19 April 2020
By Maynard Paton
Results summary for S & U (SUS):
- Another set of record annual figures that showed steady progress — albeit overshadowed entirely by the potential impact of Covid-19.
- The boardroom’s confidence is encouraging. The final dividend was reduced only slightly and no staff have been furloughed.
- Some £302m has been loaned to customers with patchy credit histories, and recouping that money has become vital. Management says collections are “very good”.
- Net debt of £118m and a 26% net-interest margin lead to respectable returns on capital, but the borrowings will not prove ideal if defaults increase and profits fall.
- Current-year earnings have become anyone’s guess, and a bargain-basement P/E may be rather less than the current 10x trailing multiple. I continue to hold.
- Event link and share data
- Why I own SUS
- Results summary
- Coping with Covid-19
- Revenue and profit
- Advantage Finance
- Aspen Bridging
Event link and share data
Shares in issue: 12,120,093
Market capitalisation: £206m
Why I own SUS
- Provides ‘non-prime’ credit to used-car buyers and property developers, where disciplined lending and reliable service have supported an enviable track record.
- Boasts veteran family management with 40-year-plus tenure, 50%-plus/£103m-plus shareholding and a “steady, sustainable” and organic approach to long-term growth.
- Offers some hope for a resilient Covid-19 performance following recent dividend declaration and decision not to furlough staff.
Coping with Covid-19
- How S&U has so far coped with the Covid-19 pandemic was the most pressing matter within these results.
- The company provides ‘non-prime’ loans to used-car buyers and property developers with patchy-but-improving credit histories.
- The economic disruption resulting from the pandemic could mean S&U suffers significant defaults and becomes nervous about its own borrowings.
- The latest balance sheet showed outstanding customer loans of £302m and net debt of £118m.
- Given the circumstances, the management narrative was relatively reassuring.
- S&U said (my bold):
“Our collections performance for March 2020 remains just below normal, although declining incomes and a temporary increase in unemployment, will undoubtedly see customer payments lower than last year and many falling into arrears.
Forbearance and the extra work on customer contact and relations being done by our collections teams… should encourage customers to “stay in their cars“, minimise any decline and encourage customers to resume normal payments when the pandemic recedes.”
- The company reckoned customers would pay back their loans, and debt would then fall:
“We expect our borrowing requirements to accelerate the trend evident since year-end by falling significantly over the next four months, as demand for our products falls and our collection performance proves relatively resilient.”
- Mind you, S&U did admit “consistent trends are impossible to discern”.
- The firm also admitted only a “nominal” number of new loans would be issued until at least 1 July 2020.
- Management’s confidence was underlined by the declaration of a final dividend.
- The 50p per share payout was a penny less than last year’s final, but could easily have been 51 pennies less at zero.
- S&U justified the payment by claiming:
“Whilst cash conservation is sensible, our strong treasury position and relatively low gearing give us a firm base for the preservation and renewed expansion of our business. Indeed, on current trends the next few months should be cash generative for the Company.”
- Even though the final divided was reduced by 1p per share, the payout for the full-year was 2p higher at 120p per share following earlier interim-dividend increases.
- S&U has an illustrious long-term dividend record, having never cut the payout since at least 1987:
- Keeping that growth record intact will be tough, given the next few months are likely to see collection rates decline and next-to-no new business come in to compensate.
- Management confidence was also expressed by staff being kept on and being paid in full during the pandemic (my bold):
“Nearly 90% of staff at Advantage, Aspen and Head Office are working from home with some staff redeployed to collections – none are being furloughed”
- For now at least, management’s remarks and actions are not sounding an alarm of imminent deep trouble.
Revenue and profit
- First-half figures from September and a trading update during December had already heralded a steady full-year performance.
- Revenue gained 8% while operating profit climbed 2%:
|Year to 31 January||2016||2017||2018||2019||2020|
|Operating profit (£k)||23,643||26,871||32,978||39,101||39,984|
|Other items (£k)||-||-||-||-||-|
|Finance cost (£k)||(3,243)||(1,668)||(2,818)||(4,541)||(4,850)|
|Pre-tax profit (£k)||20,400||25,203||30,160||34,560||35,154|
|Earnings per share (p)||133.6||170.7||203.8||233.2||239.6|
|Dividend per share (p)||76.0||91.0||105.0||118.0||120.0|
- Revenue, profit and the aforementioned full-year dividend all registered new highs.
