S&U — Elevated regulatory impact

Regulatory discussions on affordability and forbearance have had a larger impact than expected since the full-year earnings were announced, reflected in a further drop in the payment rate from an average 92.1% in FY24 to 87.7% at the end of April. S&U is exercising caution in its handling of customers at this stage and until the conclusion of discussions with the regulator, which management expects will be in H2CY24.

Following the Q1 trading update, we have made sizeable reductions to our estimates, particularly in FY25, as the ongoing industry regulatory changes affect payment rates and hence impairments, volumes and margins (as management takes a cautious view on originations). Some of the impact in FY25e will be temporary, particularly potential remediation costs (in impairments), and we expect payment rates to improve in FY26e, which should lead to lower impairment rates and a rebound in earnings in FY26e. However, the ultimate balance between margin and risk is difficult to ascertain at this stage, so we have taken what we believe to be a conservative approach in our estimates.

We have lowered our group revenue forecasts by 7% and 11% in FY25 and FY26, respectively, as motor transactions have slowed and are likely to slow further into the summer of 2024 following loan re-pricing actions at the end of Q125. FY26e revenues are affected by a lower level of average balances in FY25e and somewhat more conservative margin assumptions. Over time, we would expect the industry to adapt in terms of risk-adjusted pricing, but there may ultimately be a higher proportion of nearer prime customers at S&U following the regulatory changes.

We have reduced our FY25 and FY26 EPS estimates by 22% and 15%, respectively, and have trimmed our DPS estimates by 4% in each year to smooth the payout profile. EPS in FY26e represents growth of just under 7% compared to FY24.

We have not modelled in any benefit for base rate reductions; thus, we believe we are conservative in our estimated 11% RoE for the group in FY26.

Our estimates are summarised in Exhibit 1 below.

Our revisions to group PBT forecasts are entirely due to reductions in our estimates for Advantage based on the impact of regulations flagged in the Q1 statement. S&U disclosed Q1 group PBT of £6.9m (Q124: £10.5m), explained by higher impairment in Advantage. However, we also note this implies a flattish performance in profit before impairments.

Exhibit 2 summarises the contribution of Advantage and Aspen to group PBT. We now expect PBT at Advantage to fall to £23.0m in FY25e from £28.8m in FY24 before recovering in FY26e to a level slightly above that of FY24. We have maintained our Aspen forecast of double-digit growth in both FY25 and FY26.

Exhibit 3 below presents our detailed estimate revisions for Advantage. There are two major factors that drive forecasts: the number of transactions and impairments.

We have sharply reduced the number of transactions in both FY25e and FY26e. FY25e represents a slightly bigger revision (-15%) and reflects an expected slowdown, especially over the summer of 2024, as loan pricing has been adjusted at the end of Q125. We have also carried forward a 13% lower level of transactions in FY26e as there is uncertainty as to the composition of the addressable market for S&U and there may be a continued adjustment period post closure of discussions with the FCA this year. The lower level of transactions results in a lower level of receivables and hence revenue. We have also slightly reduced margins in anticipation of a greater proportion of nearer prime and lower-risk customers in the overall mix. We have thus reduced our revenue estimates for Advantage by 9% in FY25 and 13% in FY26.

We have modelled a 14% increase to our impairment forecast in FY25 as a result of the continuing decline in the payment rate, as well as to take into account any potential remediation costs, which should prove temporary. Payment rates are expected to improve once the regulatory discussions are concluded and there is clarity on the relative profitability of different customer segments. Hence our impairment cost normalises in FY26e against a lower receivables base. Our forecast changes for sales and other costs partially offset the revenue revisions in light of lower transactions and reduced volumes and financing requirements.

Our overall PBT forecast for Advantage falls 26% to £23m in FY25 and 18% to £29m in FY26. Our FY26 estimate assumes a PBT margin recovering to our previous assumption for FY25 at just under 29%.

Aspen is benefiting from continuing investment by S&U, along with becoming an increasingly wellrecognised brand in the market and improving housing market data (see economic indicators below). Aspen is not subject to consumer regulation and is, therefore, unaffected by the FCA initiatives.

