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Hargreaves Lansdown Plc – 07th May 2014

Company Overview:

Hargreaves Lansdown (HL) is one of the UK’s leading financial services businesses. The company provides a multitude of investment-related services including share dealing, discretionary wealth management,  ISA administration, pension administration and custodianship services.

HL is best known for its Vantage brand which enables investors to house a portfolio containing multiple asset classes within the one platform. The group is often perceived as offering a premium brand among the retail investor community, and while not the cheapest, it has distinguished itself from competitors over the years through placing a significant emphasis on the customer experience.

The group earns income through a percentage charge on assets under management as well as commission charges on individual transactions. The biggest contributor to earnings is the annual management fee levied against the market value of assets under management.

Index FTSE 100 Ticker HRGV.L Latest Close 1200.00
52 Week High 1580.62 52 Week Low 845.45 P/E 31.68
Dividend Yield % 1.41 Dividend Cover 1.85 Dividend (Pence) 16.95
CEO: Ian Gorham CFO: Tracey Taylor

Global Economic Recovery Set to Continue Driving Indices and Investor Trading Activity

2013 proved a turning point for global markets and economic recoveries in the developed world as quantitative easing from many of the major central banks and another year of ultra-low interest rates led to a rally in global stock markets. This was while fiscal policies such as the UK government’s Help to Buy housing initiative helped to create a wealth effect which aided a return of both consumer and investor confidence.

The outcome has been UK investors entering 2014 with a different outlook over the year going forward when compared with the same period for 2013, a time that was characterised by ongoing concerns over the elevated levels of share prices, fiscal deadlock in Washington and a potential re-ignition of the euro area crisis.

So far, the volatility seen in equity markets toward the latter half of the last year has continued into 2014, leaving many global indices below their earlier peaks (as of the time of writing). Despite this, the outlook for the months ahead remains bright.

With global growth expectations positive, and a wave of fiscal initiatives in place to support activity at home in the UK, the year ahead looks set to be another of continued high allocations toward equities and increased levels of trading activity.

This could prove positive for the second half performance of Hargreaves Lansdown as higher commissions from execution services, greater fee income from higher valuations on AUM and further inflows from increased tax allowances are likely to continue to drive earnings growth at Hargreaves Lansdown over the remainder of 2014.

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Chancellor’s Budget and Implications for UK Investors

The UK Parliament’s budget announcement of 2014 saw the Chancellor announce a range of rule changes, legislation tweaks and revisions to regulations, most notably where pensions, ISAs and tax relief for businesses are concerned. The most likely change to have proved popular among existing investors was an increase to the individual savings allowance up (or ISA rate) to £15,000, enabling investors to shelter higher amounts of both cash and shares from income tax.

The budget also saw changes to pension rules announced. These will see those with defined benefit schemes afforded greater choice over how they will manage their money. Under the new regime, pensioners will no longer be required to purchase an annuity following retirement, but will now have the option to withdraw all monies held within pension plans to either keep on account, spend freely or invest elsewhere.

In addition to the above changes, the Chancellor announced an increase to the Business Investment Allowance which enables UK companies to invest in plant, equipment and machinery and then reduce their tax liability on eligible corporate profits by an amount up to the sum invested, so long as it falls within the threshold.

The Business Investment Allowance limit was also raised from £250,000 to £500,000 until 31 December 2015. The move is designed to aid growth by boosting the level of business investment within the economy.

Although the effects of tax incentives for businesses may take some time to feed through to the actual economy, and thus be relevant to the performance of investor’s portfolios, the changes to the ISA allowance and pension rules may have a more direct impact.

This is while further along the road ahead, an ageing population in the UK and low savings rates among the general population could lead the government to continue with campaigns designed to increase awareness of the need to provide for retirement, which could also prove positive for new customer acquisitions at HL.

Ultimately, the above measures and trends could lead toward an increased level of cash becoming available for investment over the next 12 – 18 months and outwards which, although unlikely sufficient to prop up markets, may prove positive for trading activity and AUM income at Hargreaves Lansdown.

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Record Gains in Global Stock Markets Drive Hargreaves Lansdown to Records of its Own

While a vintage year for many stock markets, 2013 saw Hargreaves Lansdown achieve records of its own, ensuring that the group retains its crown as the number one investment supermarket in the UK. AUM (assets under management) increased by 43% over the period while consequent revenues and profits also grew by an attractive margin.

In addition to this, the group increased its client base by 13% throughout H1, while also reducing its cost base by a notable measure. This was despite a number of new hires and investments in the technology infrastructure over the period.