- The results extended SUS’s run of growth following the sale of the group’s home-credit business during 2015.
- The figures were distorted somewhat by revised accounting for the main motor-finance operation.
- S&U said:
“On reviewing its accounting policies in preparing the 2020 financial statements, the group has determined that revenue should be recognised ‘net’ of the impairment provision to align the accounting treatment under IFRS 16 with the requirements of IFRS 9 and also with the treatment adopted for similar assets in Aspen.”
- The prior-year 2019 results were therefore restated. Group revenue of £89m was reduced to £83m while the total loan impairment — effectively a charge for likely bad debts — was reduced from £23m to £17m.
- The restatement did not affect S&U’s 2019 profit — the prior-year operating profit remained at £39.1m. Nor was the prior-year balance sheet or cash flow altered.
- The revised accounting led to a £6m reduction to the 2019 impairment charge for car loans, which therefore distorted the analysis of whether S&U’s lending quality had improved.
- SUS suffered from rising loan impairments during the second half of 2018 and throughout 2019, but the bad loans started to subside during the first half of 2020.
- S&U’s interim 2020 figures applied the old accounting standard, which meant the first-half/second-half splits for motor-finance revenue and impairments were not directly comparable (see Advantage Finance below).
- At least S&U’s ‘risk-adjusted yield’ calculation remained consistent.
risk-adjusted yield is a ‘profit margin’ KPI used by SUS and is calculated as: (revenue - impairment provision) / average outstanding customer loans
- Risk-adjusted yield represents the net return SUS enjoys (before administration costs and broker commissions) on the money the group lends to customers.
- The higher the risk-adjusted yield, the healthier the loan book.
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- The typical Advantage Finance customer has a patchy-but-improving credit history and borrows £6.4k to buy a five-year-old used car.
- The customer then pays back £11.6k over 51 months — equivalent to a flat c18% interest rate.
- Customers are described by management as ‘non-prime’ — “borrowers that have had a problem in the past but are on an upward trend” (point 3).
- Within the table below, the aforementioned accounting change meant the risk-adjusted yield was the sole consistent ratio during the past four half-year periods:
|H1 2019*||H2 2019||FY 2019||H1 2020*||H2 2020||FY 2020|
|Loan provision (£k)||11,320||5,415||16,735||11,075||5,432||16,507|
|Average customer loans (£k)||257,335||261,113||255,013||266,291||277,264||269,784|
|Loan provision/Revenue (%)||26.2||14.7||20.9||24.3||13.6||19.3|
|Loan provision/Average customer loans (%)||8.8||4.1||6.6||8.3||3.9||6.1|
|Revenue/Average customer loans (%)||33.6||28.2||31.4||34.2||28.8||31.7|
|'Risk-adjusted yield' (%)||24.8||24.1||24.9||25.9||24.8||25.6|
(*old accounting standard)
- My sums differ slightly from SUS’s official figures, which claim a risk-adjusted yield of 25.4% for 2020 and 24.6% for 2019.
- At least my calculations and SUS’s calculations suggest the risk-adjusted yield has improved slightly.
- Mind you, Advantage has some way to go to reach the yield levels of a few years ago.
- For example, the risk-adjusted yield (red line below) topped 30% during the ‘boom’ years of 2013, 2014 and 2015:
- I now view those boom years as unusually favourable rather than as a period that could be repeated easily.
- The results powerpoint admitted a slightly higher proportion of motor-loan accounts were in arrears — 21% versus 20% for 2019:
- The interim statement had shown the number of accounts in arrears falling to 19%. The percentage was less than 10% a few years ago:
|Up to date accounts||29,460||37,447||45,668||47,307||50,825|
|Up to date/Total (%)||90.4||87.0||83.8||80.0||79.3|
- Further hope of bad debts remaining under control comes from the proportion of car-loan borrowers making their first payment.
- The first-payment ratio (blue line, left axis) for Advantage has improved from 95.5% to almost 98% since late 2017:
- SUS believes this first-payment improvement should lead to lower future write-offs (dotted red line, right axis).
- The powerpoint slide below has taken on much more importance following the pandemic:
- The blue bars represent the money borrowed by customers during a particular year, while the red bars represent the money paid back within 30 months and the green bars represent the total money paid back.
- For example, approximately £100m was advanced during 2016, of which 98% was paid back within 30 months and 136% has since been repaid in total.
