S&U — PBT ahead, encouraging volume trends

S&U (LSE: SUS)

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Research: Financials

S&U — PBT ahead, encouraging volume trends

S&U reported FY24 PBT of £33.6m, down from £41.4m in FY23 on higher funding and regulatory costs and higher impairments in Advantage in H2. PBT was 2% ahead of our forecast as stronger revenues – up 12% to £115.4m – and better costs offset higher-than-expected impairments. Net receivables grew to a record at both Advantage and Aspen and management noted particular strength in Q4 and a good trading environment in the current year. Having absorbed a significant rise in funding cost as well as additional regulatory cost, the company looks well positioned to deliver steady growth from here on, especially if interest rates fall in the latter half of 2024 (which we have not included in our model). Diluted EPS was 209.3p (FY23: 277.5p) and DPS was 120p (FY23:133p). We have raised FY25e EPS estimate by 2.4% to 230p and introduced FY26e EPS at 263p.

Written by

Robert Murphy

Managing Director, Financials and Investment Trusts

Financials

S&U

PBT ahead, encouraging volume trends

FY24 results

Financial services

22 April 2024

Price

1,845p

Market cap

£225m

Net debt (£m) at end January 2024

225

Shares in issue

12.2m

Free float

25%

Code

SUS

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

0.6

(16.0)

(23.7)

Rel (local)

(1.1)

(20.2)

(23.8)

52-week high/low

2,570p

1,800p

Business description

S&U’s Advantage motor finance business lends to lower- and middle-income groups that may have impaired credit records. The Aspen property bridging business supports UK residential property development and has been growing successfully since launch in 2017.

Next events

AGM update

May 2024

Analyst

Rob Murphy

+44 7900 484 805

S&U is a research client of Edison Investment Research Limited

S&U reported FY24 PBT of £33.6m, down from £41.4m in FY23 on higher funding and regulatory costs and higher impairments in Advantage in H2. PBT was 2% ahead of our forecast as stronger revenues – up 12% to £115.4m – and better costs offset higher-than-expected impairments. Net receivables grew to a record at both Advantage and Aspen and management noted particular strength in Q4 and a good trading environment in the current year. Having absorbed a significant rise in funding cost as well as additional regulatory cost, the company looks well positioned to deliver steady growth from here on, especially if interest rates fall in the latter half of 2024 (which we have not included in our model). Diluted EPS was 209.3p (FY23: 277.5p) and DPS was 120p (FY23:133p). We have raised FY25e EPS estimate by 2.4% to 230p and introduced FY26e EPS at 263p.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

01/23

102.7

41.4

277.5

133

6.6

7.2

01/24

115.4

33.6

209.3

120

8.8

6.5

01/25e

133.2

37.3

230.0

125

8.0

6.8

01/26e

145.7

42.6

263.0

130

7.0

7.0

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

A challenging FY24

S&U has weathered a challenging period for the business leading to a decline in earnings. Funding costs more than doubled over the period to £15.1m on higher interest rates, IFRS 9 provisions accelerated on slower payment rates in H2 at Advantage and additional regulatory cost was incurred around FCA initiatives on Consumer Duty and forbearance. Despite this, the company delivered a very respectable return on equity (ROE) of 11.1% in FY24, and S&U is not in scope for the FCA investigation on discretionary commissions in the motor finance industry.

Encouraging volumes, earnings to pick up

The bottom-line performance belied good underlying customer activity with record receivables at Advantage (up 8% to £332.5m) and Aspen (up 15% to £130.4m). Management noted encouraging trading since year-end following strong volumes in Advantage in Q4 and continuing momentum in Aspen against an improving housing market backdrop. The receivables growth will feed through to further revenue growth in FY25. We expect c 9% volume and PBT growth at Advantage in FY25, with Aspen growing PBT c 25% on 21% volume growth and margin expansion following continued investment in the business.

Valuation: 32% implied uplift

S&U trades on P/E multiples of 8.0x and 7.0x in FY25e and FY26e respectively. We forecast an ROE of 11.6% in FY25, rising to 12.5% in FY26. Our ROE/cost of equity (COE) model, using an ROE of 12.5%, a COE of 10% and a 2% growth rate, suggests a valuation of 2,432p (previously 2,142p), a 32% uplift from the current price.

Investment summary

S&U reported FY24 PBT of £33.6m, down from £41.4m in FY23 on higher funding and regulatory costs and higher impairments in Advantage in H2. PBT was 2% ahead of our forecast as stronger revenues – up 12% to £115.4m – and better costs offset higher-than-expected impairments.

S&U has absorbed rapid Bank of England (BOE) base rate rises, increased inflationary and regulatory cost and a challenging UK economy and still delivered an 11.1% ROE in FY24 – above our 10% COE assumption. Encouragingly, net receivables grew to record levels at both Advantage and Aspen, and management noted particular strength in Q4 and a good trading environment in the current year. This receivables growth will feed into revenue growth in FY25.

We expect c 9% volume and PBT growth at Advantage in FY25, with Aspen growing PBT c 25% on 21% volume growth and margin expansion following continued investment in the business. For the group as a whole, our estimates translate into 11% PBT growth in FY25e, accelerating to 14% in FY26e as funding and cost pressures abate. This leads to a forecast ROE of 11.6% in FY25, rising to 12.5% in FY26.

