S&U — Impairments drag FY24 PBT, moderation in FY25

Our revenue estimate for FY24 is 1% lower as we take into consideration S&U’s shift to larger and longer-term products to more creditworthy customers. As a result, we have forecast lower motor transactions, as management implements its more conservative approach to lending, and thus anticipate lower revenue yields. We anticipate that our increased revenue assumption within Aspen – projected revenue yields are slightly higher than we originally forecasted – will partially offset the downgrade in revenues in Advantage. We assume a similar scenario in FY25, with our group revenue forecast reduced by 3% to £129m, but still growing 14% y-o-y.

While impairment provisioning for Aspen in FY24 remains broadly unchanged, we increased our impairment assumption for Advantage by 18% to £21m in response to the drop in collections rate highlighted above and the accelerated impact of IFRS 9 provisioning requirements. Consequently, our group FY24 EBITDA estimate is lowered 7% to £48.7m. In FY25 we anticipate impairments in Advantage to moderate, forecasting £23.5m, 3% above our previous estimates. Our FY25 impairment assumption for Aspen remains unchanged. In response to inflationary pressures, we have adjusted our cost of sales assumption by 5% to £25.6m. Additionally, we have accounted for rising regulatory costs by increasing our administrative expense assumption by 2% to £22.9m. Group EBITDA, as a result, has fallen 5% to £55.2m.

A larger borrowing balance of £224m combined with higher interest costs has led to interest expenses being increased to £15.1m from our previous assumption of £14.1m. Hence, our FY24 PBT estimate has fallen 12% to £33.0m. In FY25 we expect borrowing to remain flat with FY24, so our interest cost assumption remains unchanged at £18.4m. Our FY25 PBT estimate is now 8% lower at £36.4m. Our EPS estimates for FY24 and FY25 have fallen 12% and 8%, in proportion with PBT declines.

We have also adjusted our FY24 DPS to 125p per share, down from our previous estimate of 133p per share, representing a payout ratio of 61% – away from the typical payout of 50% as S&U intends to ‘partially protect returns to shareholders’. Hence, we expect a DPS of 125p to be maintained in FY25.

In this section we update our compilation of UK economic indicators relevant to consumer credit markets.

To summarise, there is little change in overall expectations. The GDP growth estimate for 2023 decreased to 0.4% compared to November and December 2023 forecasts of 0.5%. Unemployment expectations for Q423 have been held in line with December 2023 at 4.3%, but down from November’s expectation of 4.4%. Meanwhile, headline inflation in December 2023 clocked in at 4.0%, up from 3.9% in November 2023 – the first increase since February 2023. UK used car transactions and value of advances are in decline as consumers’ disposable income is choked by higher interest rates and inflation. The residential property market is more resilient than the vehicle market. Month-on-month residential transactions were down slightly whereas monthly mortgage approvals saw an improvement compared to previous readings. Additionally, Halifax reported that house prices had risen by 1.3% in January, the fourth consecutive increase.

In October to December 2023, annual average regular earnings growth for public and private sectors was 5.8% and 6.2%, respectively, according to data compiled by the Office for National Statistics (ONS). Compared to recent periods, wage growth has decelerated but still sits comfortably atop inflation, implying real wage growth.

For the 12 months to December 2023, the Consumer Price Index (CPI) rose 4.0%, up a notch from the 3.9% in November 2023. Core CPI (which excludes energy, food, alcohol and tobacco) rose 5.1%, in line with November 2023.

In Exhibit 2, we show GDP growth, CPI and unemployment forecasts for 2023 collected by HM Treasury and released on a monthly basis. In the January release, estimates for GDP growth in 2023 declined to 0.4%, 0.1pp down from the 0.5% estimates collected in December. Meanwhile, unemployment estimates were in line with December 2023, at 4.3%.

In 2024, GDP growth is forecasted at 0.4%, unchanged from the 2023 estimate (see Exhibit 3). Unemployment expectations have marginally fallen to 4.6%, compared to estimates of 4.7% in December 2023. Q424 inflation estimates have dropped slightly, with expectations now at 2.4%, compared to 2.6% in December 2023.

Exhibit 4 illustrates a rising trend in consumer confidence. This indicator represents personal finances and the economic outlook for the next 12 months. The overall index score is made up of five measures: personal finance situation (over the last 12 months), personal finance situation (over the next 12 months), general economic situation (over the last 12 months), general economic situation (over the next 12 months) and the Major Purchase Index.

