Impax Asset Management (IPX) – undervalued?

Background

Impax specialise in environmental, social and governance (ESG) fund management and have performed very well over the last 5 years, with organic growth of assets under management (AUM) of 4.7x. Including acquisitions AUM is currently around £14.5bn.

Fund managers earn a percentage of AUM and so the main element of their valuation is current and forecast AUM. Future AUM is very hard to forecast since it is highly dependent on asset performance which (for an equity fund) in turn is largely dependent on the performance of stock markets as a whole. Not only does strong asset performance increase the value of existing assets, it also encourages (with a lag) new investment inflows. Furthermore, fund managers are highly operationally geared with a percentage of incremental AUM feeding fairly directly into their bottom line.

Accordingly, fund manager valuations tend to be volatile as both market level and market sentiment moves. This volatility can be seen in the chart (from Stockopedia) below:

In the longer term, relative management performance and strategic positioning become more important. And it is worth noting that in the 12 months before the above snapshot Impax’s share price tripled as it benefited from (what was in hindsight) a transformation in scale and the unwinding of a structural undervaluation.

Back to the short term. You can see clearly in the peaks a toughs in the above chart the highs and lows in sentiment not only for Impax’s future prospects but world stock markets as a whole, and quite a bit of irrationality. As an example you can see the dip in November 2018 as sentiment took a sharp turn for the worse, but the lows were in mid-January 2019 after investors digested and projecting forward a -14% quarterly asset performance, despite the fact that US Markets had starting rallying immediately after Christmas and inflows had remained very strong throughout.

Looking good value

My reason for writing today is that sentiment at Impax has been falling once again, perhaps over fears about the level of US stock markets, and yet those stock markets themselves have continued to rise. As a result my projections show that they currently trade at 2.2% of AUM, which is the level at which my historical figures indicate makes a good purchase point.

Set against this is a strongly falling brokers consensus trend (as shown on Stockopedia, and I dare say, elsewhere), with 2019 EPS forecasts falling from nearly 15p a year ago to 10p today, and a relatively high forward PE of 20.4. I have briefly reviewed some brokers notes and I think this reflects a mixture of irrational exuberance at the beginning of the period (prior to the awful calendar Q4 investment performance) and undue pessimism today.

Although I expect Impax to become overvalued again at some point in the future, my investment case does not rely on this. I would be quite happy holding them for the long term at this kind of AUM multiple and simply taking dividends growing in line with long term inflow and stockmarket trends.

I should however acknowledge some question marks over the durability of the ESG niche in the Trump era and my own longstanding concerns about the medium-term size of this niche and sustainability of fund management fee levels.

Back-testing

I have a model for the valuation of Impax that I have successfully back tested, but it is easy make a model that fits price movements with the benefit of hindsight. I prefer to rely on actual contemporaneous trades and public statements based on the model.

A year ago with the share price at 271p I wrote:

The share price has risen sharply recently and I have come to the conclusion it is now significantly over valued.

I calculate market cap as a percentage of assets under management (Graham [Neary]’s preferred measure I think) to be 3.1%. I don’t think it has ever been this high before and the closest I can see it has ever been was back in early 2014 with 2.8% on a share price in the mid-50s. Following this the share price was under 50p in Autumn 2016 with a ratio of 1.4%. I accept that scale means a higher ratio is justified, but I don’t think to this extent and they have also been much cheaper on this basis recently.

Furthermore TNAV is much weaker than a year ago even before the payment of a special dividend and I think this will constrain future distributions and growth by acquisition. And even if they could fund further takeovers without significant dilution I don’t think there is another PAX and so the positive effect from this must be considered a one-off.

Finally, although inflows remain impressive in their non-PAX funds, both these and investment returns have faltered somewhat recently especially when including PAX. There remains (IMHO) a risk of a 40%+ correction in US stocks which would badly affect both.

Consequently I have now sold almost all of my holding. I think they are well run in an attractive sector and am hoping to buy back much more cheaply in 1-3 years time.

I subsequently sold the remainder of my shares and this did indeed prove to be close to a peak. I then made a quick turn in November buying and reselling. Looking at my notes at the time it was clear that I was also influenced by market sentiment. I then failed to take advantage of their 185p low in January from which I could have made a considerable turn.

Conclusion

This is a share that regularly becomes over- and under-valued, at least with the benefit of hindsight. I am generally bearish about US stockmarket valuations but this means I have some hedges in place. If markets hold steady then today looks like a good re-entry point. Additionally due to sales elsewhere I have excess cash. For these reasons I decided that, for me, today was the time to buy back in at 244.5p.