S&U — Softer volumes but solid EBITDA growth expected

S&U (LSE: SUS)

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Research: Financials

S&U — Softer volumes but solid EBITDA growth expected

S&U held a cautious approach to new lending in H124, emphasising higher-quality customers and avoiding competition directly on price. Consequently, net receivables were 5% below our expectations in H124. Encouragingly, S&U has experienced a rise in transactions and new customer pipeline in the past two months in the Advantage motor business, but weakening consumer confidence, higher interest rates and paydowns are likely to curtail the usual rate of growth in Aspen for FY24. Despite this, impairments and arrears are below budget, which should provide some resilience to the net interest margin. We have marginally lowered our estimates for FY24 and FY25 but still expect EBITDA growth of 16% and 15%, respectively.

Written by

Robert Murphy

Managing Director, Financials and Investment Trusts

Financials

S&U

Softer volumes but solid EBITDA growth expected

H124 update

Financial services

14 August 2023

Price

2,320p

Market cap

£282m

Net debt (£m) at end January 2023

193

Shares in issue

12.2m

Free float

16.8%

Code

SUS

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

0.7

(6.6)

(2.2)

Rel (local)

(3.9)

(5.1)

(2.3)

52-week high/low

2570p

1905p

Business description

S&U’s Advantage motor finance business lends on a simple HP basis to lower- and middle-income groups that may have impaired credit records restricting access to mainstream products. It has c 65,000 customers. The Aspen property bridging business has been developing since its launch in 2017.

Next events

H124 results

3 October 2023

Q324 trading update

12 December 2023

Analysts

Rob Murphy

+44 (0)20 3077 5700

Armando Hoxha

+44 (0)20 3077 5700

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

S&U held a cautious approach to new lending in H124, emphasising higher-quality customers and avoiding competition directly on price. Consequently, net receivables were 5% below our expectations in H124. Encouragingly, S&U has experienced a rise in transactions and new customer pipeline in the past two months in the Advantage motor business, but weakening consumer confidence, higher interest rates and paydowns are likely to curtail the usual rate of growth in Aspen for FY24. Despite this, impairments and arrears are below budget, which should provide some resilience to the net interest margin. We have marginally lowered our estimates for FY24 and FY25 but still expect EBITDA growth of 16% and 15%, respectively.

Year

end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

01/22

87.9

47.0

312.7

126.0

7.4

5.4

01/23

102.7

41.4

277.5

133.0

8.4

5.7

01/24e

116.8

41.4

258.5

133.0

9.0

5.7

01/25e

131.5

48.4

298.7

150.0

7.8

6.6

Note: *PBT and EPS are reported. EPS is diluted.

Credit quality a positive

In Advantage, net receivables were a reported £313m, up 12% y-o-y but marginally below our expectations. Demand for used cars remains robust with 50% of used car buyers willing to finance their purchases – above the 10-year average, according to S&U. Additionally, strong repayment performance has continued as S&U has improved origination quality over the past few years. Aspen reported lower-than-expected new business transactions as high interest rates affected activity in the real estate market. Subsequently, net receivables for Aspen were c £104m, up 15% from £90m in H123, but 15% below our forecasts. Despite this, management notes that the average pipeline has doubled over the current period as risk pricing has improved. Additionally, management states that repayment quality is solid and good default control has led to impairments being below budget.

Forecasts lowered slightly

Having already provisioned for margin compression in our forecast prior to the update, the reduced volume outlook has led us to trim FY24 estimates for revenue and profit before tax (PBT) to £116.8m and £41.4m from £119.3m and £42.9m, respectively. Our FY25 estimates remain broadly unchanged, which results in a solid result this year coupled with an attractive dividend yield and a return to stronger growth in FY25.

