Inheritance tax planning AIM favourite yielding 11% – what’s the catch?

The share price of AIM quoted Redde (LON:REDD), the provider of accident management services and an inheritance tax planning AIM favourite, has been in the doldrums ever since the announcement of its interim results at the end of February 2019. Recent news of its failure to secure the renewal of a sizeable contract has also pulled the shares down further to 4 year lows, this has also seen the forecast dividend yield rise to 11 per cent, but is this compelling return sustainable?

At first glance the interim results for the 6 months ending 31 December 2018 were actually pretty good with revenue up 14% to £291m and pre-tax profit up 7.2% to £21.3m. An interim dividend of 5.50p, equivalent to a yield of 5.5 per cent, highlighted the inheritance tax planning appeal of this AIM company.  However, cash flow wasn’t quite as rosy as usual, with claims taking longer to settle and debtor days rising to 109 from 105 previously. Reported net debt at 31 December 2018 had also risen to £41.2m from £8.5m at 30 June 2018, however in mitigation, this relates to asset backed finance leases, rather than bank debt, so is fairly low risk. The Group increased its car fleet 27% to meet increased hire days which meant finance leases rose.

It’s worth noting that the business doesn’t have any bank borrowings, reflected in the finance costs which only encompass interest on finance leases and bank facility fees; the latter for a facility which isn’t even used.

Management cautioned that growth for the remainder of the second half would not have the beneficial effect experienced last year from the “Beast from the East” – Redde was a beneficiary of the terrible weather.

While the interim results tempered investors’ enthusiasm for the shares, it was the contract renewal announcement which really accelerated the selling.

The failure to secure the renewal of a hire and repair contract with a large insurer won’t have any immediate effect for the current financial year ending June 2019 but will impact 2020. Management now expects a net reduction in sales of approximately £111.9m (representing 18.2 per cent. of consensus expectations) and a reduction in adjusted operating profits of approximately £4.7m (representing 8.7 per cent. of consensus expectations).

Thankfully the pipeline of new business remains encouraging with a number of live prospects, and management remains hopeful it can fill the void.

The stated £4.7m reduction in operating profits on sales of £111.9m suggests the lost contract was at lower margins than the majority of the Group’s business.

At the current share price of 105p the shares trade at an estimated 8.2x revised earnings estimates of 12.8p for the financial year ending June 2020. This looks a very modest rating for a business which will remain highly cash generative and should therefore be able to support the dividend.

Having consistently raised its dividend every year for the past 6 years, the dividend is now forecast to remain flat at 11.7p, moving the forecast dividend yield to approximately 11% at the current share price. That looks appealing to patient, long term inheritance tax planning investors, looking out for some extra income.

There will be concerns that the failure to renew the contract could be the start of other problems, however Redde is well diversified across contracts large and small, regularly winning and losing contracts with insurers. As at 30 June 2018, the most significant five customers represented 23% (2017: 25%) of receivables. That implies an acceptable level of customer concentration.

While the car fleet has grown materially, they have the flexibility to trim this back at short notice.

Hargreaves Lansdown’s reporting of a claimed JPMorgan target price of 11p (rather than 111p!) wasn’t terribly helpful for the share price either – we suggest HL should pay closer attention to their reporting!

Directors have shown their confidence in the business by snapping up £185,000 of shares in aggregate.

Fundamental AIM for Inheritance Tax planning portfolios hold shares in Redde