S&U — Seeing recovery and adapting to grow

S&U is an established specialist lender with businesses addressing the non-prime motor finance and the property bridging markets. While Advantage motor finance was significantly affected by the pandemic, it has a record of strong, profitable growth and has demonstrated a strong bounce back as restrictions were released. It has also continued to work on improvements to support longer-term growth. Aspen Bridging, a relatively new business, has gained experience and is scaling up to make a more significant contribution to the group while maintaining a conservative underwriting approach. The Coombs family owns c 52% of the equity and management takes a long-term, sustainable approach to the development of the group. The shares are valued at c 1.4x book, a level that would be consistent with a return on equity (ROE) of 13.2%; this is below the 14% or more we estimate for FY22 and FY23 and the pre-COVID-19 five-year historical average of over 16%.

S&U’s origins lie in a business founded by the chairman’s grandfather in 1938. That evolved into a home collected credit company and in 1999 a nonprime motor finance business was added with the foundation of Advantage Finance. The sale of the home collected credit business to Non Standard Finance in 2015 for £82.5m represented a significant change for the group and provided the means to finance a £15m special dividend and to invest in continued strong growth at Advantage and subsequently the formation of a new property bridging business (Aspen Bridging) in 2017.

Advantage Finance was formed in 1999 and is based in Grimsby with c 180 employees. Graham Wheeler took over as managing director in 2019, bringing extensive experience as a senior executive in the motor finance sector, while much of the management team has been with the company since launch. Advantage has a strong long-term growth record and, at £259m, net customer receivables have grown at a 10-year compound growth rate of 20%, even after a contraction in FY21 as a result of the pandemic. The company has c 62,000 live customers and recorded 19,747 new transactions in FY22 (pre-pandemic it had over 23,000 transactions in FY20). Advantage focuses on the non-prime area of the market, all loans are hire purchase loans and 90% of its lending is through over 40 brokers, with 5% each direct from dealerships and existing customers. The broker-sourced business is divided roughly 60/40 between internet and dealership brokers. S&U has relationships with the largest UK brokers including names such as Carfinance247, Zuto, Evolution Funding, Jigsaw and Midland Credit. This gives access to both large dealership networks and smaller local dealers.

Almost all the loan applications are submitted to the Advantage web-based system, which provides immediate in-principle lending decisions. The in-house IT capability at Advantage (about 10% of the staff) is an important enabler for the business as it helps maintain a high-speed response to loan applications (within 10 seconds for 95% of all applications) and rapid adjustments to systems to meet business requirements. An example of this was the introduction of a third credit rating agency (Equifax was added to Experian and TransUnion) including the merging of its data into the score card. Current projects include linking the scorecard to aggregators and decision-making platforms (including CrediCar, HD Decisions and Motiv Finance) to allow a better matching of applicants to Advantage’s offering.

Most loans range from £5,000 to £9,000, with a maximum loan amount of £15,000; the average advance in FY22 was £7,138. The average original term was 53 months with a flat interest rate of 16.3% (on a typical loan of £7,000, c £12,400 is repayable including interest and fees). The provisional approval rate for loan applications in the last financial year was approximately 40%, with c 0.6m out of c 1.5m applications approved. The 19,747 that actually signed up in FY22 were therefore equivalent to about 3% of approvals or 1% of original applications. The small ratio of deals signed in part reflects buyers’ use of the internet to source finance before shopping for a car and is not onerous for Advantage given the automation of responses to applications. Advantage’s Dealflo esignature system helps to support the sign-up rate following approval, by guiding customers through terms and conditions and verifying their digital signatures.

Advantage had achieved 20 years of consecutive profit growth until FY21, reflecting growth in the loan book paired with successful credit control, underpinned by continuous refinement of a bespoke underwriting and scoring system, developed in conjunction with Experian and referencing a range of data sources. The pandemic affected FY21 results through substantial forward-looking impairment provisions. Exhibit 1 shows the development in receivables, revenue and profit margin at Advantage since 2011. Growth accelerated in the post financial crisis period (notably from 2013) when limited availability of credit created a particularly favourable environment with customers who might previously have been served by the incumbent banks migrating to specialist providers such as Advantage. Revenue and margin benefited subsequently with the latter rising to more than 40% for four years followed by a moderation as a result of rising broker commission and impairments, and, to a lesser extent, the withdrawal from the sale of gap insurance (2015). In FY21 the impact of the pandemic on margins was marked as increased provisioning almost halved the profit margin. In FY22 a reduction in the provision charge to below normal levels together with strong collection performance lay behind the bounce in margin to 55% (see discussion of FY22 results for more detail).

