S&U — Advantage growth resumes

A summary of figures from the H120 results is shown in Exhibit 1 and key points from the results are noted below with percentage changes versus H119 unless stated.

The following exhibits show a number of measures for the motor finance business starting with the trends in Advantage’s customer credit score and flat interest rates. Historically, the credit score was at a high level following the financial crisis as mainstream lenders drew back from the market driving borrowers with higher credit ratings to alternative providers such as Advantage. More recently the score has run at a lower level as these borrowers settled and an experimental move towards higher risk categories pulled the average down. Credit criteria have been tightened and on various measures (including first payment performance) this is starting to gain traction. H120 saw a small increase in the average score while the flat interest rate was only down slightly on FY19. Turning to Exhibit 3, the cost of sales per loan has shown a consistent rise in recent periods reflecting the growing role of internet brokers in the market and competitive pressures. The latest increase, to £823 per loan, reflects a deliberate decision to increase commissions paid in order to improve the flow and mix of deals from brokers. As shown, the level of transactions in the first half (annualised in the chart) saw a marked recovery and ran at a similar level to FY18.

Next we look at revenue and impairment as a percentage of average receivables (Exhibit 4). The revenue yield rose in the post-crisis period and has then subsided with changes in risk exposure playing a role as well as the market environment. As noted earlier, impairments as a percentage of receivables were slightly lower year-on-year in H120. Combining the revenue yield and rate of impairment, the risk-adjusted yield (Exhibit 5) increased slightly in the first half (S&U reports a risk adjusted yield of 24.9% at end July compared with 24.6% based on average monthly receivables). The cost of sales increase shown in Exhibit 3 and investment in collection were drivers of a lower pre-tax profit margin at Advantage, also shown below. Despite this Advantage continued to record a return on capital employed of over 15% (as it has in each year from FY12).

Other indicators reported for Advantage showed limited change with the original term of loans standing at 51 months compared with 50 for FY19 and the average advance up 3.5% at £6,353.

Advantage reached its 20th anniversary in the period and it was announced with the results that Guy Thompson, current chief executive and managing director at its inception, is to retire in 2020 having overseen a period in which the company achieved profit growth in every year. His successor will be Graham Wheeler, who joins in October and brings with him extensive experience in motor finance in the UK including senior roles at VW Financial Services and Jaguar Land Rover Financial Services. His remit is to develop the business further, retaining the culture and conservative approach that characterise the business.

Turning to Aspen Bridging, the business remains at an early stage but increased its net receivables to £24.7m by end July and having made 137 loans in the 30 months since inception. Of these loans 73 have been repaid. The average loan size has increased to c £0.400m (from £0.375m). Maximum loan to value is 71%, the average interest rate just over 1% per month and the original term between six and 14 months. As noted above, reduced liquidity in the UK property market (for example, residential property transactions in the period were down nearly 5% y-o-y) has affected the ability of some borrowers to meet their target exit dates and this has contributed to one crystallised loss and late repayments on nine loans. Higher interest rates may be applied where repayments are delayed so, providing an exit is simply delayed and repayment is made in full, this can enhance the returns earned.

As highlighted in previous notes, S&U sees the main potential sensitivity for its Advantage business as being the financial well-being of its borrowers rather than used car prices, given the relatively low value of vehicles being financed and their typical use for transport to work. Consumer confidence is running at a lower level than pre-referendum levels but could be seen as resilient so far given the uncertain background. Similarly unemployment remains low and redundancies have been muted, although these indicators will tend to lag any significant economic downturn were this to occur.

Exhibits 8 and 9 show trends in the UK new and used car markets. Used car market transaction volumes have been less volatile and recent quarters have seen smaller reductions in used car activity. The value of car finance through dealerships shows a similar relationship and used car financing has continued to see growth in value over the period shown (to Q219). The latest monthly reading for the value of used car financing (in July) showed a YoY increase of 8%.

Prospectively the prevailing macro uncertainties seem likely to persist, but for Advantage the positive trend in transaction numbers and indications that the tightened credit criteria are taking effect are encouraging.

At Aspen the incidence of slower repayments and a lower than expected pace of new loans in the first half may mean it is prudent to assume that the near-term pace of expansion is below previous estimates, but the market opportunity is still seen as attractive with enquiries and deal pipeline running well ahead of the prior year. Product adaption, experience in the market and further establishment of the network of introducer relationships should all be helpful in moving the business to a scale where it would be seen as more material as a diversifying profit and growth contributor (potentially with a loan book of £60–70m and profit of c £5m).

Our profit and earnings estimates only change marginally, as shown below, with higher estimated revenues for Advantage offset by higher assumed cost of sales, mirroring the changes seen in the first half figures.

Our assumptions for Advantage include motor finance receivables growth of 11% and 8% for FY20 and FY21, respectively, and a reduced percentage level of impairments at c 8.5% of receivables. At Aspen bridging receivables are assumed to reach £30m in the current year followed by £40m (£45m previously). Further details from our estimates are shown in the financial summary (Exhibit 14).

S&U’s half-yearly cash flow analysis is shown in Exhibit 11. The main features to highlight here are the swing from a net inflow to a net outflow at Advantage between the H219 and H120 as new transactions increased, while at Aspen the outflow increased with higher advances and lower collections sequentially. Net debt at end H120 stood at £125.2m (excluding lease liabilities) and committed funding facilities remain at £160m, providing headroom for growth. On our estimates, net debt could rise to c £148m by end FY21 with net debt/equity at 75%.

We have updated our peer comparison table including companies with exposure to motor finance and non-standard lending. This shows S&U trading on similar earnings multiples to the average and on an above average yield. The price to book multiple is above the average, but the return on equity is also higher than average.

Using an ROE/COE model (with cost of equity assumed at 10% and growth of 4%) the current share price implies a market assumption of a return on equity of just above 13%, which appears cautious when compared with our expectation of over 17% for this year and next and 17.6% recorded in FY19.

Exhibit 13 shows the recent share price performance of the same companies. The weakness of the whole group on a one-year view and from 12-month highs can be attributed to concerns over possible risks in the economic background for domestic lenders in the UK. Directionally, S&U has mirrored its peers though the year-to-date and from its 12-month high it has outperformed, which can be justified by the resilience demonstrated by the main Advantage business through previous cycles.