The shares are modestly valued at 0.95x book, which indicates 32% upside from the current share price based on our projected 12.5% ROE in FY26e. We believe our ROE assumptions are conservative as we have not included any interest rate cuts in our earnings forecasts and the five- and 10-year historical average ROEs are well above our 12.5% assumption, at over 14% and 15% respectively.

A long-established specialist lender

S&U is an established specialist lender, with businesses addressing the non-prime and near-prime motor finance and the property bridging markets, and operates solely in the UK. It evolved into a home collected credit company in 1975 from a retail business originally founded in 1938 by the current chairman’s grandfather. Advantage Finance, the motor lending business, was founded in 1999 and the home collected credit business was sold in 2015 to Non-Standard Finance for £82.5m. This sale helped fund rapid growth at Advantage and the founding of Aspen, the bridging loan business, in 2017. The company has been listed on the London Stock Exchange since 1961.

Advantage motor finance has a record of strong, profitable growth over more than 25 years through various economic cycles. Aspen Bridging was founded in 2017 in Solihull and supports UK residential property development. The division been steadily investing in its team and distribution network. This has translated into a meaningful contribution of 14% of group PBT by FY24 while maintaining a prudent underwriting approach.

Both businesses focus on sustaining high levels of individual customer service, investment in technology and refinement of underwriting processes as competitive differentiators. The Coombs family owns c 53% of the equity and management takes a long-term, sustainable approach to the development of the group.

The Advantage advantage

Advantage Finance is based in Grimsby and provides used car finance to subprime and near-prime borrowers. Distribution is 90% through brokers, 5% direct through dealers and 5% through refinancing for previous customers. S&U has relationships with the largest UK brokers including Carfinance247, Zuto, Evolution Funding, Jigsaw and Midland Credit. This gives access to both large dealership networks and smaller local dealers.

A typical loan currently is just over £8,150, with £14,500 repayable over 54 months including interest at a flat rate of 16.9%.

Since being founded in 1999, Advantage has exhibited a strong and consistent track record across economic cycles. Receivables hit a record in FY24 at £332.5m, representing a compound average growth rate (CAGR) of over 14% in the last 18 years, which includes the financial crisis and the COVID-19 pandemic. Over the same period, PBT has compounded at over 15% per annum.

This financial performance demonstrates the strength of the business model. All loans are underwritten and collected centrally, largely through direct debit. The Advantage web-based system is able to provide almost immediate in-principle lending decisions – less than 10 seconds for 95% of applications. The credit scoring and underwriting system, originally developed in conjunction with Experian, is under constant refinement, taking into account a range of data sources. S&U accounts for bad debts conservatively compared to the industry, as loans are transferred to IFRS 9 stage 3 provisions after just one month overdue, compared to the industry norm of three months. This policy stems from Advantage’s extensive data and analysis of payment trends and delinquencies over many years.

The use of a car often is the only realistic means of transport for S&U’s customer demographic in their daily lives of work, family and leisure. This essential customer need helps to create a resiliency in the client base. Advantage competes on customer service and works with customers when difficulties arise, hence the slogan ‘we see more than your score’. By working closely with customers, S&U is able to help the majority of its clients improve their credit scores and thus access to, and cost of, finance generally.

Advantage has been able to benefit from more difficult economic times in the past, for instance leveraging its strong internal systems during the post financial crisis credit crunch to underwrite profitably. The current period of extensive regulatory intervention around Consumer Duty, forbearance and discretionary commissions may also prove a longer-term benefit to Advantage. Indeed S&U management is looking to leverage the fallout as players with weaker customer service and outcomes and previous extensive use of discretionary commissions (Advantage never used these) pull back from the market.

S&U’s extensive technology investments are also able to reduce regulatory cost, which will add to its competitive advantage in an industry with heightened regulatory scrutiny. Examples include: AI screening of any customer complaints, especially given the publicity around current FCA investigations into collection and commission practices; voice analytics recording; and documenting every single call to customers.

Exhibit 1 below highlights the growth in key metrics at Advantage Finance since FY13. Receivables have grown more than sixfold, from £52m to £332m, and revenue has grown fivefold, from £21m to £98m. The revenue figure was affected in FY24 by higher funding costs on BOE base rate rises, higher inflationary and regulatory costs and accelerated IFRS provisioning, leading to a compression of margin to 29%.

Going forward, we conservatively do not include any interest rate cuts in our model, but it is worth pointing out that on our estimates a 50bp reduction in the cost of finance would increase FY26e PBT for the group by c 3.5%, all other things being equal (see the Sensitivities section below).

We expect some modest expansion of margin to 30% by FY25, as cost growth moderates and assuming a modest benefit from dynamic risk-adjusted pricing. Advantage expects a shift of lending towards lower-risk near-prime borrowers in FY25. Management expects this will balance headline yields against underlying pricing adjustments, but lead to lower impairments and a more attractive risk-adjusted margin.

Exhibit 1: Advantage Finance performance over time (financial years to end January)

Source: S&U reports, Edison Investment Research

Aspen: Becoming a more significant contributor

Exhibit 2: Growth in Aspen over time (financial years to end January)

Source: S&U reports, Edison Investment Research

Exhibit 2 above illustrates S&U’s success in growing Aspen since starting the business in 2017. From 2018, receivables have grown 12-fold and the division contributed a meaningful 14% of PBT in FY24 compared to 11% in FY23. The performance at Aspen last year is all the more impressive given the difficult housing market, with annual transactions averaging one million, down 19% on the previous year according to HMRC data.

We expect Aspen to continue to grow more strongly than Advantage and increase its share of group PBT from 14.3% in FY24 to 16.4% in FY26, as illustrated in Exhibit 3.

