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Short summary
Flow Traders (OTCPK:FLTLF) has been seen as an equity play to “hedge” against volatility, i.e. stress in the markets. This has even worked for a while, like the results and massive dividends for the year 2020 show.
However, since then, Flow Traders has been losing market share in its most important region. Paired with an unfavorable market environment that has seen painfully low volatility, Flow Trader’s results have been in backwardation, also pushing down the stock. With the latest results, management entirely eliminated the dividend – one of the core investment incentives for many investors – to officially switch to growth mode. However, it is not out of strength, quite the opposite.
In this article, I am going to lead you through the recent developments and tell you why the former thesis likely doesn’t work anymore.
When the flow dried up
I’ve been covering the stock of Flow Traders since 2019, i.e. for five years. What the Dutch company does is it acts as a so-called liquidity provider for exchange traded products (“ETPs”), i.e. the middleman bringing together buyers and sellers of ETFs for stocks and their derivatives for bonds, cash, commodities and cryptos. The spread – the difference between the selling and buying price – is their revenue.
In times of calm bull markets or sideways periods, the business shall be doing okay, but nothing to freak out about. Often, volatility is low and trending lower. Bid / ask spreads are low, either. Then you also have periods with little trading activity, like summer holidays (usually, not this year 🙂 ).
However, it gets interesting when markets correct or even tank. Then, due to fear and uncertainty, trading volumes shoot up and also bid / ask spreads widen, creating several tailwinds that propel sales, margins and earnings for this business up, as costs of the underlying business are relatively fixed.
Usually, this was a business with good margins in less exciting times, but exceptional margins in highly volatile periods.
The thesis has been that Flow Traders is a good pick for a partial and contrarian portfolio hedge, as the company in times of market stress simply earns disproportionately more money.
Below, you can see from their last Capital Markets Day in 2022 that in years of high turbulence, especially 2018 and 2020, EBITDA margins and net trading income (their revenue, not net income!) have been spiking along the volatility index VIX.
After such successful periods, they paid out hefty dividends.
For example, in 2020, when you bought the stock at the end of 2019 / beginning of 2020 at then fairly depressed prices of around and briefly even below 20 EUR (I did at my former employer), the subsequent dividend in spring of 2020 was 2.50 EUR and later in summer of the same year another 4 EUR per share – a return of 32.5%!
On top, the stock also appreciated by 75% and didn’t participate in the 2020 meltdown!
This was likely a once-in-a-lifetime event. However, it shows how this idea worked and was to work, though with less drama, in the future during more normal corrections. And without an expiration date compared to derivatives as a big plus.
The problem is, volatility has been pretty low since then. There were temporary high spikes during 2022, but in normal times the business seems to have lost momentum. This is evidenced by the fact that they’re continuously losing market share in their biggest market, Europe / EMEA – one of the reasons I decided to pull away.
Here’s a table I created using data from their published results, showing the respective market shares (Flow Traders ETP value traded / ETP market value traded):
While I am not so sure about the Asia data, as at some point Flow Traders started trading operations in China, this is not the deciding factor (they disclose their net trading income / revenue data only on an Asia ex China basis, but market data for both, with and without China).
While a diversification strategy does not need to be bad and if executed well, it can complement a portfolio and ignite some more growth, this hasn’t been the case at Flow Traders.
It concerns me that their by far the strongest market in the past has been melting away.
Below, you can see that this reshuffle also brought huge margin declines with it. Trading conditions have been tough as of lately, I know. But notice that the swings over the last ten years have seen lower lows – with 2023 and H1 2024 being new lows (FLOW became a publicly traded company in 2015).
I can remember that in 2017 and 2019, which both saw huge bull runs for equities, the VIX was temporarily even in the single digits in 2019 – a brutal environment for a company like Flow Traders which needs market action. Nonetheless, even back then, EBITDA margins have been higher than now.
With the latest earnings release two weeks ago, management announced a strategic shift to increase trading capital. This means, they know about their unfavorable position and try to make up for the compressed margins and market share decline via more volume.
However, first they suspended their dividend and second – and worse – they announced to use leverage from now on to ignite growth.
They have secured EUR 25 million bank term loan “as a first step”, so we can at least assume that more will follow. This EUR 25 million is the equivalent of 4% of current trading capital (EUR 524 million, see below). While this is not much, I am a bit averse towards usual leverage to play volatility.
On the right chart below, you can see that they paid out EUR 746 million since Flow Traders has been a publicly traded company – that’s more than their current trading capital. It reads somehow that this capital has been wasted and shall now be reinvested into the business.
While it is debatable or could be even seen as a positive to sacrifice the dividend in the short term for longer-term gains, I have problems with this move as it comes in a state of weakness, not strength. It somehow has a desperate taste to it for me. This is likely the cause why the stock tanked by 20% subsequently – the market seems not to be trusting the management.
Below, you can see to the right the current reaction – this is a new all-time low for the stock, likewise not a sign of strength.
Looking at all of this unemotionally and with a free mind, it seems to indicate that this company is experiencing strong headwinds. All in all, I am happy to have closed this case, as the thesis has been altered dramatically. Sometimes it’s just right to draw a line under it and move on.
I know that the stock of Flow Traders tried a rebound, as we had ideal market conditions for them to break free out of the weak last one and half years. But is this really a strong sign or a more a dead-cat bounce?
As a reminder, we have seen one of the strongest rises in the VIX over the last days ever – to the third-highest point the chart of TradingView shows! Only the 1987 crash saw a completely different level, but most charts don’t show it.
Risks to my thesis
Of course, I could be wrong with my assessment. The main risks I see, are:
1. Management could have success with its strategy and turn the company around to reach former glories.
2. Though not in the hands of management, markets could get crazy (credit event, stronger-than-expected recession, blow-up of a previously unknown hedge fund, etc.) like we saw last Monday. Either one more giant volatility spike or a prolonged period with above-average volatility (VIX > 20), would be beneficial for business, enabling it to either grow indeed, or to reinstate the dividend (or initiate a one-time special payout which usually leads to positive surprises).
3. Buyout: Despite the founders (not active in everyday business) still holding together ~23% of the stock, it is possible that a bid could arrive. This would be, of course, positive for investors long the stock, but it would make my thesis void.
Conclusion
In the past, Flow Traders was an almost ideal instrument to get exposure to a complete contrarian equity story, enabling an investor to benefit in times of market stress. However, since the highs of 2020, the former story seems not to be working anymore, evidenced by the fact that Flow Traders has been losing market share strongly – even in its most important market. That’s why I am negative about this stock. The recent high-volatility event on Monday, 05 August 2024, has not pulled the stock back up enough for me to show any sign of strength.
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