S&U — Sound liquidity, positive near-term cash flow

S&U’s results were similar to our expectations at the revenue, pre-tax profit and earnings per share levels once allowance is made for a change in accounting for revenue at Advantage.1 Exhibit 1 sets out a summary profit and loss comparison with prior years. Key points from the results are noted below with percentage changes versus FY19 unless stated.

Exhibit 2 sets out the segmental cash flow analysis provided by the company. Looking first at Advantage motor finance we can see that advances slowed in the second half but for the full year were still c £20m or 15% ahead of FY19. Monthly collections were up 7% for the year and for the second half were higher than advances allowing a small cash inflow in the period. This is likely to be a precursor of the current period as, with sales (new advances) very subdued and collections running modestly lower so far, cash flow for Advantage seems set to remain positive.

For Aspen Property Bridging there was also a first/second half contrast with the main driver of the second half inflow being a significant increase in collections combined with a higher level of debt recovery. It should be remembered that this business is naturally relatively lumpy with 57 transactions during the year (versus 62 in FY19). The average loan size increased to over £0.5m as the business focused more on larger, more professional developers and refurbishers where the risk is seen as lower.

For the group as a whole these movements translated into a second half inflow of £7.4m moderating the full year outflow to £9.8m.

Year-end net debt was £118m and the group has total borrowing facilities of £155m (including £50m in term loans and £105m of rolling credit facilities). The maturity profile reflects the four- to five-year term of motor finance loans with end-month maturities of £25m in April 2021, £25m in April 2022, £60m in March 2023, £25m in March 2024 and £20m in March 2025. The group notes that its borrowing requirements have fallen since the year end and expects them to fall significantly further in subsequent months as demand falls assuming collections remain relatively resilient.

In this section we set out indicators that provide some background in attempting to assess the outlook for S&U’s business in a very uncertain period. We focus mainly on the motor finance business. While most economic and industry data has yet to reflect the current circumstances, in Exhibit 3 we can see that the March reading for consumer confidence provides an appropriately clear signal of the impact of the pandemic and lockdown. The level of unemployment (generally a lagging indicator) and redundancies shown in Exhibit 4 is still at a pre-lockdown level but the financial crisis spike in redundancies in 2008/09 is an indicator of the substantial impact that is likely to become evident in due course, partially softened by government support for companies to furlough employees.

Economic forecasts are beginning to reflect the potential pandemic impact with the latest IMF World Economic Outlook (WEO), for example, looking for global and UK GDP contraction of 3% and 6.5%, respectively, in 2020, forecast reductions of 6.3 and 7.9 percentage points since the January WEO update. The UK Office for Budget Responsibility (OBR) has prepared an illustrative coronavirus reference scenario. The scenario does not set out to predict the length of the lockdown but illustrates potential effects assuming a three-month lockdown followed by a further three months when restrictions are partially lifted. Among the OBR’s observations is that in the scenario GDP falls by 35% in the second quarter, and that unemployment rises by more than 2 million to 10% (higher than in the financial crisis, as shown above). In its scenario GDP would bounce back quickly but unemployment would subside more slowly. Exhibit 5 shows key numbers from the scenario with average earnings and unemployment being particularly relevant for S&U.

Next, we turn to look more directly at the used car market. Exhibits 6 and 7 show trends in the number of used car transactions and, for comparison, private new car registrations since 2005. First it is worth remembering in Exhibit 6 that the number of used car transactions is substantially greater than new car registrations (these are shown on the right-hand scale). New registrations also tend to be more volatile than used car transactions and this is more visible when looking at the year-on-year percentage changes in Exhibit 7. Here we can see that new registrations swung widely around the time of the financial crisis. The downswing reflected the economic impact of that crisis but the subsequent bounce arose from a government vehicle scrappage scheme introduced in 2009 that ended in March 2010. Between 2006 and 2009 used car transactions fell by about 15% and did not regain the 2006 level until 2013 reflecting the structural impact of the crisis on the banking system and economy. During this period S&U’s motor finance business benefited as capital constraints and retrenchment in the banking sector reduced the availability of credit in the non-prime segment. In the current crisis the hope is that the duration of lockdown is sufficiently short and government support measures for employment are effective in limiting the structural damage to the economy, enabling a rapid recovery, as illustrated by the OBR scenario.

Exhibit 8 shows year-on-year changes in used car finance volume through dealerships. This shows growth in most months over the period and the same is true for the value of lending (not shown). S&U expect this growth to resume once the effects of the pandemic pass although it also signals that current new lending is understandably at a very low level (c 85% below prior levels at the time of the results presentation). Advantage has tightened its lending criteria, particularly for those who are self-employed (approximately 20% of the existing customer base) and those working in the retail or catering sectors. S&U will aim to exercise forbearance wherever possible and keep customers in their cars over this period, an approach that is in tune with its long-term attitude both in motor finance and home credit, prior to its disposal.

For reference, Exhibit 9 shows that used car prices, as represented by dealer part exchange prices at BCA auctions, had strengthened towards the end of last year and early this year. It remains to be seen how illiquid the market will be over the near term and whether prices fall, potentially adding to impairment levels and reducing debt recovery at the margin. Physical auctions have been suspended but online auctions are getting underway currently.

The FY20 presentation was the first attended by new Advantage CEO Graham Wheeler, who has succeeded Guy Thompson. Following his arrival he notes the strength of the business and its track record of profitable growth. Only minor organisational changes have been made to address the Senior Managers and Certification Regime and in line with a greater emphasis on enterprise risk management. Increased competition has been addressed both by strengthening relations with larger brokers and diversifying by establishing more relationships with smaller brokers where acquisition costs are lower.

Looking ahead Advantage is preparing to respond strongly when conditions normalise. Actions include development of a customer care centre to improve engagement, a refreshed Advantage brand, website development to facilitate customer self-service, new technology for customer underwriting and onboarding, development of a live scoreboard for existing customers to enhance collections and structuring collection teams to improve care of higher risk accounts. Beyond this there may be opportunities to develop partnerships with prime and near-prime lenders to source business, to tap into the opportunities presented by open banking, to increase the level of customer renewals and to consider developing direct to customer business.

Briefly on Aspen property bridging, the reduced level of activity in the property market is the dominant factor currently and while Aspen remains open for new business it is taking a cautious approach to any new lending with lower loan to value and more stringent valuation requirements meaning that the current emphasis is on collections. In the longer term the potential for growth in the short-term bridging market is still seen as good and, as a very small business, Aspen should have a good chance to grow to a scale where it can make a material positive contribution to the group.

In view of the major uncertainties prevailing currently S&U has withdrawn any guidance and we have followed suit for the moment by removing our estimates (S&U’s AGM update on 9 June will provide an opportunity to review this). As a result, in the updated version of our peer comparison table shown below we have only included calendar 2019 P/Es. The table includes companies with an exposure to motor finance and non-standard lending. S&U trades on an above-average P/E and yield although it is not the highest on either measure. Its historical ROE and price to book multiple are above average perhaps reflecting the market’s view of the resilience of the business and its ability to protect its equity value and return to a sustainable ROE of over 15% once the effects of the pandemic have passed.

Exhibit 11 shows the recent share price performance for the peer group. Unsurprisingly, given the economic sensitivity of most lending businesses, there are substantial negative movements for all periods on average, most of which is focused in the post-pandemic period. Against this background S&U’s share price has shown less weakness than the average in all the periods shown.