S&U — H122 ahead of expectation and outlook good

Exhibit 1 gives a summary of the results with key points highlighted below. Comparisons are with H121 unless stated.

S&U’s revenues were stable, within which motor finance revenues fell 6% on 9% lower average receivables and property bridging revenues were two and a half times above the H121 level on a 75% increase in the average loan book.

Total impairments fell by 66% with the key change being at motor finance reflecting the absence of the substantial forward-looking provisions made last year and a lower-than-normal rate of impairment this year. As a percentage of revenue, the charge was 12.6% in H122 compared with an average charge of 20.4% between FY16 and FY20 and the 52% seen in H121. As an alternative comparison, Provident Financial’s Moneybarn business had impairments equivalent to 29% of revenue in H121 (to end June) versus 56% in H120. Other cost of sales, which includes broker commissions, increased by 28% as the result of increased activity levels in both businesses. In motor finance the per-transaction cost at £861 was 3% lower than the prior year period reflecting work undertaken last year to contain costs. Administration costs increased by 21%, a figure that is boosted by the absence of a one-off VAT reclaim in H121 and the return of more normal staff bonuses in the current year. Finance expense was more than 10% lower, broadly in line with lower receivables. The result was a pre-tax profit, at £19.9m, more than three times the prior year level, with similar increases in net profit and EPS.

Reflecting this performance and an improving trading backdrop the board announced a 50% increase in the first interim dividend to 33p.

Looking more closely at the Advantage motor finance result, the rate of transactions recovered progressively during the period following the easing of lockdown restrictions: increasing by 24% from H121 and 25% sequentially to nearly 9,700. Nevertheless, the bounce back was more muted than some industry expectations with pent-up demand tempered by the availability of second-hand stock and the sharp price increases that followed. Bottlenecks in new car production contributed to the supply shortage which has had a knock-on effect through the different tiers of the used market. The higher-mileage lower cost cars which Advantage typically finances have seen a slower improvement in volumes than the nearly new segment. This has made for a competitive market with a lower percentage take-up of finance offers than previously.

Positively, the increase in used car prices did contribute to an increase in the average loan size of 10% to £7,050. While this could be seen as increasing risk somewhat, if prices correct with a better-balanced supply, Advantage is alert to this and emphasises that its close attention to affordability criteria should mitigate the risks here.

On affordability, Advantage notes that it has continued to work on improving affordability assessment and supporting customers by implementing IT systems to ease payments while providing personal attention to customers facing difficulties. This helps to reduce the number of repossessions and guides customers to return to regular payments.

Exhibit 2 is drawn from a table S&U provides to illustrate changes in the payment profile of Advantage customers. In these figures customers on a payment holiday were counted as in arrears to illustrate the impact on cash collections (in the accounts they are not counted as part of Stage 3 or credit-impaired provisioning). By end July this year only 48 customers were on a payment holiday and currently there are none. Looking at the percentage of receivables where payments are up to date, this fell by 18.5 percentage points between FY20 and H121 due to the pandemic but improved by 8.2 percentage points to 67.6% by H122 reflecting economic recovery as lockdown restrictions eased and Advantage’s own work with customers, as noted above.

Advantage has continued to fine tune its risk/reward positioning in the market and, while it remains conservative in its credit criteria, it has now taken measured steps back into higher risk segments of the market such as the self-employed and tiers D and E using modified scorecards to contain risk. At the same time, it has introduced more competitive products for near prime tiers A and A+ which will generate a lower yield but, prospectively, an attractive risk-adjusted yield. The average customer credit score increased from 867 for FY20 to 905 for H122. In conjunction with this the flat annual interest rate for the same periods fell from 17.7% to 16.2%. Prospectively, the trend in average credit score and interest rate will depend on the take up from the different tiers and the mix is likely to see continued change as Advantage adapts to changing market conditions and system refinements.

Other initiatives at Advantage include enhancing its digital marketing, work on attracting more repeat customers (currently c 5%) and developing affinity partnerships with prime lenders.

Turning to Aspen Bridging, the business carried out a record 66 transactions in the first half (25 in H121) bolstered by CBILS participation. This has given the business exposure to larger borrowers, lending on high quality properties thereby extending and improving Aspen’s customer network. To support the growing scale of the business the sales team has been increased and new products with revised rates and an increased maximum loan size have been introduced. While S&U seeks to develop the business to a size where it makes a significant profit contribution the emphasis on loan quality remains in place and at the period end only one loan was in default.

In this section we update background data we track as indicators for the Advantage and Aspen businesses starting with economic and industry figures relevant for the used car finance market.

