Cenkos Securities: Market Challenges Met With Average ROE Of 19%

A thoroughbred broker
Cenkos Securities Plc, (CNKS) differentiates itself from other small to medium-sized brokers by its (i) meritocratic remuneration policy, which is highly performance related and leads to a flexible cost structure, (ii) staff ownership of risk, (iii) focus on diversified specific, profitable niches and (iv) dividend and buy-back returns of capital to its owners (average ROE 2008-12 19%). In good times, as well as in recent tougher markets, it has consistently delivered profits and paid dividends. Its relative lack of earnings volatility highlights the value of these key characteristics and the market challenges, fatal to some other brokers, should prove a long-term opportunity rather than a threat for Cenkos.

Cenkos: Quality business model
Cenkos’ business model has a number of differentiating factors. Firstly, remuneration is unit based, transparent and meritocratic. For example, variable compensation accounts for c 85% of executive pay and the total cost/income ratio, averaging 85% 2008-12, had a peak of just 90% in 2010. Staff are remunerated well (on average above peers), but their income generation is well above peers. Secondly, high employee shareholdings and performance-related pay mean staff own risk exposures. Thirdly, the company’s chosen niches mean it is not competing head-on with bulge bracket investment banks and there is no over-dependence on any specific market. Each team has its own P&L, incentivising staff by transparently linking their reward with their unit’s profitability. Fourthly, capital is kept as a scarce resource through a high dividend and buy-back distribution approach. Since 2007, Cenkos has returned £61.6m to shareholders (close to its current market capitalisation). Staff incentivisation has delivered faster than peer revenue growth in good times – 2008-10 income up 111% against 1% at Numis and 27% at Panmure Gordon, although as coverage is not universal, specific hot spots may be missed.

Market challenges met with average ROE of 19%
The small/medium-sized broker market has been strategically and cyclically challenged. Most have reported losses and several failed. Through all this, Cenkos has been profitable and paid dividends, delivering an average annual ROE 2008-12 of 19% (low point of just 10%).

Valuation: Over 40% upside
We believe our estimates leave room for upgrade and with it valuation upside. Cenkos is already appealing to yield investors (2013e: 7.9%). Our absolute methodologies indicate over 40% upside to 137p. Peer comparisons are more mixed and highly variable given earnings volatility and sensitivity to a few deals.

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