S & U: Record FY Results Show Dividend Up 12% But Management Hints Of Slowing Growth Leave Yield At 6%-Plus

05 April 2019
By Maynard Paton

Results verdict on S & U (SUS):

  • Satisfactory double-digit growth supported mostly by additional car loans issued during the first half.
  • Rising bad debts clearly indicate borrowers are no longer as profitable or reliable as they once were.
  • Improved first-payment rate suggests underwriting tweaks have started to curb future write-offs.
  • Reduced level of customer lending during the second half generated surplus cash and lowered group debt.
  • P/E of 10.7 and yield of 6.2% reflect management hints of slowing progress. I continue to hold.

Contents

Event links and share data
Why I own SUS
Results summary
Revenue, profit and dividend
Motor-finance bad debts
Motor-finance customer numbers and loans outstanding
Aspen Bridging
Margin and ROE
Borrowings
Valuation

Event: Preliminary results and presentation for the twelve months to 31 January 2019 published 26 March 2019.

Price:
1,900p
Shares in issue: 12,011,426
Market capitalisation: £228m

Why I own SUS

sus s&U fy 2019 results car loan application
  • Provides ‘non-prime’ credit to car buyers and property developers, where disciplined lending and reliable service have supported an enviable company record.
  • Boasts veteran family management with 40-year-plus tenure, 44%-plus/£102m-plus shareholding and a “steady, sustainable” approach to organic, long-term growth.
  • Illustrious dividend has not been cut since at least 1987 and presently supports a 6%-plus income.
sus s&U fy 2019 results sharepad dividend chatr

Further reading: My SUS Buy report |All my SUS posts | SUS website

Results summary

sus s&U fy 2019 results summary

Revenue, profit and dividend

  • The results revealed revenue up 12%, operating profit up 19% and the dividend up 12%:
Year to 31 January20152016201720182019
Revenue (£k)36,10245,18260,52179,78189,215
Operating profit (£k)18,92223,64326,87132,97839,101
Other items (£k)-----
Finance cost (£k)(2,207)(3,243)(1,668)(2,818)(4,541)
Pre-tax profit (£k)16,71520,40025,20330,16034,560
Earnings per share (p)100.1133.6170.7203.8233.2
Dividend per share (p)66.076.091.0105.0118.0
  • Revenue, profit and the dividend all reached new highs.
  • The results extended SUS’s run of impressive growth following the sale of the group’s home-credit business during 2015.
  • The introduction of IFRS 9 for 2019 reduced both revenue and the group’s bad-debt impairment charge by £2.4m. 
  • The new accounting rule prevents the “grossing up of revenue and impairment for uncharged interest on arrears”.
  • SUS’s prior-year figures were not restated under IFRS 9. Revenue would have advanced 15% (vs 12% reported) and impairments would have advanced 31% (vs 18% reported) on a like-for-like accounting basis.
  • IFRS 9 had no effect on reported profit or cash flow.
  • Advantage Finance, SUS’s car-loan division, delivered its 19th consecutive year of record pre-tax profit.
  • Aspen Bridging, SUS’s fledgling property-loan division, became profitable following last year’s start-up loss. 
  • Management said: “The long-term outlook for responsible and good-quality used-car finance, at affordable monthly repayments provided by Advantage is strong.
  • Management added that its “prognosis” for the next twelve months was “realistic, but optimistic”.
  • Reading between the lines — and studying the numbers (see below) — the pace of growth is likely to subside during the next year or two.

