It’s a good time to be a Spencer. Retail giant Marks & Spencer today reported £1 billion profits for the first time since 1998 and Michael Spencer is that little bit richer too. His inter-dealer broker ICAP has unveiled massive profits across markets.
Private-client brokers have had a torrid time of late but ICAP is in a different space entirely. As the middle man in institutional investing - from bank to bank - ICAP has only benefitted from the volatility in world markets.
The firm unveiled a 31% increase in full year figures. Profits for the year ended 31st March were £330.2m against £251.6m the year before, more than £10m ahead of analysts’ guesses. Revenues came in at £1.3 billion, 18% ahead of estimates.
As a handy result of ICAP’s diversification across financial markets their balance sheet serves as a rough proxy on where the action is. Unsurprisingly, foreign exchange and commodity trading led the volume figures... punts on the soaring price of oil and the dwindling US dollar will likely have topped the order books.
The group also tipped the market that a spate of debt-based buyout bids could be on the cards. "The current environment offers many attractive opportunities to acquire businesses. ICAP is well-placed to make further acquisitions and fund the development of the group using its existing financial capacity," said Michael Spencer.
Spencer also took the opportunity to put to sleep the idea that ICAP would merge with a larger rival. "We are not involved in any discussions or negotiations on that front," said the ICAP boss. This announcement will probably take a little bit of the air out of the share price, but makes good business sense... deals done in this economic environment are unlikely to bear the same premiums as those just one year ago.
ICAP’s castle protected by moat
ICAP balance sheet has a nice consistency to it. It has what Warren Buffett might describe as a wide economic moat surrounding it. Economic moats are the competitive advantage that one company has over another. The moat’s width represents the sustainability of the advantage and hence the sustainability of revenues.
Revenues at the broker have grown while earnings growth has been double-digit for three years on the spin and the group anticipates this trend to continue. We estimate that the underlying annual growth rate of industry revenues, in the medium term, will be more than 10 percent," said Spencer.
The firm’s position, particularly in international debt markets, is comparable with that of a natural monopoly. And the thing about natural monopolies is that they are quite good at holding onto highly expensive share prices. When the London Stock Exchange was in its prime and a member of the natural monopoly club (circa 2006), very high valuations were attached to the group. Now this also as a result of the bidding frenzy surrounding the LSE, but looking at international rivals — CME and NYSE Euronext - the exchange biz had buyers pouring in.
Dealers like ICAP - a business not far removed from the exchanges - are performing strongly. Furthermore, the broker’s business model is a lot more flexible. Unlike the LSE, the long-term health of ICAP is not tied to a single asset class. Hence, the firm’s outperformance coinciding with rank underperformance in the equity markets is not a big surprise.
Stocks out of favour
As we discussed yesterday, the retail investor market is struggling to cope with the general apathy in equity markets. In fact, the only wing of the sector is spreadbetting, where market leader IG Group was reporting good trade amid the volatility. ICAP, not one to miss a trick, has a foothold in this prosperous market too — as they own UK spreadbetter City Index.
Volatility is no good for a long-term investor, and for the conviction to come back, so must the upward trend. But the recent rally in stocks is nothing to take heart from. We may be trading just 6% below recent peaks but the credit crunch is far from over and if you look closely enough you can see why.
Nobody is driving this bull-run.
Trading volumes are so low that brokers, like ICAP, are not just facilitating trading, they’re driving market direction. And they’re not moving them based on the direction of the wider market’s trades, but on their own estimations of sentiment... a recipe for status-quo.
That’s why this rally is a phony. As nice as 6,000 plus FTSE levels are, price is only one element of a powerful pair that drives the trading world. Volume completes the set and volume is nowhere near where it should be. Low levels - and yesterday the average hit it’s lowest point for 2008 - suggest that real the smart money is still on the sidelines.
This upswing has not yet been stress tested. When the big guns come back we will be able to see the true recovery of the UK stock markets. And with earnings season coming to a close, that time could be very soon. In the meantime, recession proof stocks like ICAP look like a good trading idea.
Theo Casey
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