We continue to expect net receivables to reach £158m (+22%) in FY25e and £183m (+16%) in FY26e. This results in revenue growth of 37% and 20% in FY25e and FY26e, respectively. PBT remains at £6m for FY25e and £7m for FY26e. Thus, Aspen should become a more significant contributor to PBT, averaging around 20% over the forecast horizon and providing a useful diversification of earnings in a period of adjustment for Advantage.

We base our valuation on an RoE versus CoE model, which is very common in the financial sector. The sector is highly regulated and competitive, thus sustainable growth depends on the ability to generate capital. We assume a CoE of 10% and a long-term earnings growth rate of 2% and, based on our assumed 11% RoE in FY26e, the implied valuation is 1.13x book value, or 2,169p per share. Adding in the expected dividend of 120p implies a total return of 19%.

On traditional measures, S&U trades on 10.7x FY25e EPS (which we regard as depressed by temporarily elevated impairment charges) and 8.6x FY26e EPS. The shares also provide a wellcovered dividend yield of over 6% in FY25e and FY26e.

In this section we update our compilation of UK economic indicators relevant to consumer credit markets and the motor and housing markets, in particular.

In summary, although the UK is experiencing sluggish growth, there is a stable-to-improving trend in both economic indicators and those for the motor and housing markets. The economic environment for S&U’s business looks to be a little more certain than 12 months ago.

The recent release of estimated UK GDP growth in Q124 surprised positively at 0.6%. This has been reflected in consensus estimates for GDP growth for the full 2024 rising to 0.6% from 0.4% previously (Exhibit 4). Inflation expectations (CPI) and unemployment both deteriorated very slightly and remain pretty much in line with previous estimates.

Independent forecasts are very slightly weaker for 2025, with GDP expected to be 1.2% (previously 1.3%), the unemployment rate 4.4% (4.4%) and CPI 2.2% (2.1%), as shown in Exhibit 5.

Consumer confidence (Exhibit 6) witnessed another jump in May 2024, rising a further 2pp monthon-month to an index level of negative 17. The relatively stable labour market data (Exhibit 7) would have helped, along with recovering incomes from April increases in the Living Wage (+9.7%) and state pensions (+8.5%), a 2pp cut in National Insurance and declining energy bills (12% average price cap).

Improving consumer confidence should have a knock-on positive effect on demand for S&U’s finance products in both Advantage and Aspen.

The overall picture in the used car market is one of the beginnings of a recovery. The thick grey line in Exhibit 8 shows that 2024 has started well, with transactions in Q124 7% above those in the previous year, as well as in 2022 and 2021. March transactions were above every year since 2020. This trend is also confirmed in Exhibit 9, using rolling 12-month totals from the Finance and Leasing Association. Both loan values and transactions appear to have bottomed over the 12 months to December 2023. Values have lagged loans as the high inflation witnessed post COVID-19 has worked its way through the figures. On a single month basis, used car finance transactions were up 11% y-o-y in April 2024 and loan value was up 6% y-o-y.

Exhibits 10 and 11 below illustrate a stabilisation in used car prices since falling from a peak in December 2021. In April 2024, prices were down 10% y-o-y but up by 0.5% m-o-m. From the historical series the year-on-year comparatives should improve more markedly from October 2024.

Overall, the data concur with S&U management’s commentary of record applications in Q125 and leave the potential for earnings recovery following the negative regulatory impact on collections.

Aspen benefits indirectly from the UK housing and mortgage markets as its borrowers depend on transaction activity to complete projects and recycle capital.

UK residential housing data continue to recover from depressed levels. Residential property transactions rose further in April 2024, by 10% y-o-y and 5% m-o-m (Exhibit 12). Mortgage approvals for individuals for house purchases (Exhibit 13) increased 40% y-o-y and 8% m-o-m in February 2024 as mortgage rates moderated (Exhibit 14). The improving environment should be supportive for volume growth and credit risk at Aspen, as reflected in our double-digit profit growth assumptions.