Aspen Bridging launched as a pilot project in February 2017 to test the viability of developing property bridging finance as a diversifying activity and alternative source of growth for the group. In November 2018, S&U announced that it would move on from the pilot stage and invest further in the business.

Loans are made for refurbishment, light development or investment in the residential, houses of multiple occupation, prime semi-commercial and prime commercial market segments. The average original term is 11 months with an option for Aspen to extend the term by two months where appropriate; repayment is financed by sale or re-mortgaging. Loans are all unregulated (not owner-occupier) and are secured with a first charge. The maximum loan size is £10m. S&U notes that it is addressing a market niche financing projects that larger institutions would find difficult to service with the speed and flexibility Aspen can offer.

Aspen follows a cautious underwriting approach with a process that includes third-party legal and valuation input, together with a site meeting with each customer by a member of the 20-strong Aspen team. Since launch 369 loans have been provided with an average gross value of c £500,000 and maximum gross loan to value of 72%. At end FY22 net receivables stood at £63.4m and during the year there were 111 transactions with a gross average loan size of £618,000 (excluding 24 Coronavirus Business Interruption Loan Scheme (CBILS) loans with an average value of £1.8m).

Exhibit 2 provides a summary of the results for FY22 compared with FY21 and FY20. We highlight a number of points from this, comparing the FY22 result with FY21 unless stated.

Looking at the level of customer receivables we can see that the number of new motor loans recovered significantly but not to the FY20 level. This and strong collections left motor finance receivables up 5%. Property bridging continued its development with receivables up 87% in the year. Taking the two businesses together, the average level of customer receivables increased by 6% and, reflecting the mix of revenue margins, group revenue increased by nearly 5%.

The major driver of the profit improvement compared with FY21 was the sharp reduction in the motor finance loan loss charge. This reflects the forward-looking nature of provisions required under IFRS 9 and was £3.8m compared with £36m in FY21 and a more normal £16.5m in FY20; it included a small net write-back in H222 (£1m).

Cost of sales increased by 32%, reflecting in part increased commission payments as transaction numbers rose, while other administration costs were up 29% as bonus payments increased and pay restraints were eased as business conditions normalised.

This left operating profit up by more than 130% and pre-tax profit and fully diluted EPS increased by nearly 160% at £47m and 312.7p respectively. Taking into account the 216p average of FY21 and FY22 earnings per share (given the pandemic-driven volatility), the group has proposed a final dividend of 57p giving a full year total of 126p (+40%) as this gives an average dividend for the two years of 108p, in line with the group’s aim to pay twice-covered dividends.

Exhibit 3 shows how the pandemic affected the payment profile in Advantage motor finance and the improvement seen in FY22. Here accounts on payment holiday were included as in arrears to illustrate the effect on cash payments (in the accounts, in line with Bank of England guidance, they were not counted as part of Stage 3 or credit impaired provisioning). In the analysis the proportion of net receivables where payments are up to date declined by 17 percentage points between FY20 and FY21. In contrast, FY22 has seen an improvement of more than 10 points to 71.5%, still below the pre-pandemic level of 77.9% in FY20.

Exhibit 4 sets out the analysis of balance-sheet loan-loss provisions for FY20, FY21 and FY22. This shows how total provisions as a percentage of gross receivables increased from 18% to 27% between FY20 and FY21 before declining modestly to 26% at end FY22. Therefore, even though the FY22 loan loss provision for motor finance in the profit and loss account fell substantially, the balance sheet provision coverage remains relatively high.

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

Exhibit 5 shows independent forecasts for UK GDP, unemployment and inflation as collected by the UK Treasury in March. Compared with the 2022 forecasts collated in January, average GDP expectations are slightly lower (4.2% vs 4.5%), unemployment estimates marginally lower and inflation notably higher (5.8% vs 3.5%). The FY23 estimates, now included, show a normalisation of growth following the post-pandemic recovery, stable unemployment and lower inflation. While the stability of unemployment indicated would be favourable for Advantage, we would caution that the forecasts have yet to capture the additional uncertainty introduced by the war in Ukraine. The increase in inflation expectations has prompted Advantage to adjust its affordability calculation, while its experience in coping with the impact of the pandemic demonstrates is ability to work with customers flexibly when they encounter difficulties.