Exhibit 3 shows independent forecasts for UK GDP and unemployment as collected by the UK Treasury in September. Compared with the July data shown in our last note, movements are very small. Unemployment expectations remain moderate compared with the second half of 2020 when the Q421 forecast peaked at c 7% (versus the latest figure of 5.3%). This should be positive for Advantage as unemployment is an important sensitivity for credit risk.

Exhibit 4 shows that consumer confidence has staged a major recovery, albeit with a slight recent softening. Uncertainties remain and the influence of COVID-19, supply bottlenecks and inflation fears is likely to fluctuate, but for the moment expectations remain centred on a progressive normalisation in economic activity. Exhibit 5 shows that the unemployment rate has moved up since early 2020 but appears to be flat or slightly lower on the latest, provisional, readings. Redundancies, a more immediate measure, saw a very sharp spike as the pandemic took hold, but fell rapidly and have remained on a downward trend on recent figures.

We now turn to data on used car transactions and used car finance. Exhibit 6 shows the sharp drop in used car transactions in April 2020. Volume recovered very well following the initial lockdown, albeit with a further dip following subsequent lockdowns. April to June 2021 saw a return to activity levels close to pre-pandemic levels as represented here by the 2019 monthly figures, although the April bounce was smaller than industry participants had thought possible. Exhibit 7 shows a similar pattern in used car finance.

Used car prices (see Exhibit 8), were buoyant in 2020 and have seen a sharp step up in the latest data for July and August this year, with strong consumer demand and reduced supply pushing prices up. The ONS data are supported by a similarly marked strength in the Autotrader retail price index. Advantage’s exposure to auction prices for repossessed cars is moderated by the relatively low value of vehicles it finances, but rising prices are generally favourable (unless they are a precursor to a correction, as mentioned earlier).

Looking at the background for Aspen Bridging, Exhibit 9 shows the number of UK non-residential and residential transactions, with residential being most relevant for Aspen. Both saw sustained improvement following the initial lockdown in 2020 with residential data fluctuating sharply as buyers sought to take advantage of the temporary increase in the stamp duty land tax nil rate band. On a longer view, S&U sees an imbalance between supply and demand for good-quality homes as a favourable backdrop for its customers who are refurbishing and developing properties. As a small business, Aspen should also have significant scope for expansion now that it is more established in the market. As mentioned earlier, the CBILS lending has given useful access to larger and more established developer customers as well as expanding the loan book in the short term.

The outlook for both businesses therefore appears promising in terms of market background while, as mentioned in the discussion of the results, both have been taking internal actions to improve their operations. Key sensitivities for the businesses should also be considered including the macroeconomic background, the competitive environment (both car finance and bridging markets have periodically been subject to new entrants), changes in funding costs and any adverse developments in the pandemic.

Changes in the key numbers from our estimates following the H122 results are shown in Exhibit 10. Our revenue assumptions for FY22 and FY23 are increased by 2.5% and 4.7% respectively, while lower impairment charge assumptions mean there is a much larger increase in pre-tax profit and earnings per share estimates. We have introduced an estimate for FY24 to provide a more normalised year in terms of impairment provisioning; profit in this year moves more in line with our assumed growth in customer receivables. At the earnings per share level FY24 is affected by the introduction of a significantly higher UK corporate tax rate (25%).

The next table gives details of our estimate assumptions. In the motor business our assumed receivables growth for FY22 is now more modest following the first half outcome but we look for stronger growth in FY23 as we assume used car supply normalises. Then we use a more conservative 5% growth rate for FY24 (a more tentative, illustrative estimate at this stage). Following the unusually low impairment rate in H122 we look for an increase in FY23 and FY24 to 18.5% and 20.5% of revenue respectively.

We assume bridging receivables will reach £68m by the end of the current financial year and then rise to £97m by end FY24. In that year, on our estimates, Aspen would be contributing over £5m – or more than 10% of group pre-tax profit.

The segmental cash flow analysis in the table below highlights how Advantage remained cash generative in H122 even as advances began to increase following the contraction seen in FY21. Here the strength in collections performance was an important factor. Aspen Bridging’s high level of advances resulted in a further increase in cash outflow to £22.3m although this increase was tempered by a sharp rise in collections because of early repayments of some CBILS loans. At the group level this left an outflow of £16.3m and net debt of £115.1m and net debt/equity at 61%. Funding facilities of £180m provide headroom for significant growth in lending.

P/E comparisons with peers remain difficult to interpret given differences in business mix and significant changes in provisioning levels following the initial impact of COVID-19. We therefore frame valuation using our ROE/COE calculations and the price to book ratio. If we assume a COE of 10% and long-term growth of 2%, then the share price at the time of writing (2,817p) would be consistent with an ROE of 16.5%, which is in line with our estimate for FY22.

Looking at the history of the price to book ratio (Exhibit 13) the current level of 1.8x is in line with the 10-year average following a period of strength in the shares (up 72% over 12 months).