Motor-finance bad debts

  • Bad debts continue to represent a greater proportion of revenue and outstanding loans within Advantage Finance:
Year to 31 January20152016201720182019
Motor
Loan provision (£k)5,8637,61112,19419,43422,980
Revenue (£k)36,10245,18260,52178,88286,372
Average customer loans (£k)89,678125,764169,335222,372255,013
Loan provision/Revenue (%)16.216.820.124.626.6
Loan provision/Average customer loans (%)6.56.17.28.79.0
Revenue/Average customer loans (%)40.335.935.735.533.9
'Risk-adjusted yield' (%)*33.729.928.526.724.9
  • During the last five years, Advantage’s bad-debt ‘loan provision’ has increased from 16.2% to 26.6% of divisional revenue.
  • For 2019, Advantage’s £23m loan provision was equivalent to 9.0% of the division’s £255m average customer loans, versus 6.5% back in 2015.
  • Meanwhile, revenue earned from Advantage’s customer loans has dropped from 40.3% to 33.9% a year since 2015.
  • Lower revenue from loans alongside greater bad-debt provisions has meant SUS’s own ‘risk-adjusted yield’* for Advantage has fallen from 33.7% to 24.9% since 2015.
*risk-adjusted yield is a KPI used by SUS and is calculated as:
(revenue - loan provision) / average customer loans
  • Advantage’s bad-loan ratios all deteriorated during the second half:
H1 2018H2 2018FY 2018H1 2019H2 2019FY 2019
Motor
Loan provision (£k)8,57310,84319,43411,32011,66022,980
Revenue (£k)37,47041,41278,88243,27043,10286,372
Average customer loans (£k)210,168239,011222,372257,335261,113255,013
Loan provision/Revenue (%)22.926.224.626.227.126.6
Loan provision/Average customer loans (%)8.29.18.78.88.99.0
Revenue/Average customer loans (%)35.734.735.533.633.033.9
'Risk-adjusted yield' (%)*27.525.626.724.824.124.9
  • The same bad-loan ratios had already deteriorated during the previous 18 months.
  • The proportion of up-to-date car-loan accounts declined once again:
sus s&U fy 2019 results advantage finance overdue accounts
  • The proportion of overdue car-loan accounts has actually doubled from 9.6% to 20% since 2016:
Year to 31 January2016201720182019
Motor
Up to date accounts29,46037,44745,66847,307
Overdue accounts3,1445,6208,81111,802
Total accounts32,60443,06754,47959,109
Up to date/Total (%)90.487.083.880.0
Overdue/Total (%)9.613.016.220.0
  • All this number-crunching clearly shows Advantage’s customers are no longer as profitable or reliable as they once were.
  • SUS admitted: “[The pressure on] working people’s average real incomes…  persuaded some customers to take on newer forms of high cost credit financial obligations which resulted in slightly less consistent repayments to Advantage this year than we anticipated”.
  • At least SUS continues to tweak its loan-approval processes:

Further underwriting changes, which clearly recognise these high-cost credit obligations, and marketing improvements to attract a better product mix, are designed to maintain returns and gradually return impairment levels to those of the past five years.”

  • Reflecting the tweaks and changes, the proportion of new accounts that make their first payment on time has improved during the last 18 months (blue line, left axis):
sus s&U fy 2019 results advantage finance first payment ratio
  • SUS believes this first-payment improvement should lead to lower write-offs (dotted red line, right axis).
  • Also reflecting the tweaks and changes, the proportion of approved car-loan applicants has dropped from 32% to 23% during the last two years:
Year to 31 January201720182019
Motor
Applicationsover 750,000over 860,00over 1,000,000
Approvals (%)c32%c29%c23%
Approvalsc240,000c250,000c230,000
Loans issued20,04224,51821,053
  • Only 9% of approved applicants go on to accept their new car loan.
  • SUS has never really explained why the remaining 91% of approved applicants do not collect their loan.
  • Presumably the 91% have applied for multiple loans (usually through a broker) and then choose a cheaper lender — which would suggest Advantage has the best rates for only a small proportion of qualified borrowers.
  • The typical Advantage customer has a patchy credit history, borrows £6.2k and pays back £11.1k over 51 months — equivalent to a flat c18% interest rate:
sus s&U fy 2019 results cars on a forecourt in a sale

Motor-finance customer numbers and loans outstanding

  • The tightened application criteria implemented by Advantage has reduced the rate of customer growth:  
H1 2018H2 2018FY 2018H1 2019H2 2019FY 2019
Motor
New agreements12,54211,97611,41211,8229,23121,053
Active customers
49,000*-54,47958,008-59,109
Net customer increase5,9335,47911,4123,5291,1014,630
Customer loans (£k)226,807-251,215263,455-258,810
Change to customer loans (£k)33,27824,40857,68612,240(4,645)7,595

(*rounded by SUS)

  • New car-loan agreements had been running at c12k every six months. During the second half of 2019, the number fell to c9k.  
  • SUS does not disclose the number of car-loan customers lost every year due to non-payment or full repayment. 
  • However, my sums suggest the net increase to car-loan customers had been running at somewhere between 5k and 6k every six months during 2018.
  • During 2019, the net increase to car-loan customers fell to 3.5k during the first half and then to just 1k during the second (at least according to my sums).
  • Total outstanding car loans dropped by £5m to £259m during the second half of 2019.
  • December’s update reported total outstanding car loans were £276m. Total outstanding car loans therefore dropped by £9m during the final two months of the financial year.
  • As such, the effect of the aforementioned application tightening and/or the greater loan write-offs appears to have recently accelerated.

