28 March 2018
By Maynard Paton
Update on S & U (SUS).
Summary: These results from the car-loan specialist once again provided an investment dilemma. True, shareholders received yet another respectable progress report from the accomplished executive team. However, the finer details showed potential bad debts soaring 59% — which was double the growth rate of revenue and customer advances. The chairman is set to make some ‘sensible gear changes’ to keep a lid on potential bad debts, but until the changes become evident, the share-price multiple could be stuck at 13. I continue to hold.
Shares in issue: 11,990,159
Market capitalisation: £276m
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* Advantage SUS! Celebrating 18 consecutive years of car-loan profit growth
The headline figures showed revenue up 32%, operating profit up 23% and the dividend up 15%, and every measure set a new all-time high. The numbers also marked the 18th consecutive year of growth for SUS’s Advantage Motor Finance division.
(Following SUS’s disposal of its doorstep lending subsidiary during 2015, the group’s operations now are almost entirely related to Advantage):
|Year to 31 January||2014*||2015*||2016*||2017**||2018**|
|Operating profit (£k)||12,655||18,922||23,643||26,871||32,978|
|Other items (£k)||-||-||-||-||-|
|Finance cost (£k)||(1,186)||(2,207)||(3,243)||(1,668)||(2,818)|
|Pre-tax profit (£k)||11,469||16,715||20,400||25,203||30,160|
|Earnings per share (p)||-||-||-||170.7||203.8|
|Dividend paid (£k)||2,600||3,500||4,700||9,548||11,377|
|Dividend per share (p)||-||-||-||91.0||105.0|
(*Advantage Finance, **Group)
The 2018 performance was underpinned by Advantage receiving some 860,000 loan applications (up 15% on 2017), and agreeing to approximately 24,500.
The number of active customer loans advanced by around 11,000 to 54,000, while the year-end value of outstanding customer loans climbed 30% to £251m.
* Impairments set to be controlled by ‘sensible gear changes, steering tweaks and an easing of the accelerator’
Greater revenue, greater profit and greater customer loans were also accompanied by greater a bad-debt provision. Sadly the finer impairment details remain unfavourable.
Here is a crucial accounting note:
The ‘loan loss provisioning charge – motor finance’ jumped 59% for the full year — much more than the aforementioned 32% revenue gain and 30% customer-loan increase.
For the previous 2017 year, the impairment charge surged 60% versus a 34% revenue gain and 33% customer-loan increase.
This table compares the 2018 impairment ratios to those of the previous four years:
|Year to 31 January||2014||2015||2016||2017||2018|
|Loan provision (£k)||5,087||5,863||7,611||12,194||19,434|
|Average net customer receivables (£k)||62,734||89,678||125,764||169,335||222,372|
|Loan provision/Revenue (%)||19.5||16.2||16.8||20.1||24.6|
|Loan provision/Average net customer receivables (%)||8.1||6.5||6.1||7.2||8.7|
The ratios are the highest since 2013.
As before, SUS’s veteran management did not appear too concerned about the movements. Executive chairman Anthony Coombs said (my bold):
“For some customers who have sought to maintain living standards by taking new lines of credit, this has reduced capacity and been reflected in a rise in impairment to £19.4m this year. At 24.6% of revenue this is still relatively low versus the average for the previous 10 years of 27.2%.
Further, 18 successive years of profit growth and operational refinement have given Advantage the experience and wisdom to make timely and targeted adjustments to its already sophisticated and sensitive under-writing model.
In motoring terms, the shape of the road and the nature of the terrain has made for sensible gear changes, steering tweaks and an easing of the accelerator…
Early signs of the under-writing changes already made are having a beneficial effect upon both new customer quality and early repayment performance, which we anticipate will lead to a reduction in impairment to revenue in due course.”
I can only hope Mr Coombs’ descriptive analogies can indeed lead to the impairment-to-revenue ratio reducing.
This chart from the results presentation puts the current impairment-to-revenue ratio (the red line) into perspective:
Perhaps 2015 and 2016 should be seen as exceptionally favourable years, rather than 2018 being seen as rather unfavourable.