Exhibit 3: S&U divisional PBT breakdown, £’000

FY24

FY25e

FY26e

Advantage

28,810

31,273

35,609

Aspen

4,803

5,993

7,000

Central items

(29)

0

0

Group PBT

33,584

37,266

42,609

Advantage

85.8%

83.9%

83.6%

Aspen

14.3%

16.1%

16.4%

Central items

-0.1%

0.0%

0.0%

Group PBT

100.0%

100.0%

100.0%

Source: S&U reports, Edison Investment Research

This growth is being fostered by a combination of factors:

From a cyclical point of view, the UK residential housing market has shown some signs of improvement, with stabilising interest rates and lower mortgage rates. S&U management expects market transactions to rise around 10% in 2024, with house prices rising 5%, and we are seeing evidence supporting this view from our market indicators (see Exhibits 12–15 later in this note).

S&U has been making strategic investments in the business. The team has expanded to 25 people from 21 two years ago, with increased expertise brought in on risk and recoveries for instance. Aspen is increasingly being recognised as a successful industry competitor and is building a strong brand in the marketplace. A key part of its distribution strategy is to continue to build sales channels and relationships with brokers. Aspen also aims to grow its network through participation at industry events.

Aspen is refining risk-adjusted pricing and focusing on the quality of borrowers and the underlying projects and maintaining conservative loan to value ratios (LTVs). This means working more with larger, repeat borrowers that should generate strong risk-adjusted returns for the business.

FY24 earnings beat our forecast

In a challenging environment, S&U reported PBT of £33.6m in FY24, down from £41.4m in FY23. Funding costs more than doubled over the year to £15.1m on higher interest rates, IFRS 9 provisions accelerated on slower payment rates in H2 at Advantage and additional regulatory cost was incurred around FCA initiatives on Consumer Duty and forbearance.

Despite this, PBT was c 2% ahead of our forecast, implying a 5% beat in H224. The main drivers of the better FY24 earnings performance were 2% better-than-expected revenues, 2% better cost of sales and 17% lower impairments in bridging finance. These were partially offset by 10% higher-than-forecast impairments in Advantage.

Underlying customer activity remained positive and was above expectations, with good momentum towards the end of the year. Total revenues rose 12% to a record £115m, as both Advantage and Aspen grew receivables 10% to record levels of £463m. The company delivered a very respectable ROE of 11.1% for the year (15.6% in FY23), and unlike some peers S&U is not in scope for the FCA investigation on discretionary commissions in the motor finance industry, which is an important differentiator in terms of regulatory positioning, in our view.

Exhibit 4 below illustrates the overall performance in the context of the last five years.

Exhibit 4: S&U five-year P&L summary

£000

FY20

FY21

FY22

FY23

FY24

y-o-y % change

Number of new motor loans

23,334

15,589

19,747

23,922

21,565

-9.9

Motor finance receivables at period end

280,757

246,766

259,036

306,817

332,496

8.4

Bridging receivables at period end

20,993

34,144

63,879

113,893

130,442

14.5

Net group receivables

301,750

280,910

322,915

420,710

462,938

10.0

Revenue

Motor finance

85,465

79,553

78,898

89,801

98,177

9.3

Property bridging

4,474

4,208

8,991

12,913

17,260

33.7

Total revenue

89,939

83,761

87,889

102,714

115,437

12.4

Impairments

Motor finance

(16,507)

(35,995)

(3,805)

(12,885)

(23,280)

80.7

Property bridging

(713)

(710)

(315)

(992)

(923)

-7.0

Total impairments

(17,220)

(36,705)

(4,120)

(13,877)

(24,203)

74.4

Other cost of sales

(19,872)

(14,264)

(18,771)

(23,676)

(22,821)

-3.6

Administration expenses

(12,413)

(10,576)

(13,679)

(15,731)

(19,257)

22.4

EBITDA

40,434

22,216

51,319

49,430

49,156

-0.6

Depreciation

(450)

(520)

(529)

(525)

(510)

-2.9

Operating profit / loss

39,984

21,696

50,790

48,905

48,646

-0.5

Finance expense

(4,850)

(3,568)

(3,772)

(7,495)

(15,062)

101.0

Profit before tax

35,134

18,128

47,018

41,410

33,584

-18.9

Tax

(6,252)

(3,482)

(9,036)

(7,692)

(8,147)

5.9

Net profit

28,882

14,646

37,982

33,718

25,437

-24.6

EPS fully diluted (p)

239.4

120.7

312.7

277.5

209.3

-24.6

Dividend per share (p)

120.0

90.0

126.0

133.0

120.0

-9.8

Impairments % revenues (motor finance)

19.3

45.2

4.8

14.3

23.7

Impairments % revenues (property bridging)

15.9

16.9

3.5

7.7

5.3

Total impairments % revenues

19.1

43.8

4.7

13.5

21.0

Return on equity (ROE)

16.8%

8.1%

19.6%

15.6%

11.1%

Tax rate

17.8%

19.2%

19.2%

18.6%

24.3%

Source: S&U reports, Edison Investment Research

Revenues in motor finance grew 9% y-o-y as the number of new transactions moderated by 10% but the average loan increased in line with the company’s cautious approach to new lending during the year. Property bridging achieved rapid revenue growth of 34%: net receivables grew 15% to a record £130m and margins expanded as part of management’s pricing strategy. Management noted strong activity at Advantage in Q4 and improving housing market fundamentals for Aspen.

