Duke Royalty (AIM:DUKE) is a listed royalty investment business focussed on the European Market. Founded in 2015 by an experienced management team, Duke now manages a portfolio of £90m.
Royalty financing is a really interesting business model and has found great success in mining industries - where traditional debt or equity financing is cost restrictive or not available and a more flexible solution is required. Royalties issued by Duke are usually long-term or even perpetual (but with prepayment/buy-out clauses.)
Royalty financing involves an upfront, one-off payment in exchange for a revenue stream for a long-term or sometimes perpetual period. Duke typically receives an initial 13.5% pa (which includes principal repayment and interest) over a 30-year period. Payments are paid monthly, but reset annually linked to the change in sales revenue of the invested company or partner. Annual resets on a cash basis have a ±6% cap and floor, which limits the movement in payment from one year to another. The royalty partners can prepay the investment, but there is a prepayment penalty designed to protect Duke from the time lag in reinvesting the money, as well the internal rate of return (IRR) of the project. Edison Group - 2019
However most interestingly the stock price has continued a decline post Coronavirus. This is interesting on face value for a number of reasons:
- Royalties are long term cashflows, where the cash flows in the future drive the majority of the value.
- The business holds a diversified portfolio of assets.
- Security over physical assets exist for major investments.
- Minimal leverage (~5x interest coverage in FY19)
Portfolio composition
| Company | Investment (£000) | Description | Est COVID impact | URL |
|---|---|---|---|---|
| Temarca B.V | £11,970 | Leisure boat cruises (first mortgage*) | High | https://www.sijfacruises.nl/ |
| Lynx UK | £11,970 | PE Group | Low | https://www.lynxequity.com/ |
| Trimite | £10,980 | Industrial coatings | Medium | https://www.trimite.com/ |
| InterHealth | £9,990 | Healthcare development | Low | https://interhealthcanada.com/ |
| Miriad | £9,990 | Outdoor recreation products | Upside | https://www.miriad-products.com/ |
| Bakhchysarai / BIL | £9,360 | Recruitment | Medium | https://www.brightwaterni.com/ |
| Weltel | £8,100 | Cloud communications | Low | https://www.welltelgroup.com/ |
| United Glass Group | £7,470 | Architectural glass | Low | http://www.unitedglassgroup.co.uk/ |
| BHP Insurance | £4,140 | NFP insurance | Nil | https://bhpinsurance.ie/ |
| Step Investments | £2,970 | Advertising (incl cinema) | High | https://www.pearlanddean.com/ |
| Xtremepush | £1,980 | Online marketing | Upside | https://xtremepush.com/ |
| Berkley | £1,080 | Recruitment | Medium | https://www.berkley-group.com/ |
| £90,000 |
We note that the largest, and perhaps most risky, is the Temarca B.V business which operates leisure cruises in Europe. However from a previous RNS, Duke have first mortgage over all of these vessels, therefore one would expect Duke to be in a strong position if the business fails to recover and reopen.
In addition the other two large investments in Lynx UK and Trimite also have “security by way of fixed and floating charges over certain assets and the Group” - 2019 annual report
Worst case scenarios
Debt and liquidity does not appear to be a significant risk for Duke. Management were prudent and paid a scrip dividend instead of the instead of cash in June. Part of this was to provide support for investee companies if follow on investment opportunities occurred.
A reasonable level of institutional support is reflected in a ~£14m raise in late 2019 at £0.44 per share.
Valuation based on sum of the parts
A risk however does exist if the valuation of the underlying royalty streams significantly worsens.
The total amount invested by Duke is £90m. A worst case scenario could be developed if you assign a risk weighting and markdown to each of the investments (based on original investment value) of say: High risk (-40% impact), Medium (-20%), Low (-5%), Upside (0%) you would get a discounted portfolio value of ~£67m. After adjusting for net debt of (£13m), indicates a worst case scenario of valuation of £0.28/share. This also assumes write-downs for Temarca B.V, Lynx UK, Trimite which we understand there is underlying asset security.
Valuation based on prospective yield
The majority of investments (pre-COVID) hold a yield of ~13% on average. This drove a EPS of ~£0.05/share.
If we assume a 6.5% yield (50% decrease), EPS of £0.02 giving a PE of 12x, which is not untowardly expensive, for a temporarily impacted stock, which given the broad portfolio, should bounce back at least partially.
In the latest trading update management expected cash revenue to be maintained through Q2 2020 of £0.6m/month. If this is continued throughout H2 and assuming annual operating costs of ~£1.8m/p.a, EPS for FY21 would be ~£0.015 giving a PE of 13x, which is again not expensive. However this is truly worst case scenario, with the majority of businesses likely to recover at some point in the future. Remember these are typically 30 year or perpetual royalty agreements.