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DWF Group “well positioned longer term” says Zeus Capital

DWF Group PLC (LON:DWF) has issued a trading update, indicating that its Commercial business has been hit by COVID-19, with International also not growing to our expectations. While we believe DWF remains capable of delivering its medium-term guidance implying an attractive long-term investment proposition, the earnings downgrade of 34% is no doubt disappointing. We are suspending our forecasts from 2021E, with the 2020E dividend under consideration.

Trading update: DWF has announced a trading update indicating that the key period of Q4 has been impacted by COVID-19. The financial performance of 2020E was always H2 weighted due to a variety of factors due to natural seasonality, timing of investment (particularly lateral hires in which 28 additional partners have been hired on a net basis) as well as latent capacity in the business that has not been utilised due to the disruption caused by COVID-19. The business clearly benefits from diversification both in terms of geography and activity, with areas such as litigation likely to remain stable through the cycle. Cost savings have been accelerated across the Group, with £10m expected to be delivered in cash savings in 2021E and £13.5m in 2022E on the back of this. Double digit growth in revenues and profits will be delivered in 2020E despite this disruption in its most critical period.

Divisional trends: As expected International and Insurance will drive the growth in the Group, with International driving the strongest growth with revised revenue growth of 44.7% ahead of its medium term CAGR guidance of 35% to 40%. Insurance is also trading ahead with its strong counter cyclical offering. Connected Services is also expected to deliver growth. The adverse impact has been felt in Commercial, which is now expected to be flat with corporate and real estate all said to have been impacted by COVID-19 albeit offset partially by litigation.

Impact on forecasts: Following revised guidance for 2020E, we are cutting our revenue forecast by c3%, which is largely driven by cutting back our International growth assumptions (we are now assuming 44.7% vs. 58.7%).The impact on adjusted EBITDA is much more severe and downgraded by 28% due to the lower activity in Q4 with the investment in costs already made in H1 as previously flagged. The impact on EPS is 34% with central costs and interest largely fixed. Net debt is also significantly impacted and we anticipate a 40% increase in net debt to £70m as we take a more cautious view on working capital as guided. We would hope this is short term in nature, and post COVID-19 medium term working capital goals can be achieved. The current core RCF in place is £80m (with additional facilities) and DWF expects to operate within this and the relationship with lenders remaining strong. Based on our revised forecasts, 2020E net debt/EBITDA is running at 1.8x. Clearly M&A activity for the foreseeable future is off the agenda. The dividend will be determined once the FY20 results are known and carries a cash cost of £11m for 2020E.

Investment view: While this is no doubt disappointing, as things normalise, we do believe DWF Group is well positioned longer term through its International reach Managed Services and counter cyclical offering. We also believe it remains unique in terms of its competitive position to drive disruptive change in the Legal Services markets.

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