The strong revenue performance was more than offset by impairments, finance costs and administration expenses. Impairments in motor finance were the largest detractor in absolute terms, and grew by 81% or £10.4m on a weaker payment experience in the latter part of the year. IFRS 9 provisioning requires lifetime expected loss recognition upfront for delinquent loans, which accelerates the P&L impact of any deterioration.

The second largest negative impact on profit was the doubling in financing cost following interest rate increases. Finally, admin expenses rose 22% or £3.5m due to inflationary and regulatory costs as a result of numerous FCA actions in the industry as a whole.

EBITDA was commendably stable at £49.2m, but after finance costs PBT fell 19% to £33.6m. A further headwind from the rise in the corporate tax rate led to net profit and EPS both declining by 25%, to £25.4m and 209.3p respectively. The dividend per share was lowered 10% in light of the decline in earnings.

Despite the reduction in ROE from 15.6% in FY23, S&U’s track record of shareholder value creation was nevertheless maintained, with the company recording an ROE of 11.1%, above our COE assumption of 10%.

Forecasts: Earnings acceleration projected

We have slightly raised our FY25 EPS forecasts by 2% to 230p and introduced an FY26e EPS forecast at 263p. We have maintained our DPS forecast for FY25e at 125p and estimate FY26e DPS of 130p in order to build dividend cover to 2x. This results in ROE rising from 11.1% in FY24 to 11.6% in FY25e and 12.5% in FY26e. We summarise our key estimate changes in Exhibit 5 below.

Exhibit 5: Estimate changes

FY25e

FY26e

Old

New

Change

Old

New

Change

Revenue (£m)

129.1

133.2

3%

N/A

145.7

N/A

EBITDA (£m)

55.2

57.8

5%

N/A

65.7

N/A

PBT (£m)

36.4

37.3

2%

N/A

42.6

N/A

EPS (p)

224.6

230.0

2%

N/A

263.0

N/A

DPS (p)

125.0

125.0

0%

N/A

130.0

N/A

Source: Edison Investment Research

Accelerating earnings growth

S&U reported FY24 PBT 2% ahead of our estimate, which implies a 5% beat relative to our H2 forecast. Both Advantage and Aspen contributed, with Advantage ahead of our estimate by 1% and Aspen ahead by 5% on net receivables growth of 15%. Exhibit 6 below summarises our estimates in more detail. We have modelled total receivables growth of 12% in FY25e and 9% in FY26e, which takes into account the continued good demand in Advantage as well as strong double-digit growth in Aspen given the pipeline referred to by management, investment in the team’s capabilities and expected stabilisation of interest rates. We expect the volume growth to feed into higher revenue growth of 15% in FY25e and 9% in FY26e.

Our key assumptions at Advantage include 7% growth in the number of transactions in FY25e to 23,000, with a somewhat higher average advance of £8,500 (£8,125 in FY24) as the company positions itself toward the near-prime customer. We maintain those estimates for FY26e. We expect Advantage to roughly maintain revenue margins with some slight underlying repricing offset by a shift to lower-risk customers.

At Aspen, we model high-double-digit revenue growth on strong receivables growth as well as the benefit of some repricing at Aspen’s book. We increase the average advance in both FY25e and FY26e to £900,000 (£881,000) in line with the company’s policy of pivoting towards larger, higher-quality borrowers.

FY24 was affected by both ongoing cost inflation as well as additional regulatory cost associated with FCA investigations into collections procedures. As inflation is now moderating and the FCA cost has been absorbed, we expect EBITDA and operating profit to grow in excess of revenues, both at 18% in FY25e and 14% in FY26e.

We model finance expense conservatively without assuming any market implied forward rate cuts (currently 25–50bps) and project an average cost of debt of 8% in line with H224 in both FY25e and FY26e. Should short-term interest rates fall, that would be a positive for interest margins, revenue and profit at S&U. Debt balances are expected to rise to fund receivables growth, hence finance expense is projected to grow 33% in FY25e constraining PBT to 11% growth as the average cost of debt flows into the full year figures. We expect finance expenses to moderate in FY26e, resulting in 14% PBT growth. Following the increase in the UK corporate tax rate last year to 25%, there is an additional 1% impact in FY25e, which limits net profit growth to 10% before accelerating to 14% in FY26e in line with PBT.

Exhibit 6: Expanding profitability

£000

FY24

FY25e

FY26e

% change FY25

% change FY26

Number of new motor loans

21,565

23,000

23,000

6.7

0.0

Motor finance receivables at period end

332,496

362,085

382,386

8.9

5.6

Bridging loans at period end

130,442

158,486

183,339

21.5

15.7

Total customer receivables

462,938

520,572

565,724

12.4

8.7

Revenue

Motor finance

98,177

109,565

117,385

11.6

7.1

Property bridging

17,260

23,665

28,328

37.1

19.7

Total

115,437

133,230

145,712

15.4

9.4

Impairments

Motor finance

(23,280)

(26,580)

(28,172)

14.2

6.0

Property bridging

(923)

(1,302)

(1,558)

41.0

19.7

Total

(24,203)

(27,881)

(29,730)

15.2

6.6

Other cost of sales

(22,821)

(25,156)

(25,809)

10.2

2.6

Administration expenses

(19,257)

(22,383)

(24,480)

16.2

9.4

EBITDA

49,156

57,809

65,694

17.6

13.6

Depreciation

(510)

(456)

(434)