Valuation: Trading below implied ROE for FY24

Using a return on equity/cost of equity (ROE/COE) model with a ROE of 13.5%, COE of 10% and a growth rate of 2%, we value S&U at 2,842p. Based on its current share price and maintaining the COE and growth rate constant, the market is pricing in a ROE of 11.4%. This is below the FY16 to FY23 average of 16% and below our estimates of 13.5% and 14.5% for FY24 and FY25, respectively.

Market background

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.

Key economic indicators

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 1: Evolution of UK economic forecasts for 2023

Exhibit 2: Independent forecasts for 2023 and 2024

%

Average

Average of new forecasts

GDP growth

 

2023

0.2

0.2

2024

0.8

0.7

Labour Force Survey unemployment rate Q4

2023

4.1

4.1

2024

4.4

4.4

Inflation Q4 (CPI)

 

2023

4.9

5.0

2024

2.7

2.7

Source: Collected by HM Treasury (last reading July 2023)

Source: Collected by HM Treasury (July 2023)

Exhibit 1: Evolution of UK economic forecasts for 2023

Source: Collected by HM Treasury (last reading July 2023)

Exhibit 2: Independent forecasts for 2023 and 2024

%

Average

Average of new forecasts

GDP growth

 

2023

0.2

0.2

2024

0.8

0.7

Labour Force Survey unemployment rate Q4

2023

4.1

4.1

2024

4.4

4.4

Inflation Q4 (CPI)

 

2023

4.9

5.0

2024

2.7

2.7

Source: Collected by HM Treasury (July 2023)

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 3: GfK UK consumer confidence indicator

Exhibit 4: UK redundancies and unemployment

Source: Refinitiv (last value July 2023)

Source: ONS (last value May 2023)

Exhibit 3: GfK UK consumer confidence indicator

Source: Refinitiv (last value July 2023)

Exhibit 4: UK redundancies and unemployment

Source: ONS (last value May 2023)

Indicators for Advantage motor finance

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).

Exhibit 5: Monthly used car transactions 2020–22

Exhibit 6: Used car finance through dealerships

Source: SMMT (last value June 2023)

Source: Finance and Leasing Association (last value June 2023)

Exhibit 5: Monthly used car transactions 2020–22

Source: SMMT (last value June 2023)

Exhibit 6: Used car finance through dealerships

Source: Finance and Leasing Association (last value June 2023)

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 7: Used car price index

Exhibit 8: Monthly change in used car prices

Source: ONS CPI Index (last value June 2023)

Source: ONS CPI Index. Note: Month-on-month % change.

Exhibit 7: Used car price index

Source: ONS CPI Index (last value June 2023)

Exhibit 8: Monthly change in used car prices

Source: ONS CPI Index. Note: Month-on-month % change.

Indicators for Aspen property bridging

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.

Exhibit 9: UK property transactions

Exhibit 10: Monthly number of mortgage approvals

Source: HM Revenue & Customs. Note: Seasonally adjusted, to June 2023.

Source: Bank of England. Note: Seasonally adjusted, to June 2023.

Exhibit 9: UK property transactions

Source: HM Revenue & Customs. Note: Seasonally adjusted, to June 2023.

Exhibit 10: Monthly number of mortgage approvals

Source: Bank of England. Note: Seasonally adjusted, to June 2023.

Forecasts lowered slightly on lower net receivables

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.

Exhibit 11: Estimate changes

£m unless stated otherwise

FY24

FY25

Old

New

Change

Old

New

Change

Revenue

119.3

116.8

(2%)

131.9

131.5

0%

EBITDA

58,839

57,265

(3%)

65,880

65,623

0%

PBT

42.9

41.4

(4%)

48.7

48.4

(1%)

EPS (p)

268.4

258.5

(4%)

300.3

298.7

(1%)

DPS (p)

133.0

133.0

0%

150.0

150.0

0%

Source: Edison Investment Research

Exhibit 12: Financial summary

£'000s

2019

2020

2021

2022

2023

2024e

2025e

Year end 31 January

PROFIT & LOSS

Revenue

 

