S&U — Covid-19 impacts but ready to resume progress

In this section we include updated indicators to provide some background in assessing the outlook for S&U, focusing mainly on the motor finance business. In Exhibit 1 we can see that the latest reading for consumer confidence (May) shows a further small deterioration following the initial sharp decline in April. As before, the level of unemployment and redundancies (for March), shown in Exhibit 2, have still to reflect the impact on the economy of the lockdown although redundancies had already started to tick up and, anecdotally, the recent news flow relating to significant job losses has increased. The spike in redundancies in 2008/09 arising from the financial crisis is an indicator of the substantial impact that is likely to become evident in due course, partially softened by government support for companies and subject to the pace of economic revival as lockdown is eased.

Unsurprisingly economic forecasts are changing rapidly reflecting emerging economic and health data. The table below includes both the illustrative coronavirus reference scenario prepared by the UK Office for Budget Responsibility (OBR) in April and more recent independent forecasts. The OBR scenario illustrates potential effects assuming a three-month lockdown followed by a further three months when restrictions are partially lifted. Among the OBR’s observations is that in the scenario GDP falls by 35% in the second quarter, and that unemployment rises by more than two million to 10% (higher than in the financial crisis, as shown above). In its scenario GDP would bounce back quickly but unemployment would subside more slowly. When comparing the average output of the recent independent forecasts with the OBR scenario there are two key features: (1) both GDP and average earnings are expected to fare better in 2020 but the recovery in 2021 is much less pronounced; and (2) unemployment is expected to remain higher for longer in the independent forecasts. The net effect of these differences would be a worse medium-term outcome on each measure on the recent independent forecasts.

The next chart (Exhibit 4) illustrates the dramatic impact of the lockdown on used car transactions and private new car registrations (last data March and May, respectively). As would be expected, used car finance through dealerships (Exhibit 5, latest data for April) followed a similar pattern with a near halt in transactions as dealerships were closed. As mentioned earlier, Advantage transactions have recovered from the initial hiatus as the lockdown took effect and are now running at 40% of normal levels. Further recovery is expected following the opening of car retailers and with the constraints on public transport due to social distancing, the importance of a car for transport to work for many will be underlined.

Looking ahead, it is worth repeating some of the points made at the time of the FY20 results regarding Advantage’s preparations to respond strongly when conditions normalise. Actions include development of a customer care centre to improve engagement, a refreshed Advantage brand, website development to facilitate customer self-service, new technology for customer underwriting and onboarding, development of a live scoreboard for existing customers to enhance collections and structuring collection teams to improve care of higher-risk accounts. Beyond this there may be opportunities to develop partnerships with prime and near-prime lenders to source business, to tap into the opportunities presented by open banking, to increase the level of customer renewals and to consider developing direct to customer business.

To provide a longer-term context, Exhibit 6 shows the history of Advantage’s net receivables and revenue less the annual impairment charge as a percentage of average net receivables (risk-adjusted yield). The risk-adjusted yield aids comparison following the change in accounting for revenue in FY20.1 Evident here is the substantial increase in the level of receivables over the period and, in the period to FY15, the rise in risk-adjusted yield following the financial crisis when capital constraints and retrenchment in the banking sector reduced the availability of credit in the non-prime segment. During this time Advantage has continuously refined its underwriting system and invested in IT development. The business has therefore developed significantly since the financial crisis while the nature of the current crisis is also markedly different meaning there are probably few direct parallels.

Accounting standards have also evolved since the earlier crisis with the introduction IFRS 9, which is designed to ensure an earlier recognition of credit losses on loans and receivables and requires provision for the expected lifetime loss for loans in stages 2 and 3 (see an explanation of S&U’s application of accounting standards in relation to impairment and measurement of receivables on page 61 of the FY20 annual report). The potential for reclassification of loans, requirement for estimates of lifetime losses in stages 2 and 3 and need to allow for macroeconomic factors when assessing expected 12-month losses on stage 1 loans all suggest a greater magnitude of impairment charge as a downturn takes place than might have been seen under previous accounting standards. Having said this with regard to reported figures, it is important to recall that S&U manages its business with an emphasis on understanding customer behaviour and the resulting cash flows, neither of which are affected by changes in accounting approach.

For Aspen property bridging, the reduced level of activity in the property market (Exhibit 7) is a prominent factor but there are some positive indicators following the reopening of the market. S&U references increases in Rightmove enquiry levels and has seen robust applications that have allowed it to develop a good quality pipeline. Transaction levels at Aspen in Q121 have been below a quarter of the full year budget and a cautious approach is being taken to new lending, but given the recent trends and the small scale of the business there should be scope to develop the loan book subject to opportunities with an appropriate risk/reward balance remaining available. The long-term aim remains for Aspen to grow to a scale where it can make a material positive contribution to the group.

On the group’s treasury position, the reduced level of new transactions at Advantage has resulted in positive recent cash flows and group debt is reported as £98m (8 June), £30m below budget and compared with £118.5m at end February. Gearing is approximately 55%. The group has repaid a £25m tranche of debt early leaving loan facilities maturing at end April 2022 (£25m), March 2023 (£60m), March 2024 (£25m) and March 2025 (£20m). With these facilities the group retains headroom of over £30m.

Given continuing heightened uncertainty and in the absence of guidance from S&U we have not included forecasts in this report. The updated version of our peer comparison table shown below therefore only shows calendar 2019 P/E ratios. The table includes companies with an exposure to motor finance and non-standard lending. S&U trades on a historical P/E in line with the peer average, while the yield is above average. Its historical return on equity (ROE) and price to book (P/BV) multiples are above the peer average, while an ROE/COE model (with assumed growth of 3% and cost of equity of 10%) would only require an assumed return on equity of c 10.8% to match the share price at the time of writing (1,660p) given the company’s book value. Increased confidence in the outlook could generate a significant revaluation (as for others in the comparison).

Exhibit 9 shows the recent share price performance for the peer group. The economic sensitivity of most lenders explains the significant negative share price moves of most of the stocks over most of the periods shown. Compared with the average, S&U’s share price has shown less weakness over all periods except the past month.