Strong performances from global stock markets will have no doubt aided the performance of the group, as an appreciation of assets under management is positive for fees levied. However, auto enrolment for the workplace pensions scheme rolled out by the UK government last year was also believed to have had a positive influence on new client numbers.

Going forward, group strategy sees it continue to focus on key areas such as further developing the Vantage offering by renegotiating fund fees and charges on behalf of its clients as well as by further developing the services under the name.

HL management also intend to continue investing in the group’s new advisory business, while work has already begun on launching an Equity Research division which will see HL offering their own in-house research reports and recommendations, which is an area that the group has previously steered away from. The move is expected to lead toward higher trading volumes while helping to attract and retain new clients.

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Influx of New Clients from Royal Mail IPO Provides Scope to Grow Active Client Base

Although HL posted a strong performance across the board for 2013, one of the areas of out-performance likely to offer long-term benefits to investors in the shares is in new client acquisition. Over the period, HL increased its client base by 13%, or 77,000 clients.

Estimates reported in February’s interim management statement sees 27,000 of these new clients as novice investors who hold shares in Royal Mail alone. Over time, management expect these investors to become more active and to begin building upon their new shareholdings, particularly given the positive performance of Royal Mail shares since their IPO.

In addition to client growth from the previous period, the first half of the New Year has already seen a number of IPOs slated for the coming months, including the Saga flotation.  Should the pipeline for new issues remain strong going forward, then this would be viewed as a positive for new client acquisitions at HL.

HL Hourly Chart

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Risks

While HL has all of the requisite ingredients to continue its 2013 success into the new year, the road ahead is not without risks, both in the macroeconomic environment as well as closer to home.

High valuations across global stock markets and geopolitical conflict present a threat to the performance of equities over the near and medium term. Should markets become struck by a sustained period of weakness then HL revenues could come under pressure as a result of reduced management fees (% of assets charge) and lower trading volumes.

In addition to the above, a highly publicised revolt in January 2014 which resulted from HL’s attempt to increase charges to clients also has the potential to negatively impact upon client retention numbers, trading volumes and fee income. Although the reaction from customers was strong enough to force HL into a retreat on some of its plans, the true extent of the damage, if any, will only become clear when the group reports preliminary results on September 4.

Until this time, there is a risk that the group has suffered a material exodus of clients who will remain attached to the shares. This is while the incident itself highlights the longer term challenge that firms like HL will face in the competitive UK financial services industry – improving margins. The implication of having price sensitive customers is that, in order to grow further, HL will need to build upon its service differentiation strategy while seeking to develop new products and services which will offer sufficient value to help attract and retain clients.

Further from here, recent changes to pension rules could also pose a threat to HL. While we ultimately expect this to be positive for the group, there is the chance that the imagined scenario will not evolve into reality. The worst case scenario outcome for the new rules would see pensioners, with greater control of pension cash, withdrawing in large numbers from HL platforms in order to invest into alternative asset classes such as property, which would be negative for HL earnings.

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Valuation

For the 2013 year HL paid total dividends of 16.95 pence that based upon today’s price equates to a yield of 1.41%, which is covered 1.85 X over by earnings.

After undergoing a year of strong growth across all metrics, HL now trades on a premium to the wider financial sector from a price to earnings perspective. This isn’t surprising. However, it does go some way to increasing the risk attached to the shares as any failure to deliver upon market expectations for a continuation of previous growth could lead to a deeper correction than that which has been seen since the beginning of Q2 2014.

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Summary

Hargreaves Lansdown enjoyed a good year throughout much of 2013 as well as H1 2014, with impressive growth across the business driven by easy monetary policy, low rates and a return of investor confidence.

So far, 2014 has seen a number of changes in tax and pension legislation that will be likely to benefit the group over both the near as well as longer term. In this regard, the increase to the ISA savings allowance rate has the potential to contribute significantly, over time, to growth in AUM, which will be positive for management fee income.

This is while a strong IPO pipeline for the period ahead looks set to support new client growth, most notably in relation to the Saga flotation. In addition to this, the group continues to maintain a strong emphasis on service that bodes well for client retention rates while a management efficiency drive has led the group toward a reduced cost profile without any material impact upon hiring or expansion in key areas.

In summary, the future for HL remains bright over the near to medium term, while the shares now appear to have bottomed following a sell off from their January all time high of 1,577.00 pence.

Our view of the shares sees strong support for prices at or around their previous low of 1,150.00 pence. This is while our medium term price target of 1,480.00 pence indicates our expectation of another push back toward January highs over the remainder of the year.

The next major event scheduled for the group is the release of preliminary results that are due on the 3rd September 2014.

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