-10.6

-4.8

Operating profit / loss

48,646

57,354

65,260

17.9

13.8

Finance expense

(15,062)

(20,087)

(22,650)

33.4

12.8

Profit before tax

33,584

37,266

42,609

11.0

14.3

Tax

(8,147)

(9,317)

(10,652)

14.4

14.3

Net profit

25,437

27,950

31,957

9.9

14.3

EPS fully diluted (p)

209.3

230.0

263.0

9.9

14.3

Dividend per share (p)

120.0

125.0

130.0

4.2

4.0

Dividend cover (x)

1.7

1.8

2.0

Source: S&U filings, Edison Investment Research

Cash flow and balance sheet

We summarise the cash flow of the business below in Exhibit 7. S&U’s finance receivables are funded by a combination of borrowings and equity. One can expect there to be cash outflow on new business as the company grows and invests in additional receivables, partially offset by collections performance. This stems in particular from Advantage as loans and interest are repaid on average over a 4.5-year term. Exhibit 7 below shows the cash flow development of the motor and bridging businesses over the last few years. The cash flow strain in FY24 was much lower than in FY23 mainly due to slightly lower new business in motor finance, as S&U operated a cautious approach to lending combined with excellent collections performance in both motor and property bridging.

Exhibit 7: Cash flow analysis by division

£m

FY21

FY22

FY23

FY24

Comments

Motor finance

Advances

(102.6)

(140.9)

(186.6)

(175.9)

Lower transactions on cautious underwriting

Monthly collections

138.5

152.7

161.8

172.1

Strong collections

Settlements/reloans

28.0

34.1

35.8

35.4

Debt recovery

13.8

17.1

18.1

17.9

Overheads/interest

(27.2)

(30.6)

(39.1)

(45.3)

Higher funding, regulatory and other costs

Corporation tax

(6.2)

(8.3)

(7.1)

(7.5)

Dividend

(12.7)

(10.0)

(15.0)

(15.0)

Major contributor to group dividend capacity

Motor finance (outflow)/inflow

31.6

14.1

(32.1)

(18.3)

Property bridging

Gross advances

(43.5)

(111.6)

(133.9)

(144.5)

Record new business

Retention collections

5.2

13.3

14.8

18.2

Collections

15.2

65.7

62.5

92.7

Record collections

Debt recovery

13.6

11.4

18.9

33.5

Successful recoveries

Overheads/interest

(2.8)

(5.3)

(7.5)

(11.5)

Corporation tax

(0.2)

(0.4)

(0.8)

(1.0)

Dividend

(1.2)

(1.5)

Dividend contribution growing

Property bridging (outflow)/inflow

(12.5)

(26.9)

(47.2)

(14.1)

Aided by strong collections performance

Other (outflow)/inflow

(0.1)

(2.0)

0.5

0.4

Group (outflow)/inflow

19.0

(14.8)

(78.8)

(32.0)

Modest net debt increase

Source: S&U reports, Edison Investment Research

Advantage is a major source of dividends for the group, with £15m paid to the group in FY24. However, we can see that Aspen’s contribution is beginning to grow and we would expect that trend to continue in the medium term due to our faster earnings growth forecast. The overall increase in net debt was £32m or +16.5% in FY24, which will likely accelerate a little in FY25 as receivables growth builds. As S&U has £280m of committed available facilities, the financing position looks comfortable.

Macroeconomic background

The UK economy remains subdued, with slow growth and elevated interest rates. On the other hand, inflation has been gradually declining and from April 2024 there will be a c 10% rise in the Living Wage, an 8.5% rise in the State Pension due to the ‘triple lock’, a 2% cut in National Insurance rates and a 12% average drop in the energy price cap. These are important factors that should help support UK households, and hence demand for housing and motor finance and overall credit quality at S&U.

Exhibits 8 and 9 below illustrate expectations have not changed dramatically for UK GDP growth in 2024, which remains very low at 0.4%. More positively, expectations for both inflation (2.1% close to target) and unemployment, have drifted downwards without affecting the overall growth expectation. In 2025 forecasts envisage a moderate improvement in GDP growth to 1.3%, with stable unemployment and CPI. Thus, based on current forecasts, the economy is likely to remain sluggish over the next two years but with some benefit from lower inflation and potentially interest rates, with the market currently discounting 25–50bp of cuts by year-end 2024.

Exhibit 8: Evolution of independent UK economic forecasts for 2024

Exhibit 9: Independent forecasts for 2024 and 2025

%

Average

GDP growth

 

2024

0.4

2025

1.3

Labour Force Survey unemployment rate Q4

2024

4.3

2025

4.3

Inflation Q4 (CPI)

 

2024

2.1

2025

2.1

Source: collected by HM Treasury (last reading April 2024)

Source: collected by HM Treasury (April 2024)

Exhibit 8: Evolution of independent UK economic forecasts for 2024

Source: collected by HM Treasury (last reading April 2024)

Exhibit 9: Independent forecasts for 2024 and 2025

%

Average

GDP growth

 

2024

0.4

2025

1.3

Labour Force Survey unemployment rate Q4

2024

4.3

2025

4.3

Inflation Q4 (CPI)

 

2024

2.1

2025

2.1

Source: collected by HM Treasury (April 2024)

Consumer confidence (Exhibit 10) has continued to trend upwards from a low point in September 2022 around the time of the ‘Truss mini budget’ and in an environment of surging inflation, particularly household energy costs, which peaked in August 2022. We attribute the recovery to relatively stable unemployment (Exhibit 11) and recovering incomes, which are now rising in real terms with further increases coming through from the Living Wage rise (+9.7%), state pensions (+8.5%), reduction in National Insurance (-2pp) and declining energy bills (-12% average price cap). The uplift in redundancies (Exhibit 11) has not fed into unemployment and the level is in line with the last 10 years. Again, we would regard this data as supportive to consumer lending activities.