In February’s release, four of the constituents were down month-on-month, while personal financial situation (over the next 12 months) remained at 0 for a second consecutive month, but well above last year’s score of -18. The overall Consumer Confidence Index dropped two points month-on-month to -21, but improved from last year’s reading of -38. The ascendancy from lows of -49 in September 2022 indicates that Britons are increasingly feeling more positive about the economic outlook. Optimism has been supported by moderating oil prices, decreasing inflation and real wage growth, all coming together to curtail the impact of a higher interest rate environment. We note that the upcoming budget, to be delivered by Chancellor Jeremy Hunt on 6 March, will most likely aim to boost consumer confidence ahead of the forthcoming election.

Unemployment has been falling consecutively by 0.1 points per month since July 2023, from 4.7% to 3.8% in December 2023 (see Exhibit 5). However, redundancies have followed an opposite trend, rising to 116,000 in December 2023 compared to 94,000 in November and 105,000 in July. Redundancies were last this elevated in March 2021 when they reached 149,000. Per 1,000 employees, redundancies rose to four in December 2023 compared to 3.3 in November and 3.7 in July, but remain in line with the five years preceding the pandemic.

UK used car transactions grew 5% in 2023 to 7.24m versus 6.89m in 2022 (see Exhibit 6). Greater availability and choice helped volumes as supply constraints experienced in 2022 eased in 2023. December transactions finished strongly at 466,521, the highest since December 2019 (479,106 transactions) and the third highest December transactions figure in data going back to 2014. Although petrol and diesel cars continue to be the most popular vehicle type, used battery electric car transactions improved significantly, increasing 90.9% to 118,973 units, representing a 1.6% market share, up from 0.9% in 2022. Exhibit 7 shows the value of advances and the number of used cars that were purchased on finance. Values and volumes dropped off in December, attributable to seasonal factors. Compared to December 2022, values and volumes both declined 5%. Commenting on the data, Geraldine Kilkelly, director of research and chief economist at the Finance and Leasing Association, said: ‘Consumer spending is expected to remain subdued this year.’ Combined with more industry data (see below), we concur with the view that consumer spending will be subdued and expect vehicle transaction volumes to decline as the impact of higher interest rates continues to sweep through the economy and tighten household budgets.

Exhibit 8 shows that the descent in used car prices is now pronounced. We can attribute this to the factors describe above – a real interest rate environment that is squeezing household incomes. Exhibit 9 presents a chart on the month-on-month changes in used car prices. In data to December 2023, month-on-month used car prices have reported declines consecutively since June 2023. Seven months of consecutive negative price changes has not been achieved since May 2016 to October 2016. Should January’s reading come out negative, meaning eight months of negative prices changes, one would have to look towards data collected in 2008 to find a similar period of prolonged price declines (month-on-month prices dropped consecutively from May 2008 to January 2009, totalling nine months). A fall in prices may trigger higher loss given defaults, which would then translate into a rise in impairments.

Exhibit 10 illustrates both non-residential and residential property transactions (seasonally adjusted figures) in the UK, with the latter more appropriate for Aspen. Non-residential transactions are holding up well. In fact, both year-on-year and month-on-month non-residential transactions increased 3% to 10,030 (provisional estimate), suggesting that investors are still interested in the non-residential market, despite the promoted worry about work-from-home policies that has driven some large corporates to downsize their offices. However, residential transactions fell 2.2% m-o-m and 18% y-o-y to 80,420 (provisional estimate). We attribute the decline to a rising real interest rate environment. A recent decline in two-year fixed rates (see Exhibit 12 below) has encouraged some buying as shown in the marginal increase in mortgage approvals in Exhibit 11. As the gap between interest rates and inflation widens, we would expect overall growth and market activity to be stymied. Although monthly mortgage approvals have recovered slightly since September 2023, levels still remain subdued compared with 2010.

Exhibit 12 illustrates UK monthly interest rates for two-year fixed mortgages to households with a 75% loan-to-value (LTV). Aspen’s average maximum LTV in H124 was 65%. Although Aspen deals in bridging finance – short-term lending (average of 11 months at H124) to experienced landlords and developers – the data should be somewhat indicative of the environment Aspen is operating in.

Between January 2014 and December 2021, the average two-year fixed mortgage on a 75% LTV was 1.7%. In this period, mortgage holders were beneficiaries of a low interest rate environment. After subsequent Bank of England interest rate rises, the average two-year fixed mortgage rate between January 2022 and December 2023 is now 4.4%. Following the peak of 6.2% in July 2023, rates have now fallen to 5% as the market expects subsequent rate cuts in the latter half of 2024 and onwards into 2025. Although rates are significantly higher relative to recent history, the fall from the peak has provided some relief for incumbent and prospective homeowners as affirmed by the slight uptick in the monthly mortgage approvals shown in Exhibit 11.