Shares in the financial group CMC Markets, best known as a spread betting company, have risen well over 100% so far this year. The market volatility has been good for the group. The longer it continues, the better CMC will do. This performance makes CMC countercyclical so worth holding in difficult markets like the one we’ve seen in 2020.
The strong performance has allowed CMC to increase its dividend by an amazing 640%. Raising the question is it a good income share?
Brief overview of the company
CMC Markets is mostly a spread betting company with 76% of its net trading revenue coming from business to consumer contracts for difference (CFD) and spread betting. This is activity done by individuals and professionals, but excluding institutions. It’s also a stockbroker in Australia with around 17% share of the Australian stockbroking market.
It operates in 12 countries and around 57,000 clients. Its CFD and spread betting business covers Europe, UK, Ireland, Australia, New Zealand, Singapore and Canada.
The company founded by Peter Cruddas, listed on the London Stock Exchange in 2016. Since then for most of the time, the shares have been well below the listing price of 240p. That’s changed recently though due to Covid-19. Volatility has been good for CMC Markets and competitors like IG Group and Plus500.
Dividend rise and recent performance
The increase to the dividend came back in June 2020. The final dividend for the year of 12.18p per share was declared, resulting in a total dividend of 15.03p, up from 2p paid the year before. This was part of the group’s policy of shares 50% of post-tax profit with shareholders.
What allowed management to increase the dividend so drastically was the increase in profit. Profit before tax (PBT) was £98.7mln for the year to 31 March. A healthy increase from £6.3mln the previous year and £60.1mln and £48.5mln in the previous two years.
The performance was driven by a doubling income from clients’ contracts for difference (CFDs) – a financial instrument which is an agreement between an investor and a CFD broker to exchange the difference in the value of a financial product between the time the contract opens and closes. They are generally considered to be high risk and only suitable for very experienced investors.
The June update has been followed by another upbeat trading update. In September 2020, CMC updated that ‘FY 2021 net operating income will exceed the upper end of current market consensus’. The group revealed this was due to a healthy combination of clients spending more and attracting new clients. The group described its stockbroking business as performing strongly.
How it compares to IG Group
IG Group is broadly similar to CMC Markets. Its share price has also risen in 2020, but by far less. It’s up around 20%. Partly explaining this difference is that CMC Markets was starting from a lower starting point, making big gains easier. There are though other factors at play which also explain the difference in recent performance.
IG Group held its dividend from FY2019 to FY2020 flat at 43.20p; even as earnings and profit both rose. Its annual results from July 2020 said on the dividend that earnings needed to further increase before a progressive dividend could be reintroduced.
Although its growth wasn’t quite as good as that of CMC Markets, IG Group had a good year, in part because of Covid-19. PBT rose from £194.3m in 2019 to £295.9m in 2020.
One other factor which may have held back IG Group is reported problems with its IT. Complaints on social media indicate it has recurring technical problems and this may have some impact – although hits doubtful it would drag down much demand for the shares.
However, potentially on the positive side for IG Group seems to have more ambition to target the Chinese market which they think has about 4m potential professional investors. The group has also doubled its client base in Japan which has 2m traders and could be a £1bn revenue opportunity.
CMC by comparison hardly splits out the Asia Pacific region and gives it far less emphasis in its annual report – this could be a strength or a weakness, depending on what you think of being geographically diverse and operating in these markets.
What the future might bring (and will the divi keep rising)
If we look to the past first this might give us an insight into what the future may hold. CMC Markets’ share price was previously struggling over the last five years because of regulatory concerns. Any reoccurrence of this headwind could reverse some of the large gains seen this year.
‘The group’s focus on the three initiatives of established markets, client journey optimisation and institutional offering remains unchanged for the year ahead.’
The established markets of the UK, Australia and Germany generate a significant part of the group’s revenue and, given the size and development of the markets, they also offer the greatest absolute growth opportunities. This means that we continue to focus on developing brand and product awareness with the aim of becoming the choice provider to new clients in these regions and offer the premium proposition and financial strength required to attract clients from competitors.
The group’s stated priorities for 2020/21 in its established markets are:
• UK: growth in net trading revenue generated from active professional clients and high value retail clients.
• Australia: continue to grow the high value client base and prepare for regulatory change.
• Continue to maintain market-leading client service levels in all three countries.
When it comes to the group’s institutional offering the aims are:
• Brokerage: strengthen the Group’s position as broker of choice for tier 2 banks, hedge funds, family offices and other institutional trading desks.
• API: further optimise both the product and augment sales for what is already a globally recognised CFD liquidity provision solution to the brokerage community.
• White label: expansion of our global B2B FX and CFD sales campaign, along with further deployment of our white labelled equity stockbroking business in Australia.
For me, these aims seem to be sensible and I think show the group could have a positive future. CMC Markets does in my opinion have a lot of strengths.
Strengths and weaknesses
The CEO, Peter Cruddas, is the founder of the company and a 60%+ shareholder. For some investors this may be too much power in one person’s hands and there’s a risk he may sell down in future but for the foreseeable future he seems committed to the business. He knows how to run the company and most shareholders will be happy for him to remain at the helm.