 

82,970

89,939

83,761

87,889

102,714

116,841

131,499

Impairments

(16,941)

(17,220)

(36,705)

(4,120)

(13,877)

(18,541)

(21,075)

Other cost of sales

(15,751)

(19,872)

(14,264)

(18,771)

(23,676)

(24,677)

(26,392)

Administration expenses

(10,763)

(12,413)

(10,576)

(13,679)

(15,731)

(16,358)

(18,410)

EBITDA

 

 

39,515

40,434

22,216

51,319

49,430

57,265

65,623

Depreciation

 

 

(414)

(450)

(520)

(529)

(525)

(551)

(652)

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

 

 

39,101

39,984

21,696

50,790

48,905

56,714

64,971

Exceptionals

0

0

0

0

0

0

0

Non-recurring items

0

0

0

0

0

0

0

Investment revenues / finance expense

(4,541)

(4,850)

(3,568)

(3,772)

(7,495)

(15,354)

(16,573)

Profit before tax

 

 

34,560

35,134

18,128

47,018

41,410

41,360

48,398

Tax

(6,571)

(6,252)

(3,482)

(9,036)

(7,692)

(9,946)

(12,100)

Profit after tax

 

 

27,989

28,882

14,646

37,982

33,718

31,414

36,299

Average Number of Shares Outstanding (m)

12.1

12.1

12.1

12.1

12.1

12.2

12.2

Diluted EPS (p)

 

 

232.0

239.4

120.7

312.7

277.5

258.5

298.7

EPS - basic (p)

 

 

233.2

239.6

120.7

312.8

277.5

258.5

298.7

Dividend per share (p)

118.0

120.0

90.0

126.0

133.0

133.0

150.0

EBITDA margin (%)

47.6%

45.0%

26.5%

58.4%

48.1%

49.0%

49.9%

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

47.1%

44.5%

25.9%

57.8%

47.6%

48.5%

49.4%

Return on equity

17.6%

16.8%

8.1%

19.6%

15.6%

13.5%

14.5%

BALANCE SHEET

Non-current assets

 

 

185,383

197,806

173,413

184,189

222,031

239,573

267,645

Current assets

 

 

95,430

108,275

111,426

143,040

206,143

229,443

244,556

Total assets

 

 

280,813

306,081

284,839

327,229

428,174

469,016

512,200

Current liabilities

 

 

(6,722)

(7,424)

(5,309)

(8,789)

(6,918)

(7,478)

(8,118)

Non current liabilities inc pref

(108,724)

(119,183)

(98,501)

(111,693)

(196,371)

(221,399)

(243,927)

Net assets

 

 

165,367

179,474

181,029

206,747

224,885

240,139

260,155

NAV per share (p)

1,375

1,493

1,490

1,702

1,852

1,977

2,142

CASH FLOW

Operating cash flow

 

 

10,530

4,946

32,940

(2,094)

(62,760)

(307)

(15,663)

Net cash from investing activities

(785)

(265)

(1,112)

(284)

(660)

(1,080)

(1,080)

Dividends paid

(13,080)

(14,461)

(13,098)

(12,263)

(15,546)

(16,161)

(16,282)

Other financing (excluding change in borrowing)

14

14

2

1

1

0

0

Net cash flow

 

 

(3,321)

(9,766)

18,732

(14,640)

(78,965)

(17,547)

(33,025)

Opening net (debt)/cash

 

 

(104,990)

(108,311)

(118,077)

(99,345)

(113,985)

(192,950)

(210,497)

Closing net (debt)/cash

 

 

(108,311)

(118,077)

(99,345)

(113,985)

(192,950)

(210,497)

(243,522)

Source: S&U, Edison Investment Research. Note: EPS is on a reported basis.

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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.

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Copyright: Copyright 2023 Edison Investment Research Limited (Edison).

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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.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2023 Edison Investment Research Limited (Edison).

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