Aspen Bridging

  • Established two years ago, Aspen offers property bridging loans aimed at small/individual property developers/investors with awkward financial circumstances.
  • The average bridging loan is £375k with a monthly interest rate of “just over” 1% and a term of between 6 and 14 months. These case studies give a flavour of the borrowers involved:
sus s&U fy 2019 results example of aspen bridging customer and property
  • The half-year split shows Aspen making very encouraging progress, with start-up losses having now turned into profit:
H1 2018H2 2018FY 2018H1 2019H2 2019FY 2019
Revenue (£k)868138991,1901,6532,843
Pre-tax profit (£k)(280)(18)(298)279559838
  • Bridging loans generate lower annual revenue (i.e. interest) than car loans for every £1 lent (19.5p vs. 33.9p):
H1 2018H2 2018FY 2018H1 2019H2 2019FY 2019
Property
Loan provision (£k)1914316298108206
Revenue (£k)868138991,1901,6532,843
Average customer loans (£k)8996,3205,42113,58417,29014,547
Loan provision/Revenue (%)22.117.618.08.26.57.2
Loan provision/Average customer loans (%)4.24.53.01.41.21.4
Revenue/Average customer loans (%)19.125.716.617.519.119.5
'Risk-adjusted yield' (%)*14.921.213.616.117.918.1
  • But bridging loans do enjoy lower rates of bad debts (7.2% vs. 26.6% of revenue).
  • The loans are secured on the property involved and repaid through the property’s onward sale or by re-mortgage. Every property is visited by Aspen before a loan is granted.
  • Aspen’s 18.1% ‘risk-adjusted yield’ compares to 24.9% at Advantage.
  • I suppose further expansion at Aspen and greater bad debts at Advantage could see their risk-adjusted yields meet in the middle.
  • For now at least, Aspen remains a small part of SUS. Outstanding bridging loans total £18m versus £259m for car loans.
  • SUS has high hopes for Aspen. Management anticipates “controlled revenue growth at Aspen of at least 50% per year over the next two years.”
  • 50% revenue growth for two years equates to 125% growth.
  • Could Aspen become another Advantage — and go from start-up to an annual £30m-plus profit within 19 years?
  • SUS cites research that claims the property-bridging market could grow from £7.5 billion to £10 billion by 2021. 
  • In comparison, the market for used cars bought on finance is £12 billion (point 1).

Margin and ROE

  • The 2018 annual report (point 11) says SUS borrows money from mainstream banks at 4% to then lend out at 31%.
  • The wide net interest margin is required to cover debt impairments and operating costs, but still led to a high 43.8% operating margin for 2019:
Year to 31 January2015*2016201720182019
Operating margin (%)45.647.044.441.343.8
Return on average equity (£k)-15.115.216.717.6
Return on average equity (£k)**-12.613.212.011.9

(*ROE figures not shown due to distortion following demerger of home-credit subsidiary **adjusted for debt and interest payments)

  • SUS requires a high level of profit to generate a respectable return on the equity that supports the business.
  • Since 2015, SUS’s shareholder equity has advanced by £84m to £165m while earnings have advanced by £16m to £28m. 
  • The resultant incremental return on equity (ROE) during that period was an attractive £16m/£84m = 19%.
  • Note that SUS’s ROE is assisted by significant levels of debt. 
  • Year-end net debt was £108m — more than 3x 2019 earnings of £28m.
  • Adjusted for debt and interest payments, the 2019 ROE falls to around 12%.
  • Adjusted for debt and interest payments, the incremental ROE for 2015 to 2019 falls to around 13%.
  • SUS calculates the return on capital employed (ROCE) within Advantage to be 15% for 2019 (red line):
sus s&U fy 2019 results advantage finance return on capital chart
  • The 3% difference between my ROE calculation and SUS’s ROCE calculation is due mostly to my calculation including tax.