- Collections rates have deteriorated slightly during the past few years — a trend linked to the increased impairments seen during 2018 and 2019.
- Between 2010 and 2015, S&U issued loans where the subsequent 30-month repayments totalled at least 105% of the original advance:
- For 2016, the 30-month collection percentage had dropped to 98%, and then dropped to 96% for 2017 and 2018.
- The 19% collection rate for the latest year (2020) is not out of the ordinary. The same presentation slides for 2017, 2018 and 2019 showed current-year collections of 20%, 19% and 21% respectively:
- The 61% two-year collection rate for the previous year (2019) is not out of the ordinary. The same presentation slides from 2017, 2018 and 2019 showed two-year collections of 61%, 61% and 59% respectively.
- Exactly how collections will fare from here remains difficult to predict.
- The firm’s Covid-19 FAQs give the folowing response to the question Can I have a payment holiday?
“We are eager to discuss your individual circumstances with you in order to agree the best solution possible, and we will apply the appropriate levels of forbearance to all cases of genuine hardship. With that in mind, please call our staff on 01472 233200 Option 2 then Option 1 in order to speak to an advisor.“
- I will be very pleased if the 2021 results presentation shows current-year collections maintained at c20% and two-year collections maintained at c60%.
- I would like to think SUS will update shareholders well before next year’s presentation should future collection rates fall short of previous levels.
- “Tighter and cautious underwriting” meant the proportion of car-loan applicants that receive an approval was trimmed by two percentage points to 21%:
|Applications||over 750,000||over 860,00||over 1,000,000||over 1,350,000|
|Loans issued/Approvals (%)||8.4||9.8||9.2||8.2|
- Applications for car loans increased significantly. More than 1,350,000 applications were received during 2020 — up at least 30% on 2019.
- Note that only 8% of approved applicants go on to collect their new loan.
- Management expalined at a presentation last year (point 3) why 92% of approvals did not conclude with a loan:
- The customer decided not to buy a car;
- The chosen car was not acceptable to Advantage (e.g. too old, too high a mileage, etc), or;
- A cheaper loan was found elsewhere.
- Management reckoned the third reason was the most common — but hinted the cheaper lender was likely to lose money on such deals.
- The 8% take-up suggests Advantage has the best rates for only a small proportion of potential borrowers.
- Despite the tighter underwriting, the 30%-plus increase to applications meant the level of new loan agreements recovered to 23,334 for 2020 — second only to the 24,518 issued during 2018:
|H1 2018||H2 2018||H1 2019||H2 2019||H1 2020||H2 2020|
|Net customer increase||5,933||5,479||3,529||1,101||2,923||2,193|
|Customer loans (£k)||226,807||251,215||263,455||258,810||273,771||280,757|
|Change to customer loans (£k)||33,278||24,408||12,240||(4,645)||14,961||6,986|
- 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 run at 11,412 during 2018.
- The net increase to car-loan customers then fell to 4,630 during 2019 and then rebounded slightly to 5,116 for 2020.
- Total outstanding car loans (less impairments) advanced by £22m to £281m during the year.
- 90% of Advantage’s business comes from loan brokers, with 5% direct from motor dealers and 5% being previous customers.
- Commissions paid to loan brokers continue to rise:
- Advantage’s cost of sales has jumped to £824 per loan, from £727 last year and £558 back in 2015.
- SUS commented upon the appointment of Advantage’s new managing director Graham Wheeler (my bold):
“In terms of leadership, this year saw the passing of the baton from Guy Thompson, Advantage’s founder MD, and inspiration for the past twenty years, to Graham Wheeler, an equally iconic figure in the motor finance industry and the driving force behind the expansion of Volkswagen motor finance in the UK a decade ago. The transition has, as expected, been smooth and seamless, and, irrespective of the current market disruption, promises still more of the continuous improvement in customer service and sensitivity to the market it serves that has characterised Advantage’s history.”
- Mr Wheeler’s predecessor established Advantage during 1999 and led the subsidiary to 20 years of uninterrupted profit growth.
- Within my previous SUS write-up, I wrote: “I trust Mr Wheeler can continue the same approach”.
- Now I am hoping Mr Wheeler can simply keep the collections coming in.
- Mr Wheeler’s social-media account is worth monitoring.
- In among messages about his back garden and daughter’s books, he sometimes lets slip details of company activity:
- 1,000 applications a day compares to last year’s 1,350,000 total — or c3,700 a day (spread over 365 days).