Exhibit 10: GfK UK consumer confidence indicator

Exhibit 11: UK redundancies and unemployment

Source: LSEG (last value February 2024)

Source: Office for National Statistics (last value March 2024)

Exhibit 10: GfK UK consumer confidence indicator

Source: LSEG (last value February 2024)

Exhibit 11: UK redundancies and unemployment

Source: Office for National Statistics (last value March 2024)

Key indicators for Advantage

Overall indicators for the used car market are supportive to our lending growth assumptions, with year-on-year strength in transactions and stabilising values. Exhibit 12 shows monthly used car transactions, with the usual seasonal decline into the last quarter, but Q4 CY23 volumes were c 8% ahead of the same quarter in 2022. We can also see similar resilience in Exhibit 13, which shows used car finance through dealerships. One would expect a seasonal recovery in Q1 CY24 and S&U management has noted a strong start to trading this financial year.

Exhibit 12: Monthly used car transactions, 2020–23

Exhibit 13: Used car finance through dealerships

Source: SMMT (last value December 2023)

Source: Finance and Leasing Association (last value February 2024)

Exhibit 12: Monthly used car transactions, 2020–23

Source: SMMT (last value December 2023)

Exhibit 13: Used car finance through dealerships

Source: Finance and Leasing Association (last value February 2024)

The SMMT used car price index was down 8% y-o-y to the end of March 2024 (Exhibit 14),but has shown some stability in recent months with a quarter-on-quarter increase of c 1.4% in Q1 CY24 (Exhibit 15). This would indicate some resilience in demand for vehicles, which ties in with S&U management’s commentary on customer demand at Advantage and should be supportive of collateral values against receivables.

Exhibit 14: Used car prices index

Exhibit 15: Monthly change in used car prices

Source: Office for National Statistics (last value March 2024)

Source: Office for National Statistics (last value March 2024)

Exhibit 14: Used car prices index

Source: Office for National Statistics (last value March 2024)

Exhibit 15: Monthly change in used car prices

Source: Office for National Statistics (last value March 2024)

Key indicators for Aspen

Although Aspen is not directly linked to the housing and mortgage markets, its borrowers depend on being able to complete projects, sell them on time and then recycle capital. Hence, a healthy UK residential housing market supports volume growth and reduces credit risk at Aspen.

UK residential housing data has been improving from depressed levels. Mortgage approvals for individuals for house purchases increased 40% and 41% y-o-y and 7% and 8% m-o-m in January and February 2024, continuing the recovery from the low point in January 2023 (Exhibit 16). Levels of activity remain below those pre-pandemic, leaving potential for further recovery.

Exhibit 16: UK property transactions

Exhibit 17: Mortgage approvals for house purchase

Source: HM Revenue & Customs. Note: Seasonally adjusted to February 2024.

Source: Bank of England. Note: Seasonally adjusted to February 2024.

Exhibit 16: UK property transactions

Source: HM Revenue & Customs. Note: Seasonally adjusted to February 2024.

Exhibit 17: Mortgage approvals for house purchase

Source: Bank of England. Note: Seasonally adjusted to February 2024.

The improvement in transactions and approvals will have been helped by mortgage rates easing c 150bp since August 2023, as shown in Exhibit 18, as well as improving consumer confidence as mentioned earlier. The improving housing market indicators provide weight to S&U’s management’s confidence in the pipeline and ultimately good volume growth at Aspen while maintaining underwriting standards.

Exhibit 18: Average two-year fixed-rate mortgage at 75% LTV

Source: Bank of England (last reading January 2024)

Valuation: ROE versus COE implies 32% uplift potential

We base our valuation on an ROE/COE model, which is very common within 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 12.5% ROE in FY26, the implied valuation is 2,432p (2,142p previously). This represents an uplift potential of 32% compared to the current share price. We believe our ROE assumption in FY26 is conservative as S&U has generated an ROE in excess of 15% over the last 10 years, but we believe this assumption is appropriate given the current UK economic outlook.

Sensitivities

S&U is a UK- based specialist lender operating in consumer finance and property bridging finance. Thus in the near term, its fortunes are closely tied to the health of the UK economy. Personal income and employment trends drive demand for its motor finance products and derived-demand for bridging finance. Similarly credit quality is based on customers’ ability to pay. Like most finance companies, S&U relies on debt funding along with equity to fund its receivables and is therefore also sensitive to the cost of borrowing in the market.

S&U has a high level of variable costs, including funding, administrative and sales costs and credit costs, which means that changes in volume will tend to flow through to PBT (perhaps with a little operational leverage). This has been borne out over the longer term, as compound PBT growth of 15% over 18 years has slightly outpaced receivables growth of 14%.

In light of this, we model sensitivities to impairment charges and interest rates in isolation in Exhibit 19 below. Advantage is the largest business and clearly drives most of the impact.

A 50bp instantaneous reduction in average funding costs (with no impact on asset yields) would increase group profit by c 3.3% relative to our estimates in FY25 and FY26. The reverse would be true for an increase. As we have mentioned elsewhere, we have not assumed any interest rate cuts in our model, while the market is currently discounting interest rate reductions of 25–50bps by the end of calendar year 2024 and further reductions beyond into 2025.