Borrowings

  • SUS’s net debt has increased over time as cash flow was reinvested heavily into working capital (essentially new customer loans):
Year to 31 January20152016201720182019
Operating profit (£k)16,44521,25126,87132,97839,101
Depreciation (£k)129426253294414
Net capital expenditure (£k)(601)(396)(308)(1,040)(785)
Working-capital movement (£k)(8,576)(6,057)(48,488)(68,881)(19,041)
Net debt (£k)(53,565)(11,901)(49,167)(104,990)(108,037)
  • The £19m absorbed into working capital for 2019 was split as a £21m outflow during H1 and a £2m inflow during H2:
H1 2018H2 2018FY 2018H1 2019H2 2019FY 2019
Operating profit (£k)15,42717,55132,97818,81320,28839,101
Working-capital movement (£k)(34,725)(34,156)(68,881)(21,056)2,015(19,041)
Other cash-flow movements (£k)(3,373)(4,142)(7,515)(4,649)(4,881)(9,530)
Operating cash flow (£k)(22,671)(20,747)(43,418)(6,892)17,42210,530
  • That H2 £2m inflow presumably followed the aforementioned tightening of Advantage’s application criteria — and reflected car-loan repayments exceeding new car-loans issued.
  • As such, operating cash flow during H2 was £17m — of which £13m was used to reduce debt.
  • The moderation of new car loans being issued could lead to further surplus cash generation and reduce debt during the current year.
  • Interest payments of £4.4m were covered a healthy 9x by operating profit during 2019.
  • SUS maintains a tiny defined-benefit pension scheme that last reported a surplus.

Valuation

  • SUS ended the year with total outstanding customer loans of £277m.
  • During H2, SUS earned revenue equivalent to 32.1% of outstanding customer loans.
  • Multiplying £277m by 32.1% gives possible revenue of £89m for the current year.
  • Also during H2, SUS recorded:
    • a bad-debt impairment equivalent to 26.3% of revenue;
    • other cost of sales equivalent to 17.7% of revenue, and;
    • administrative expenses equivalent to 12.5% of revenue.
  • Potential revenue of £89m less those percentage charges would leave a potential £39m operating profit. 
  • Applying the 19% tax used in these results to a potential £39m operating profit delivers possible earnings of £31m or 261p per share.
  • Adding the £108m debt to the current £228m market cap gives an enterprise value (EV) of £336m or £28 per share
  • Dividing the £28 EV per share by my 261p EPS guess leads to a multiple of 10.7x.
  • The 118p per share dividend supports an appealing 6.2% income. 
  • Assuming the seasoned family management can continue to deliver its mantra of “steady, sustainable growth”, the shares do not appear expensive for patient investors. 

Maynard Paton

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Disclosure: Maynard owns shares in S & U.

One thought on “S & U: Record FY Results Show Dividend Up 12% But Management Hints Of Slowing Growth Leave Yield At 6%-Plus

  1. Andy

    Hi Maynard
    I’ve not studied S&U – just your (excellent) write up.
    My work background was reinsurance underwriting – not a million miles from assessing the risks for lending money.
    I imagine that the published figures are on an accounted during the report year basis? ie interest received & bad debts provisioned from all loans current – irrespective of when they were made?
    Do they make “loan year” figs available? ie figures showing the loans made, flow of interest received, debt provisions over time in respect of all loans made during a particular year? This would be especially interesting to show how bad debt provisions evolve – I imagine these evolve from initially being anticipated default rates to actual experience over a number of years and it would show how good they are at estimating.
    With accounted year figs and, especially, with a growing account, it’s very difficult to take a view on how adequately reserved they might be. In insurance, fast growth and under-reserving always ends in tears…. Independent Insurance being a classic example.
    Personally, I’d be a bit jittery looking at your table under Motor-finance bad debts – bad debts up nearly fourfold on income just over double. How much (if any) of the later year bad debts relate to loans made in earlier years, but falling outside the provisions made then?
    BUT – Accounting may be v different from insurance……
    Hope these comments are of some interest!
    Andy

    Reply

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