- I assume these 1,000 applications will not result in eventual loans because car dealers should be closed at present.
- Established three years ago, Aspen offers property bridging loans aimed at small/individual property developers/investors with awkward financial circumstances.
- The average bridging loan to date has been c£450k with a monthly interest rate of “just over” 1% and a term of between 6 and 16 months. These case studies give a flavour of the borrowers involved.
- Management said the average transaction size at Aspen “rose to just over a half a million pounds as the business targeted more professional, and therefore reliable, residential developers and refurbishers”.
- A recent Aspen survey indicated many brokers wanted the £1.5m maximum loan size increased. The subsidiary’s website suggests the maximum is now £2m.
- Revenue and profit increased by more than 40% after total bridging loans climbed 35%:
|FY 2018||FY 2019||FY 2020|
|Pre-tax profit (£k)||(298)||838||1,205|
|Loans advanced (£m)||12.9||23.1||31.3|
|Loans advanced/agreements (3k)||369||373||549|
- The second half was more profitable than the first:
|H1 2019||H2 2019||FY 2019||H1 2020||H2 2020||FY 2020|
|Pre-tax profit (£k)||279||559||838||502||703||1,205|
- Although bridging-loan impairments more than tripled to £713k, the amount remained small (at less than 4%) compared to the average level of bridging loans outstanding during the year:
|FY 2018||FY 2019||FY 2020|
|Loan provision (£k)||162||206||713|
|Average customer loans (£k)||5,421||14,547||19,623|
|Loan provision/Revenue (%)||18.0||7.2||15.9|
|Loan provision/Average customer loans (%)||3.0||1.4||3.6|
|Revenue/Average customer loans (%)||16.6||19.5||22.8|
|'Risk-adjusted yield' (%)*||13.6||18.1||19.2|
- Fractionally higher revenue (i.e. interest) earned from customer loans helped Aspen’s risk-adjusted yield improve a percentage point to 19%.
- The half-year splits show a similar trend:
|H1 2019||H2 2019||FY 2019||H1 2020||H2 2020||FY 2020|
|Loan provision (£k)||98||108||206||318||395||713|
|Average customer loans (£k)||13,584||17,290||14,547||21,472||22,842||19,623|
|Loan provision/Revenue (%)||8.2||6.5||7.2||15.3||16.5||15.9|
|Loan provision/Average customer loans (%)||1.4||1.2||1.4||3.0||3.5||3.6|
|Revenue/Average customer loans (%)||17.5||19.1||19.5||19.3||21.0||22.8|
|'Risk-adjusted yield' (%)||16.1||17.9||18.1||16.3||17.6||19.2|
- Note that Aspen’s outstanding loans increased from £18m to £25m during the first half, then fell to £21m during the second. Those movements explain why average customer loans for the year were £20m — less than the averages for H1 and H2.
- SUS confirmed 112 of the 154 property loans issued during the last three years had been repaid in full.
- 42 loans therefore remain outstanding, with an average size of £467k.
- SUS admitted the remaining property-loan book was “smaller than anticipated” after the “interminable Brexit process dampened consumer and developer confidence”.
- Maybe the “smaller than anticipated” book has become a blessing following the pandemic.
- Management not surprisingly said: “Covid-19’s effect on the property market has seen Aspen rein back its lending and concentrate its energies on collections.”
- At the half year, management was very bullish on Aspen’s near-term future: “The current pipeline augurs a good second half, and a significant contribution by Aspen to Group profits in the next two years.”
- No such optimism was issued within this RNS.
- Aspen contributed 3% of group profit during 2020.
- Net debt increased by £10m to £118m during the year:
|Year to 31 January||2016||2017||2018||2019||2020|
|Operating profit (£k)||21,251||26,871||32,978||39,101||39,984|
|Net capital expenditure (£k)||(396)||(308)||(1,040)||(785)||(265)|
|Working-capital movement (£k)||(6,057)||(48,488)||(68,881)||(19,041)||(24,067)|
|Net debt (£k)||(11,901)||(49,167)||(104,990)||(108,037)||(117,844)|
- Of the £40m operating profit generated, a net £24m was reinvested back into working capital (i.e. to fund new loans) while £5m was paid as interest, £7m was paid as tax and £14m was paid as dividends.
