bell’s latest Annual Report shows their strategy to be pretty well aligned with this research. The report lists four strategy guiding principles:
Propositions to match the customers’ needs
Highly competitive pricing
High quality service
Make investing easy
Growth in customer numbers is currently being driven by younger, less experienced investors, and AJ Bell’s proposition may be appealing more to this group than its competitors. The average age of AJ Bell’s D2C customers is now 43, compared to Hargreaves Lansdown’s 46, and that figure is still falling - the average new customer age for AJ Bell in H121 was 38.
AJ Bell may also have another competitive advantage that shouldn’t be underestimated - culture. In the 2020 Annual Report, the company recognises that “Our people are the most important asset of our business“, and last year AJ Bell broke into the top 25 of the ‘Sunday Times 100 Best Companies To Work For’ list.
The operational gearing in the business means that any reduction in revenue could have a much larger impact on profits. Future revenue growth would be impacted by a significant or sustained downturn in the markets. This in itself would reduce the value of AUA, but may also result in customers losing confidence and withdrawing funds resulting in a further AUA reduction.
The business is also exposed to the UK economy, which can have an affect on the amount of disposable income that customers have available to invest.
Another risk is from regulation. The investment platform market is highly regulated and there is the potential that the FCA could introduce new regulations in the future that have an impact on revenue.
Primed for a Breakout?
AJ Bell has several characteristics indicating that it is a quality business. The latest trading update released ahead of the final results in December also reported continuing strong growth in customers and AUA during 2021.
The shares though continue trade in a narrow range with a premium valuation. How much longer the consolidation phase will last, nobody knows, but eventually the share price will breakout from this range, and when that happens, the shares may become much more interesting.
This article is intended for informational purposes only. It is not a recommendation to buy or sell shares or other investments. Always do your own research before buying or selling any investment or seek professional financial advice.