A 5% lower impairment charge in isolation would increase group PBT by 3.7% in FY25 and 3.5% in FY26e compared to our current forecasts. Again, the reverse would be true for a 5% increase in impairments.

These sensitivities are not particularly high in our view and the impact is lowered due to S&U’s strong margins and efficiency. In reality, management at S&U would react to major changes in the environment to benefit the company.

Exhibit 19: Sensitivity of PBT to financing costs and impairments

£m

FY25e

FY26e

Group PBT

37.3

42.6

-50bp financing cost

1.2

1.4

Advantage

0.9

1.0

Aspen

0.4

0.5

-5% impairments

1.4

1.5

Advantage

1.3

1.4

Aspen

0.1

0.1

-50bp financing cost

3.3%

3.3%

-5% impairments

3.7%

3.5%

Source: S&U reports, Edison Investment Research

Over the longer term, sustainable growth and returns are driven by S&U’s ability to win profitable customers based on its high level of service quality and efficiency, which S&U has demonstrated over many years.

Regulatory risk: S&U well positioned versus peers

The UK financial sector is heavily regulated and the FCA has become more interventionist in recent years. The FCA is particularly concerned with Consumer Duty, forbearance and more recently discretionary commissions in the motor finance industry. Such investigations can result in significant costs: regulatory cost in terms of additional compliance and monitoring requirements, increased cost to handle customer complaints and potentially fines and legal redress costs.

The market has been concerned with the potential financial impact of the discretionary commissions investigation, especially given the regulator is looking back to lending from 2007. The practice has led to some customers at some lenders paying higher interest rates than necessary as dealers were incentivised to offer these loans.

Unlike some peers, S&U has never paid discretionary commissions at any time, which takes it out of the scope of that investigation. Moreover, the company has always followed a high-service client-focused model, which we believe shows up in comparative statistics on the numbers of complaints to the Financial Ombudsman Service (FOS) and the percentage of complaints upheld by the FOS. Exhibit 20 illustrates the very strong position of S&U compared to peers in the motor finance industry.

Exhibit 20: Motor finance complaints to the FOS and uphold rate

Source: S&U

Exhibit 21: Financial summary

£'000s

2019

2020

2021

2022

2023

2024

2025e

2026e

Year end 31 January

PROFIT & LOSS

Revenue

82,970

89,939

83,761

87,889

102,714

115,437

133,230

145,712

Impairments

(16,941)

(17,220)

(36,705)

(4,120)

(13,877)

(24,203)

(27,881)

(29,730)

Other cost of sales

(15,751)

(19,872)

(14,264)

(18,771)

(23,676)

(22,821)

(25,156)

(25,809)

Administration expenses

(10,763)

(12,413)

(10,576)

(13,679)

(15,731)

(19,257)

(22,383)

(24,480)

EBITDA

39,515

40,434

22,216

51,319

49,430

49,156

57,809

65,694

Depreciation

(414)

(450)

(520)

(529)

(525)

(510)

(456)

(434)

Op. profit (incl. share-based payouts pre-except.)

39,101

39,984

21,696

50,790

48,905

48,646

57,354

65,260

Exceptionals

0

0

0

0

0

0

0

0

Non-recurring items

0

0

0

0

0

0

0

0

Investment revenues / finance expense

(4,541)

(4,850)

(3,568)

(3,772)

(7,495)

(15,062)

(20,087)

(22,650)

Profit before tax

34,560

35,134

18,128

47,018

41,410

33,584

37,266

42,609

Tax

(6,571)

(6,252)

(3,482)

(9,036)

(7,692)

(8,147)

(9,317)

(10,652)

Profit after tax

27,989

28,882

14,646

37,982

33,718

25,437

27,950

31,957

Average number of shares outstanding (m)

12.1

12.1

12.1

12.1

12.1

12.2

12.2

12.2

Diluted EPS (p)

232.0

239.4

120.7

312.7

277.5

209.3

230.0

263.0

EPS - basic (p)

233.2

239.6

120.7

312.8

277.5

209.3

230.0

263.0

Dividend per share (p)

118.0

120.0

90.0

126.0

133.0

120.0

125.0

130.0

EBITDA margin (%)

47.6%

45.0%

26.5%

58.4%

48.1%

42.6%

43.4%

45.1%

Operating margin (before GW and except.) (%)

47.1%

44.5%

25.9%

57.8%

47.6%

42.1%

43.0%

44.8%

Return on equity

17.6%

16.8%

8.1%

19.6%

15.6%

11.1%

11.6%

12.5%

BALANCE SHEET

Non-current assets

185,383

197,806

173,413

184,189

222,031

244,450

274,460

297,968

Current assets

95,430

108,275

111,426

143,040

206,143

222,396

250,436

272,564

Total assets

280,813

306,081

284,839

327,229

428,174

466,846

524,896

570,532

Current liabilities

(6,722)

(7,424)

(5,309)

(8,789)

(6,918)

(8,483)

(9,165)

(9,639)

Non-current liabilities inc pref

(108,724)

(119,183)

(98,501)

(111,693)

(196,371)

(224,201)

(268,201)

(297,201)

Net assets

165,367

179,474

181,029

206,747

224,885

234,162

247,531

263,692

NAV per share (p)

1,375

1,493

1,490

1,702

1,852

1,928

2,038

2,171

CASH FLOW

Operating cash flow

10,530

4,946

32,940

(2,094)

