Current trading conditions are proving tricky, but this inter-dealer broken is biding its time, says Phil Oakley. Investors with an appetite for risk should buy in now.
Buying the shares of financial companies is risky because the financial system itself is full of risk. The financial crisis has taught us that you can think everything is OK and then something happens and you find out very quickly that it isn't. Do you really know what a bank owns and owes, for example? Can you trust even a big insurance company not to slash its dividends? Then there is regulation.
To stop financial firms taking the kind of big risks that taxpayers end up paying for if things go wrong, they are being asked to hold a lot more reserves to act as a buffer. This means that they can't make as much money as they did in the past. In short, investing in financial companies is a minefield. You need to tread carefully.
So what to make of inter-dealer broker Tullett Prebon? It makes money acting as a middleman between the buyers and sellers of products such as bonds, currencies, shares and derivatives. As some of these are tricky to trade, the inter-dealer broker provides the necessary liquidity (by tracking down buyers and sellers) to make trading easier. An inter-dealer broker also provides anonymity and allows big customers to buy and sell without revealing who they are.
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This type of business has been going through a rough patch largely because the big banks and hedge funds aren't trading as much as they used to. Inter-dealer brokers do well when financial markets move around a lot, as this leads to more activity. The trouble is that the money printing by central banks has calmed the markets and volatility is low.
Low interest rates have subdued the bond markets. The regulation of risky derivatives means that more of the trades in them have to be done electronically rather than over the telephone.
Competition is also increasing, with firms such as Bloomberg looking to have a slice of the pie. This has led to sharp falls in the profits and share prices of brokers. Tullett's shares are down 12% during the last 12 months compared with a rise of 30% for the FTSE 250 over the same period.
But there will always be a role for skilful inter-dealer brokers that can place difficult trades. And the markets are unlikely to be calm forever. Unlike many banks, Tullett has a flexible cost base (if it makes less money its traders get paid less) and has net cash on the balance sheet rather than debt. It also made a healthy return on capital of 29% last year.
Yes, there are lots of uncertainties. But on the upside you can buy the shares for just seven times projected earnings with a 6.4% dividend yield that is well covered. For that reason, I think Tullett shares are worth a punt.
Verdict: speculative buy
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Phil spent 13 years as an investment analyst for both stockbroking and fund management companies.
After graduating with a MSc in International Banking, Economics & Finance from Liverpool Business School in 1996, Phil went to work for BWD Rensburg, a Liverpool based investment manager. In 2001, he joined ABN AMRO as a transport analyst. After a brief spell as a food retail analyst, he spent five years with ABN's very successful UK Smaller Companies team where he covered engineering, transport and support services stocks.
In 2007, Phil joined Halbis Capital Management as a European equities analyst. He began writing for MoneyWeek in 2010.
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