Initiation of Coverage: Meeting customer needs, giving investors returns

DUKE’s unique product provides SMEs across diversified sectors with hybrid capital, allowing the existing team to retain control. By optimising the best of equity and debt, DUKE aims to achieve equity-type returns with debt levels of risk. The loan and participating preference share elements support DUKE shareholders’ high (2024E: 9.0%), growing (2026E: 7% above 2024), and covered dividend. Early exit fees and equity stakes should generate ongoing capital growth as the portfolio matures. PE-style due diligence before providing capital, and board participation after, reduces downside risk. Management and shareholder interests are aligned.

• Growth options: DUKE’s earnings can grow with i) more revenue in the existing book as clients grow revenue, ii) positive inflation gearing, iii) gross advances (new clients and follow-on investments), iv) operational leverage, v) exit fees, vi) increasing value in equity stakes, and vii) high barriers to entry limit competition.
• Downside protections: Risk appears well managed with i) a highly selective approach to new deals, ii) appropriate counterparty assessment and excellent ongoing monitoring, iii) portfolio diversity and senior security, iv) active management of problem situations, and v) a floor to annual revenue adjustment.
• Valuation: The FY’24E dividend yield is currently 9.0%. On the long-term assumptions outlined later in this report (growth 5%, RoE 14%, CoE 12%), our valuation approaches indicate GGM growth 47.0p, discounted cashflow 71.1p, and dividend discount 36.9p, with an average of 51.6p.
• Risks: Counterparty risk is core to any finance provider. Currently, there is adverse sentiment to most speciality finance businesses. We see a short-term dependence on key staff. Many investors are unfamiliar with the product, there are few comparators, and the underlying assets are likely to be illiquid.
• Investment summary: By having a unique proposition, which adds value to clients, and with high barriers to entry, DUKE is able to generate strong returns and so pay a high, consistent dividend. The way the product is structured provides multiple levers for both income and capital growth, as well as limiting the downside risk. DUKE has invested in new staff in FY’24 to optimise the opportunity while showing good discipline in the pacing of new investments.