S&U — Softer volumes but solid EBITDA growth expected

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

In summary, we have seen a slight improvement in consensus forecasts for unemployment and GDP growth in recent months but expectations regarding the pace of inflation have worsened as the market now expects 5% by the end of the year, higher than the 4% forecast in February. Consumer confidence is on a downturn following some recovery from very depressed levels between September 2022 and June 2023. The used car market remains resilient, with the value and number of cars on finance at elevated levels despite declining from 2022. Monthly mortgage rate approvals and UK property transactions have fallen as interest rates have risen and credit standards have tightened.

S&U management has acknowledged the toughening macroeconomic conditions and the slowdown in economic growth. However, both Advantage and Aspen remain well-positioned to steer through the headwinds as a shift towards prime lending has helped keep impairments and repayments at strong levels, while growth in net receivables is still anticipated in both businesses.

Inflation remains sticky in the UK. Headline inflation was 7.9% with core inflation (which strips out volatile energy and food prices) at 6.9% in the 12 months to June 2023. Inflation continues to be supported by the strong purchasing power of consumers. According to data compiled by the Office for National Statistics (ONS), average regular pay growth rose 7.7% and 5.8% between March and May 2023 for private and public sector workers, respectively.

Exhibit 1 reflects the forecasts of GDP growth, CPI and unemployment in 2023. Given expectations of negative GDP growth and worsening unemployment in the first quarter of the year, there was more optimism in the outlook for inflation for 2023. Inflation was expected to head towards 4% because of tightening monetary policy. However, inflation has proved more resilient in the UK and expectations have trended back towards 5%. Unemployment and GDP forecasts have slightly improved to 4.1% and 0.2%, respectively (see Exhibit 2).

Exhibit 3 shows the consumer confidence indicator of personal finances and the economic outlook between now and the next 12 months.

Consumer sentiment about the future remains depressed and has fallen again recently after a recovery from extremely low levels between September and June. The stickiness of inflation appears to have removed any optimism around interest rate cuts before the end of the year as was previously anticipated. Current consumer activity has, on the other hand, been strong because of excess savings amassed during the COVID-19 period backed by pay growth broadly in line with inflation.

Alongside this, we notice that both unemployment and redundancies have begun edging upwards (Exhibit 4). In the most recent May data, redundancies were 3.3 per 1,000 employees and unemployment was 4%, above May 2022 where redundancies were 1.5 per 1,000 employees and unemployment was 3.8%. We continue to monitor redundancies and unemployment but expect both to rise as the UK goes through a period of credit tightening and slowing activity.

Exhibit 5 displays the monthly used car transactions for each year since 2020 up to the first six months of 2023. 2023 is currently tracking slightly above 2022 at around the 600k mark, and we should expect the usual downtrend later in the year towards c 400k in the December holiday period. We can see that transactions fell rapidly at the start of the COVID-19 pandemic, before recovering to above normalised levels later in the year and into 2021, which has distorted the figures. In the first six months of 2023, transactions were 3.7m, below the FY14–22 average of 3.8m but above the first half of 2022 with 3.5m transactions.

S&U has recognised that the market backdrop remains challenging but is confident that growth will persist into the second half of the year, albeit it with a slightly compressed, but still strong, margin. This view is backed by Geraldine Kilkelly, director of research and chief economist at the Finance and Leasing Association (FLA), who said: ‘The industry remains cautiously optimistic about the prospects for future growth, with three-quarters of motor finance respondents to the FLA’s Q2 2023 Industry Outlook Survey anticipating some increase in new business over the next year.’

Exhibit 6 outlines the value of advances and number of cars that were bought on finance through dealerships. In data corresponding to June, we can see that the number of cars financed is roughly in line with historical averages (excluding 2020 impact of COVID), while values remain elevated in comparison to the previous four years (excluding 2022) as prices have risen. The data show that the values and number of cars have both fallen 7% to £1,918m and 124,401, respectively, compared to the same period last year (£2,051m and 132,305 in June 2022).

Prices continue to remain elevated above the pre-pandemic level as consumer demand and constrained supply have persisted (see Exhibit 7). The drop in June in used car prices (Exhibit 8), looks in line with usual seasonal patterns. Advantage appears well positioned in this environment as it services more affordable, relatively low-value vehicles (average advance of £7,799 in FY23).

Exhibit 9 shows the number of UK non-residential and residential transactions, with residential being more relevant for Aspen. We notice volatility in 2020 driven by sequential lockdowns and the implementation of temporary stamp duty holidays extended into 2021. As of late, residential transactions have dipped below the pre-pandemic norm of 101k to 94.7k (provisional estimate).

Current interest rates in the UK are 5.25% having risen 500bp since the maiden increase in December 2021. The current hike is the steepest since the 1980s when rates rose 600bp to 14.875% by October 1989. As a result, mortgage rates have increased, credit standards have tightened and added to pressures on household budgets from elevated inflation. In short, the cost of borrowing has begun to hit restrictive levels. Subsequently, monthly mortgage approvals have declined to decade-lows (shown in Exhibit 10) as the demand for real estate is beginning to subside.

S&U management has noted the impact of the above factors on the residential property market. However, it remains optimistic that the business can continue to grow profitably as it continues to focus on experienced property developers and maintain appropriate credit quality and repayment standards.

Following the Q224 update we have made changes to key estimates, detailed in Exhibit 11 below. Net receivables for both Advantage and Aspen came in lower than forecast – £313m and £104m for Advantage and Aspen versus our estimates of £318m and £120m. We have maintained our 9% net receivables growth estimate for Advantage for FY24 but lowered our estimates for Aspen, nevertheless with 5% growth expected for the year. Although S&U highlighted that its net interest margin was under pressure as interest rates have increased, this had already been incorporated into our forecasts. Naturally, after implementing the actual net receivables figures into our model, our revenue and PBT estimate for FY24 has fallen 2% and 4% to £116.8m and £41.4m, respectively. Earnings per share has also declined 4% to 258.5p/share. Our FY25 estimates remain broadly unchanged.