Exhibit 6 shows how consumer confidence staged a major recovery last year before falling sharply again through a combination of the arrival of the Omicron wave, growing concern over the cost of living and the war in Ukraine. The cost-of-living pressures are potentially particularly relevant for Advantage customers, although the company notes that wages are likely to adjust and that its customers tend to depend on their vehicles for transport to work. As noted above, Advantage has made allowance for the rise in inflation within its affordability calculations. Exhibit 7 shows that, after an increase, the unemployment rate has moved close to prior levels while forecasts have also been falling. The level of redundancies, a more immediate measure, saw a very sharp spike as the pandemic took hold, but fell rapidly and is now below pre-pandemic levels.

Next we look at data on used car transactions and used car finance. Exhibit 8 compares the monthly sales pattern in the three years 2019–21. This highlights 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. Since April 2021 activity has been close to pre-pandemic levels, as represented here by the 2019 monthly figures, although the final quarter of 2021 saw volumes below the 2019 level, probably reflecting the prevailing supply limitations. Exhibit 9 shows a similar pattern in used car finance with seasonal dips evident in addition to lockdown impacts. Looking ahead, Advantage notes that much will depend on consumer confidence but that it expects transaction numbers to return to increased growth in the final third of FY23 as used car availability gradually normalises.

Used car prices (see Exhibit 10) were buoyant in 2020 and then experienced a very sharp step up from mid-2021, with strong consumer demand and reduced supply pushing prices up. The ONS data are fully supported by marked strength in the Autotrader retail price index. An improving supply of new cars and hence used stock seems likely during 2022 and Advantage confirms that it expects a gradual improvement during the year. Exhibit 11 shows the month-on-month change in the price index underlining the changes in trend and a stabilisation of prices in the most recent months. At the margin a fall in auction prices, prompted by greater supply, would be a negative for Advantage, but its exposure here through repossessed car sales is moderated by the relatively low value of vehicles it finances. Also, for the moment, the demand side of the equation appears to remain robust.

Advantage also looks to work on a number of initiatives to strengthen branding and marketing and increase efficiency. This includes entry to the aggregator car finance market, digital marketing to capture customer renewals, re-design of the website and the development of affinity and other partnerships.

Turning to the background for Aspen Bridging, Exhibit 12 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. The latest reading here, for February 2022, shows an activity level slightly above pre-pandemic levels. Lower consumer confidence and macro-economic developments could affect transaction volumes during the rest of the year. However, 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.

Changes in key numbers from our estimates are shown in Exhibit 13 and further details are included in Exhibit 14. For FY22 and FY23 earnings per share are increased by 2% and 3%, respectively, reflecting only modest assumption changes.

The next table gives details of our estimate assumptions. In the motor business we have allowed for receivables growth of 10% and 6% for FY22 and FY23, respectively, and look for a normalisation in the level of impairments in both years, leaving FY23 impairments at 20% of revenue and the risk-adjusted yield (revenue less impairments as a percentage of average receivables) at 24% (FY18–20 average: 25.4%). Bridging receivables are assumed to reach £80m in the current fiscal year followed by £97m as the business is expanded to a level where it makes a more significant contribution to the group.

The segmental cash flow analysis below highlights the major turnaround in cash flow at Advantage between FY20 and FY21 as growth was replaced by contraction. The pattern was as expected, with the slowdown in advances outpacing the reduction in collections as payment holidays and forbearance took effect. In FY22 advances increased substantially but were still outpaced by very strong collections. Debt recovery was also stronger, contributing to an inflow of £14m compared with £32m in FY21.

Aspen property bridging expanded with sharply higher advances augmented by CBILS lending in FY22. Collections were also strong leaving the net outflow at £27m compared with £13m. At the group level this left an outflow of £15m compared with the inflow of £19m in FY21. Net debt increased to £114m and net debt/equity was 55%. With debt facilities available of £180m there is headroom to finance expected growth. On our estimates, net debt could rise to c £156m by end FY24 with net debt/equity at 65%.

P/E comparisons with peers remain difficult to interpret given the impact of forward-looking provisions in the post-COVID-19 period, so we continue to frame valuation using our ROE/COE calculations. If we assume a cost of equity (COE) of 10% and long-term growth of 2%, then the share price at the time of writing (2,390p) would be consistent with an ROE of 13.2%, which is below our estimates for FY23 (14.8%) and FY24 (14%). Arguably, even that year might not reflect a full recovery from the impact of COVID-19 with our assumed transaction levels at Advantage still below prior levels and scope for Aspen to expand further. Historically, S&U has achieved higher returns on equity (the five-year average for the period FY16–20 is 16.3%). As noted on the first page, the prospective earnings multiple is just over 9x and the yield above 5%.