Staying on the topic of the board, it’s a positive that most of the board have no external appointments. In an industry which often faces challenges this focus and dedication I think should be more of the norm than it is, and is a positive which private investors should be pleased to see.
The improvement in profits has been put down to CMC Markets’ focus on technology. Cruddas has even described CMC Markets as increasingly a tech business (which may in part explain the uptick in the share price, given tech stocks are in vogue). Deals with ANZ in Australia and other white label partners have increased the B2B part of the business to 30% with the aim to get to 50%.
The group is also much more focused in recent years on high value, sophisticated investors. Partly this is driven by regulation but it has the additional benefit for CMC Markets that it can better target these people with marketing and they are likely to take large positions giving CMC Markets more commission and profits. CMC says its proprietary technology is easily adapted to meet regulatory requirements. This should make it appealing to other future partners.
Another strength of the business is its geographic diversity. Its strong stockbroking position in Australia as well as having operations in Canada and elsewhere make it not as UK-reliant as might be expected. With the UK market out of favour this is a positive and also limits the damage regulation in any particular market can do to the group as a whole.
The group doesn’t appear to have too many significant weaknesses. Perhaps a strong reliance on the UK for revenue still could be a weakness given how out of favour the UK is with investors right now. Active client growth is also modest in the UK with a 5% increase in the UK between 2019 and 2020. In Europe, active clients decreased by 4% over the same timeframe.
One weakness which is more long-term is the difficulty the group has maintaining consistent dividend growth. If the company was better able to smooth out its earnings and dividends that would be preferable. In this regard, I think IG Group which has held its dividend flat for a few years might be better.
Overall, though I think the strengths far outweigh the weaknesses.
Opportunities and threats
The group has a lot of strengths but it does also face ongoing threats. Regulation is the big one. CMC itself notes in its annual report that the Australian regulator, ASIC, set out proposals for regulatory intervention in the market for binary options and CFDs in August 2019. These proposals are broadly similar to those implemented by ESMA in 2018. The key changes proposed as part of the product intervention consultation include:
• prohibition of the issue and distribution of OTC binary options to retail clients;
• implementation of CFD leverage ratio limits;
• protection against negative balances;
• standardised approach to the automatic close-out of retail client positions;
• prohibition on firms offering monetary and non-monetary benefits to retail investors;
• enhanced transparency of CFD pricing, execution, costs and risks.
Investors should keep an eye on the costs associated with regulation and compliance. There was a massive increase in regulatory fees between 2019 and 2020. The cost went from £2.9m to £5.2m over that timeframe. This means it’s not a major cost but the rise needs to be contained in future otherwise it’ll more seriously eat into returns.
There’s also the risk that these increases in costs won’t feed through into future profits, for example, there were much higher staffing costs in the last year. CMC Markets has benefitted from market volatility but it’s unclear just how long that will last.
Brexit is also an issue the group has said it is prepared for. Given the deadline has been extended this is likely the case but because it’s a financial business, Brexit uncertainty may still hit the share price in the coming months, regardless of the actions the group has taken.
On the opportunities side, the big one seems to be the B2B side and developing technology. The CEO has identified this as a growth area and in the current market, with technology shares trading at a premium this could be a major catalyst for growth. Investors should keep an eye out for future deals, especially in CMC’s other established markets like the UK and Canada.
Is CMC Markets a good share for income investors?
With a dividend at the time of writing of over 4%, CMC Markets for me sits in the income category of shares. The most recent dividend growth does follow on from a previous sharp cut to the dividend and before that the dividend was flat. So this isn’t a consistent dividend growth stock. That’s to be expected I think given the market it operates in.
The shares despite the strong rise in 2020 still look cheap on a trailing P/E of below 11, so income investors get good value to go alongside the current income. With markets set to continue to be choppy I’d be happy to hold CMC Markets with an eye firmly on the income it can provide. While knowing at the same time it’s not the most consistent of dividend payers, so if things change in the future any investor should be ready to sell if the dividend doesn’t keep increasing. As earnings are going up and dividend cover is twice earnings this doesn’t seem like an immediate concern.
Recent months have been kind to CMC Markets and its shareholders. The share price and the dividend have risen strongly in a difficult market. CMC Markets thus far has benefitted from the volatility which could well continue now we have more lockdowns and concerns about the virus remain at the fore.
The shares combine, in my opinion, a combination of income, growth potential and a reasonable price. The shares aren’t overvalued despite their recent rise.
Investing in a predominantly spread betting company isn’t the most relaxing of investments. There will likely be ups and downs (no pun intended) that will be driven by regulatory concerns, how volatile the markets are – factors which are beyond the control of CMC Markets. That said, when it comes to what it can control; its technology, its strategic directions and so forth it seems CMC Markets does well. Therefore, if you are happy to invest in the industry I think it could be a top choice.
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With Cineworld also closing down all its UK cinemas you can see my thoughts from before the announcement on why it was always a bad investment.
Please note I do not own any share mentioned in this article at the time of writing.