United Capital Plc has recently made a significant move that could reshape its capital structure, which may influence investor sentiment.
At an Extraordinary General Meeting held virtually on August 21, 2024, the company announced a bold plan to increase its share capital from N3 billion to N9 billion and issue a bonus of 12 billion new shares of 50 kobo each, while the total outstanding shares rise from 6 billion to 18 billion.
The restructuring reallocates N6 billion from the company’s retained earnings to share capital, effectively capitalizing these earnings into equity. This is likely to reduce retained earnings further.
The company’s retained earnings declined by 9.7% to N28.67 billion as of June 2024, likely due to the company’s first-ever dividend paid of N0.90 per share for the first half-year of 2024.
For investors, this development brings both opportunities and considerations and requires a closer examination of how this might affect the company’s profitability, future dividend distribution and financial stability.
The strategic use of retained earnings to fund the bonus issue signals confidence in the company’s financial health. With the increase in share capital, the company not only strengthens its balance sheet but also enhances its financial flexibility, potentially positioning itself for future growth.
However, the increase in the number of shares also introduces the potential for earnings dilution, which could lead to a decrease in earnings per share (EPS) unless it is offset by substantial growth in profits. This potential impact on EPS might influence the company’s valuation and investor sentiment.
The crucial question then arises: can United Capital sustain the level of profitability needed to mitigate the effects of this capital restructuring?
The potential for earnings dilution is a critical factor that could influence United Capital Plc’s valuation and investor sentiment. The key to mitigating this risk lies in the company’s ability to sustain or grow its profitability post-restructuring.
United Capital Plc has consistently increased its earnings. Over the past five years, pre-tax profit has increased at a compound annual growth rate (CAGR) of 37%, closing 2023 with N17.3 billion. The company’s EPS also exhibited strong growth, increasing at a CAGR of 23%.
This momentum continued into the first half of 2024, with the company achieving a pre-tax profit of N9.1 billion, reflecting a 63% year-over-year (YoY) growth; surpassing its five-year CAGR.
Commenting on the Group’s first half of 2024 performance, Group CEO Mr. Peter Ashade said: “I am pleased to inform all stakeholders that United Capital Plc closed the first half of the year on a strong note as evident in our impressive earnings growth and performance across key financial parameters.
For the first time ever, we declared interim dividend payment of N0.90 for every 50 kobo ordinary share, and Bonus Shares of “2 for 1. This affirms our commitment to wealth creation and superior value delivery to our shareholders.
We are assured about sustaining our performance in 2024 having kicked off the second half of the year 2024 in a robust financial position with close to N1.3trillion funds under management comprising trusts, mutual funds, and other professionally managed investments for our clients across diverse segments.
The Group is strongly positioned to deliver on our growth objectives while remaining competitive and sustainably profitable. We will continue to prioritize activities that create and preserve value for all our stakeholders into the foreseeable future.”
The Group CEO’s statements are reassuring, but the company’s ability to sustain its profitability growth remains crucial.
In its first half 2024 earnings release, the company attributed the growth in gross earnings to significant increases in Fee and Commission income (+72% year-on-year), Net trading income (+183% year-on-year), and other income (+75% year-on-year).
However, a closer review of the first half of 2024 results shows that although gross earnings grew by 38% year-over-year (YoY) to N15.15 billion, this represents only 33% of the total gross earnings recorded in 2023.
Additionally, this growth trails the company’s impressive five-year compound annual growth rate (CAGR) of 53% and reflects a slowdown compared to the 71% YoY growth seen in 2023.
This deceleration in gross earnings despite the growth in fee and commission income, etc. can be attributed to rising interest expenses on managed funds and other borrowings, which have outpaced the growth in interest income. As a result, the company’s net interest income has narrowed, putting pressure on profitability.
On average, United Capital expends over 89% of its interest income to cover interest-related expenses, leaving a relatively narrow margin for profitability.
This tightening margin could signal challenges ahead, particularly if the trend of increasing interest expenses continues.
Despite these pressures, the company’s recent earnings per share (EPS) growth remains impressive relative to its historical trend.
In the first half of 2024, United Capital’s unaudited financial statements show that EPS grew by 65.4% to N2.58, which is about 37% higher than the 2023 figures.
This growth not only outpaced the 2023 rate but also exceeded the company’s five-year compound annual growth rate (CAGR) of 23%.
However, the recent bonus issue, which increased the number of outstanding shares from 6 billion to 18 billion, introduces the potential for earnings dilution.
To sustain the 2023 EPS of N1.90 with the increased share count, the company would need to achieve a profit after tax of about N34.2 billion. This is a significant jump from the previous profit levels, highlighting the challenge of maintaining valuation.
The bonus issue, while reflecting confidence in the company’s financial health, places a greater burden on future profitability to avoid diluting shareholder value.
If United Capital fails to achieve the required profit levels to maintain its EPS post-bonus issue, it could lead to earnings dilution, a lower stock valuation, decreased investor confidence, and potential cuts in dividends.
A possible decline in EPS will lead to an increase in the P/E ratio if the stock price remains constant. Investors often view a rising P/E ratio due to declining EPS as a warning sign of potential overvaluation, which could trigger a negative reaction in the market.
This is especially pertinent given United Capital’s recent share price performance; the share price has shown a bearish trend this year, losing 14.13% YtD of its value as of the close of trading on Friday, August 23, 2024, in contrast to the 64.3% year-to-date gain in 2023.
Investors will need to carefully weigh the impact of this capital restructuring on the company’s ability to sustain its growth trajectory and maintain its strong earnings performance.
The success of United Capital in navigating these challenges will be crucial in determining whether the stock can regain its upward momentum or continue to face downward pressure.