- The half-year cash-flow split is informative:
|H1 2019||H2 2019||FY 2019||H1 2020||H2 2020||FY 2020|
|Operating profit (£k)||18,813||20,288||39,101||19,410||20,574||39,984|
|Working-capital movement (£k)||(21,056)||2,015||(19,041)||(20,717)||(3,350)||(24,067)|
|Other cash-flow movements (£k)||(4,649)||(4,881)||(9,530)||(5,234)||(5,737)||(10,971)|
|Operating cash flow (£k)||(6,892)||17,422||10,530||(6,541)||11,487||4,946|
- The second half of 2020 witnessed only a net £3m reinvested back into working capital (i.e. to fund new loans), which left H2 operating cash flow at £11m and helped reduce debt during the six months by £7m.
- The second half of 2019 also showed positive cash generation, this time with £2m returned from working capital after collections exceeded new loans issued.
- The current year should also witness positive working-capital movements that lead to favourable cash generation, given few new loans are being issued as repayments come in.
- As such, current-year net debt should reduce.
- For now, though, net debt of £118m equates to more than 4x 2020 earnings of £29m.
- Servicing the debt did not appear problematic last year. Bank interest payments of £4.7m were covered a reasonable 8-9x by operating profit.
- The prospect of positive working-capital movements should ensure interest cover on a cash basis is higher than 8-9x during 2021.
- Paying interest of £4.7m on debt that averaged £113m during 2020 implies an interest rate of 4.2%.
- The 2019 annual report (point 11) claimed SUS borrows money from mainstream banks at 4% to then lend out at 30%.
- The wide, 26% net interest margin is required to cover debt impairments and operating costs, and in turn earn a respectable return on the capital employed.
- SUS reckons the return on capital employed (ROCE) within Advantage was 15% for 2020 (blue line):
- The 26% net-interest margin and reasonable ROCE are reflected in my operating margin and return on equity (ROE) sums:
|Year to 31 January||2016||2017||2018||2019||2020|
|Operating margin (%)||47.0||44.4||41.3||47.1||44.5|
|Return on average equity (%)||15.1||15.2||16.7||17.6||16.8|
|Return on average equity (%)*||12.6||13.2||12.0||11.9||11.5|
(*adjusted for debt and interest payments)
- The 3% difference between my ROE calculation and SUS’s ROCE calculation is due mostly to my calculation including tax.
- For the record, since 2015, shareholder equity has advanced by £98m to £179m while earnings have advanced by £17m to £29m.
- The resultant incremental return on equity during those five years is a respectable £17m/£98m = 17%.
- SUS maintains a tiny defined-benefit pension scheme that last carried a surplus.
- The pandemic has meant current-year earnings have become anyone’s guess.
- Management would not make any projections (my bold):
“The onset of the Covid-19 virus and the unprecedented disruption surrounding it, pose great challenges for consumers both in Britain and the wider world. S&U has strategies in place and the skills, resilience and experience to meet these challenges. However, they are unprecedented and their effect on the economy at present is unknown, as a result the Group is withdrawing future guidance.”
- Executive Chairman Anthony Coombs was interviewed by Proactive Investors after the results:
- Mr Coombs delivered a few positive snippets:
- “Some of our competitors have actually shut up shop completely — in fact the largest introducer is no longer doing business for the next two or three weeks”
- “Collections, however, still go on… and they have been very good. Altogether we’re becoming very cash generative…so on that basis we are pretty confident”
- “Covid has put the company behind by about 18 months on our development plans”
- “Our covenant level is about 50% higher than the current [65% gearing] level”
- “Cash is not a problem… we will probably repay overdraft facilities to reduce non-utilisation fees… we are very strong financially”
- For the record, operating profit of £40m taxed at the 18% applied in these results gives earnings of £33m or 272p per share.
- Adding the £118m debt to the current £206m market cap gives an enterprise value of £324m or £27 per share.
- Dividing the £324m enterprise value by my £33m earnings figure leads to a trailing multiple of almost 10x.
- A 10x multiple would normally seem appealing, but these times are not normal.
- The shares have not typically sported a premium rating. For perspective, the multiple was 14x when the price was almost 50% greater at £25 during 2018.
- A bargain-basement purchase ahead of any post-pandemic recovery may therefore require a P/E of rather less than 10x trailing earnings — assuming of course that earnings do one day recover.
- If maintained, the trailing 120p per share dividend supports a 7.1% income at £17 a share.
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Disclosure: Maynard owns shares in S & U.