(62,760)

(15,508)

(28,747)

(12,427)

Net cash from investing activities

(785)

(265)

(1,112)

(284)

(660)

(189)

(340)

(340)

Dividends paid

(13,080)

(14,461)

(13,098)

(12,263)

(15,546)

(16,154)

(14,581)

(15,796)

Other financing (excluding change in borrowing)

14

14

2

1

1

0

0

0

Net cash flow

(3,321)

(9,766)

18,732

(14,640)

(78,965)

(31,851)

(43,668)

(28,563)

Opening net (debt)/cash

(104,990)

(108,311)

(118,077)

(99,345)

(113,985)

(192,950)

(224,801)

(268,469)

Closing net (debt)/cash

(108,311)

(118,077)

(99,345)

(113,985)

(192,950)

(224,801)

(268,469)

(297,032)

Source: S&U filings, Edison Investment Research

Contact details

Revenue by geography

S&U, 2 Stratford Court

Cranmore Boulevard, Solihull.

B90 4QT

0121 705 77 77

www.suplc.co.uk

Contact details

S&U, 2 Stratford Court

Cranmore Boulevard, Solihull.

B90 4QT

0121 705 77 77

www.suplc.co.uk

Revenue by geography

Management team

Chairman: Anthony Coombs

Deputy Chairman: Graham Coombs

Anthony Coombs joined S&U in 1975 and was appointed managing director in 1999 and chairman in 2008. Between 1987 and 1997 he served as an MP. He is on the executive of the Consumer Credit Association and is a director of a number of companies and charities including the National Institute for Conductive Education.

Graham Coombs joined S&U after graduating from the London Business School in 1976. He is responsible for strategic matters

Group Finance Director: Chris Redford

CEO, Advantage Finance: Karl Werner

Chris Redford is a chartered accountant with over 10 years’ business experience in the fast-moving consumer goods, food and travel sectors. He was appointed as finance director of Advantage Finance in 1999 and as group finance director from 1 March 2004.

Karl Werner joined S&U in December 2023 and was appointed CEO of Advantage Finance following Graham Wheeler’s retirement. Karl has worked in the motor finance industry for 20 years, most recently at MotoNovo Finance. Karl’s experience spans various roles including sales, marketing, operations and risk and finance.

CEO, Aspen Bridging: Ed Ahrens

Director: Jack Coombs

Ed Ahrens joined S&U in 2014, becoming group strategic development director before leading the development of Aspen Bridging. He has been in banking and specialty finance for over 30 years, with his experience including senior roles at Barclays and AIB and as a founding director at Vanquis Bank.

Jack Coombs was co-founder of Aspen Bridging, having joined S&U as group development executive. He previously worked in PwC’s valuation team and qualified there as a chartered accountant.

Director: Graham Wheeler

Graham Wheeler has over 40 years’ experience in motor finance across consumer and business lending, much of it in senior leadership roles. He developed through blue-chip companies like GM, Barclays, GE Capital and Volkswagen FS, where he held the post of UK CEO for 11 years. Graham joined the board as a non-executive director after retiring as CEO of Advantage Finance at the end of 2023.

Management team

Chairman: Anthony Coombs

Anthony Coombs joined S&U in 1975 and was appointed managing director in 1999 and chairman in 2008. Between 1987 and 1997 he served as an MP. He is on the executive of the Consumer Credit Association and is a director of a number of companies and charities including the National Institute for Conductive Education.

Deputy Chairman: Graham Coombs

Graham Coombs joined S&U after graduating from the London Business School in 1976. He is responsible for strategic matters

Group Finance Director: Chris Redford

Chris Redford is a chartered accountant with over 10 years’ business experience in the fast-moving consumer goods, food and travel sectors. He was appointed as finance director of Advantage Finance in 1999 and as group finance director from 1 March 2004.

CEO, Advantage Finance: Karl Werner

Karl Werner joined S&U in December 2023 and was appointed CEO of Advantage Finance following Graham Wheeler’s retirement. Karl has worked in the motor finance industry for 20 years, most recently at MotoNovo Finance. Karl’s experience spans various roles including sales, marketing, operations and risk and finance.

Principal shareholders

(%)

Wiseheights

19.9

JEC Coombs

13.8

GDC Coombs

13.5

AMV Coombs

10.0

JS Coombs

3.8

M Cole-Fontayne

3.3

Grevayne (controlled by A Coombs and G Coombs)

3.1

Renta 4

2.4

F Coombs

2.3

S Coombs

2.3


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General disclaimer and copyright

This report has been commissioned by S&U and prepared and issued by Edison, in consideration of a fee payable by S&U. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

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London, WC1R 4PS

United Kingdom

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Ceres Power Holdings — Strategic partnerships powering growth

Ceres Power Holdings’ innovative technology uses electrolysis to produce green hydrogen and solid oxide fuel cells to generate power. In a year where it moved to the Main Market of the London Stock Exchange, it recorded revenue growth of 13% and gross margin expansion to 61% (the highest in the sector, according to management), but is yet to record an operating profit (FY23 operating loss of £59.4m versus £54.0m in FY22). Ceres continued its strategy to drive innovation and technology across solid oxide fuel cells (SOFC) and hydrogen electrolysers (SOEC), increasing its R&D spending by 11% y-o-y to £54m (FY22: £48.5m). Management guides for FY24 revenue to be double that achieved in FY23, based on existing contacts. Net cash, including short term investments, was £140m at the end of FY23.

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