* Presentation slide shows further evidence of the adverse impairment trend
The first-half/second-half split showed impairments running at a greater rate during H2 than H1:
|H1 2017||H2 2017||FY 2017||H1 2018||H2 2018||FY 2018|
|Operating profit (£k)||12,579||14,292||26,871||15,427||17,551||32,978|
|Loan provision (£k)||4,959||7,235||12,194||8,591||10,843||19,434|
|Average net customer receivables (£k)||159,528||183,722||169.335||210,168||239,011||222,372|
|Loan provision/Revenue (%)||17.5||22.4||20.1||22.9||26.2||24.6|
|Loan provision/Average net customer receivables (%)||6.2||7.9||7.2||8.2||9.1||8.7|
Although the ratios for H2 do remain below the levels seen before 2014, the calculations are further evidence of write-offs continuing to travel the wrong way.
SUS’s presentation slides also confirmed the lower-quality loan book.
This slide indicates the proportion of up-to-date loans decreasing from 87% to 83%:
The proportion was 91% at January 2016.
* The margin has to be high and the debt has to considerable to generate a respectable return on equity
The upshot of the growing impairments was the operating margin coming in at 41% — versus 44% for 2017 and 47% for 2016.
While SUS’s operating margin remains extremely healthy compared to that seen at most businesses, a high level of profit is required to generate an acceptable return on the equity that supports the business.
I calculate SUS earned a respectable 17% (£24m) return on the average £146m of equity the group employed throughout the year. The return compares to approximately 15% produced during the prior two years.
However, the 17% return was assisted by significant debt — net borrowings increased from £49m to £105m during the period — and adjusting my sums for the loans and associated interest reduces the return to a modest 12%. That number compares to approximately 13% produced during the prior two years.
That earlier slide from the presentation is informative:
The blue line tracks the return on capital figure for the Advantage division, and the slideshow small-print admits the lower ROCE reflects “loss of insurance income since July 2015 and [a] high deal acquisition cost”.
Each new deal agreement cost SUS £692 during 2018 — up 8%. Five years ago the cost was £581.
Anyway, I presume the difference between the 15% shown in the slide and my 12% guess is due to me using the overall group numbers, which include extra central costs (such as director wages) and a fledgling property-loan operation.
Elsewhere in the accounts, SUS’s cash flow continues to be relatively straightforward.
Earnings of £24m and extra debt of £56m went towards injecting a net £68m into new customer loans, allowed £11m to be paid as dividends, and left £1m to be spent on everything else.
At least the rate on SUS’s debts appears to have been chipped lower again. I reckon SUS paid 3.5% on its borrowings during 2018, versus 3.9% and 4.2% for 2017 and 2016 respectively.
SUS has consistently generated annual revenue at approximately 35% of its net customer loans. I therefore hope the £251m currently outstanding from the firm’s car-loan customers can convert into near-term revenue of £89m.
Applying a 26.2% loan-loss provision as seen during the second half, and assuming other cost of sales and admin expenses represent 21.5% and 12.1% of revenue respectively, I arrive at a possible operating profit of £36m.
Taxed at the 19% standard UK rate, potential operating earnings could therefore be £29m or 242p per share.
Adding net debt of £105m to the £276m market cap (at 2,300p per share) gives an enterprise value (EV) of £381m, or 3,176p per share.
The P/E based on my EV and earnings guess is therefore 3,176p/242p = 13.
That rating looks very reasonable given SUS’s recent growth rate. Mind you, the rising impairment levels are difficult to ignore. I suspect the wider market may have trouble applying a higher multiple to SUS’s earnings until the bad-loan provisions start to moderate.
In the meantime, all shareholders can do is trust the seasoned Mr Coombs has everything under control — and enjoy a 4.6% income from the 105p per share dividend.
For what it is worth, Mr Coombs remains bullish (my bold):
“Whatever the wider political or economic headwinds, the markets in which we operate remain strong. Recent data from the Finance and Leasing Association showed used car sales increased by 6% in number and 12% in value in 2017 whilst the UK property market remains robust. This combination of healthy market conditions, a strong demand for our products and our focus on quality, lead us to look ahead with real confidence.
I commend these results to our shareholders.”
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Disclosure: Maynard owns shares in S & U.