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Hennessy Advisors Trades At Low Multiples Because Its Business Is Declining

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Hennessy Advisors (NASDAQ:HNNA) is simply a communal money head pinch immoderate $3 cardinal successful AUM arsenic of September 2022.

The institution has formidable margins, a beardown equilibrium sheet, and pays dividends yielding 5% astatine existent banal prices that are well covered by earnings.

Unfortunately, nan company's business exemplary has been nether onslaught because progressive finance strategies are retired of vogue. Since 2007, nan institution has only had affirmative integrated inflows supra redemptions betwixt 2013 and 2016.

With that successful mind, I judge HNNA's existent banal prices are not justified by net procreation capacity.

Note: Unless different stated, each accusation has been obtained from HNNA's filings pinch nan SEC.

Business description

An manufacture nether siege: Active communal costs person been nether siege from cheaper passive strategies and ETFs. Passive strategies, which represented 10% of AUM successful nan U.S. successful 2010, today correspond much than 40% of AUM. The image is moreover worse astatine nan integrated inflow level (new money invested alternatively than maturation generated by marketplace returns); progressive strategies faced almost $3 trillion successful outflows betwixt 2005 and 2020, compared to $3 trillion successful inflows for passive strategies.

HNNA has not been immune to this trend. After 2007, nan institution faced redemptions supra integrated inflows successful 13 retired of 16 years. The marketplace appreciation of nan costs offset portion of nan redemptions, and nan institution besides acquired costs managed by different companies, but still, nan effect was there.

After acquiring a series of costs successful 2013, HNNA much than quadrupled its AUM, from $900 cardinal to $4 billion. Then different 2 years of nett affirmative inflows elapse, which, coupled pinch marketplace appreciation, led to nan company's ATH AUM of $6.7 cardinal successful 2016. After that, nan roadworthy was down, ending pinch nan institution managing $2.9 cardinal arsenic of September 2022 (FY22 year-end).

ChartData by YCharts

Substantial margins: Still, plus guidance is simply a business pinch awesome economics. Particularly, nan institution does not require a gigantic building to negociate its business. HNNA had 19 labor successful FY22 and enjoyed operating margins supra 30%. Of course, these margins are affected by operational leverage, because nan aforesaid labor (meaning much aliases little nan aforesaid cost) tin negociate much AUM and make much revenues, aliases conversely little AUM and little revenue.

ChartData by YCharts

Great superior allocation: A institution facing a difficult manufacture tin worsen things if guidance does not grip superior allocation intelligently. Fortunately, HNNA managers understood that nan problem would not beryllium solved by throwing much money into nan business. They person returned costs to shareholders, successful nan shape of accordant dividends and stock repurchases.

ChartData by YCharts

Strong equilibrium sheet: In October 2021, HNNA completed nan offering of $40 cardinal successful 2026 notes paying 4.8% fixed. In hindsight, nan complaint ended up being cheap, though nan usage of those costs is not clear, fixed that HNNA does not person uses for those funds. Still, nan institution has those debts much than covered by $60 cardinal successful rate and balanced holdings.

ChartData by YCharts

Valuation

Why americium I not recommending HNNA if it has a beardown equilibrium sheet, precocious margins, and bully management? The reply is value compared to income, coupled pinch maturation prospects.

Multiples not expensive: With existent AUM levels, HNNA tin make astir $6 cardinal successful nett income, much than covering its yearly $4 cardinal dividend. The institution trades astatine a marketplace headdress of $70 million, aliases a P/E ratio of 11.5x.

But nan business is declining: This aggregate would not look excessive pinch a institution showing stagnant profits, but HNNA's business shows a semipermanent antagonistic trend. Moreover, pinch precocious liking rates, markets plummeting, and a looming recession, nan short and medium-term outlook does not look awesome for HNNA's business either.

Use of nan $40 cardinal successful debt: I commented antecedently that HNNA's managers did not squander institution costs trying to conflict against their industry's secular winds. However, astatine nan extremity of past year, nan institution asked for a $40 cardinal indebtedness and has kept nan proceeds unused.

In my opinion, nan astir evident usage of these costs is to leverage nan institution by paying a typical dividend. The shareholders little their acquisition cost, and nan post-dividend institution has a higher return connected equity (considering that return connected invested superior is higher than pre-tax indebtedness costs). I would not estimate connected this development, though, arsenic it is intolerable to predict.

Conclusions

I for illustration galore things astir HNNA: A beardown equilibrium sheet, a well-covered dividend, blimpish managers, and precocious margins. The banal besides trades astatine what could beryllium considered a debased aggregate to existent earnings, connected a wide basis.

However, I do not urge HNNA because it participates successful a declining industry. The institution has faced integrated outflows successful 13 retired of 16 years since 2007. The inclination was accelerated by nan pandemic and will astir apt proceed moreover if markets retrieve from nan caller sell-offs.

Therefore, I inquire for a overmuch little aggregate earlier considering HNNA. The existent inclination implies that today's 11.5x is tomorrow's 15x, and truthful on, aliases conversely, that stock prices will alteration successful nan future.

Editor's Note: This article covers 1 aliases much microcap stocks. Please beryllium alert of nan risks associated pinch these stocks.

This article was written by

Tomas Andrade Campanini floor plan picture

I specialize successful world micro, mini and mean size companies that waste and acquisition successful nan US utilizing a Due Diligence approach, scrapping for arsenic overmuch accusation arsenic imaginable astir nan company, and making qualitative judgments. I speak 5 languages (Spanish, English, Chinese, Italian, Portuguese). I besides create written contented utilized successful various formats including blogs, emails, achromatic papers, and societal media for financial advisors and finance firms successful a cost-efficient way. My passion is putting a communicative to financial data. Working pinch teams that see elder editors, finance strategists, trading managers, information analysts, and executives, I lend ideas to thief make contented relevant, accessible, and measurable.Homo sum, humani nihil a maine alienum puto Disclaimer: All of nan author's articles are written connected an "as is" ground and without warranty. They correspond nan author's sentiment only and successful nary measurement represent master finance advice. It is nan work of nan scholar to behaviour their owed diligence and activity finance proposal from a licensed master earlier making immoderate finance decisions. The writer disclaims each liability for immoderate actions taken based connected nan accusation contained successful immoderate articles published.

Disclosure: I/we person nary stock, action aliases akin derivative position successful immoderate of nan companies mentioned, and nary plans to initiate immoderate specified positions wrong nan adjacent 72 hours. I wrote this article myself, and it expresses my ain opinions. I americium not receiving compensation for it (other than from Seeking Alpha). I person nary business narration pinch immoderate institution whose banal is mentioned successful this article.

Editor: Naga



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