S&U — Resilient despite macroeconomic uncertainty

S&U’s H124 overall performance was in line with our expectations. Group revenue rose 12% to £55.3m, 3% shy of our expectations, but impairments and cost of sales came in at 19% and 12% below our expectations, respectively. Impairments benefited from cautious underwriting and cost of sales benefited from a lower number of new loans (but larger loan size). Administrative costs proved more stubborn, up 19%, and 15% above our forecasts, while finance costs surged by 161% due to rapid base rate increases. The net effect was a robust performance at S&U, with PBT reported at £21.4m, 3% above our estimates. A higher tax rate brought net attributable profit within 1% of our estimates to £16.2m. EPS was 133.2p for the period. S&U’s profit and loss account is shown in Exhibit 1 below.

Group revenues advanced 12% y-o-y to £55.3m, driven by an enlarged net receivables book. Advantage, S&U’s motor financing business, generated £47.5m in revenues, 9% above H123, as Advantage focused on growing its mid-quality customer lending to protect its margins supported by record average car lending of £8,040. In Aspen, S&U’s property bridging business, revenues grew 38% y-o-y to £7.9m, benefiting from a larger receivables book. Year-on-year, risk-adjusted margins remained in line for Aspen at 13.7% while for Advantage they dropped 1.7pp to 26.2%. See Exhibits 2 and 3 for our risk-adjusted yield analysis.

Impairments were reported at £6.8m and £0.4m for Advantage and Aspen, respectively, an improvement on our expectations of £8.3m and £0.6m. Credit quality and collections remained solid during the period as UK consumers showed resilience despite persistent inflation; this was partly due to excess savings amassed from COVID-19, average wage growth in lock-step with inflation and unemployment subdued below 4% (see Macroeconomic background section). Advantage also highlighted that the average customer credit score rose in the period, which helped keep collection rates of 94.1% – in line with H123.

Aspen pursued a conservative lending policy in H124, reducing its LTV ratio to 65% versus 72% at the end of FY23, seeking to attract more affluent and experienced borrowers. This translated into better collection rates. However, it reported that out of 130 outstanding facilities, 15 were in technical default (up from 10 in the Q124 trading statement), but S&U remains confident that all assets will be recovered profitably (due to low LTVs) and indeed the number has, according to management, reduced at the time of writing.

S&U was unable to avoid the impact of the inflationary environment, resulting in a 19% y-o-y increase in administrative costs to £9.2m. Despite this, operating profit grew by 20% to £28.2m (H123: £23.5m).

Finance expenses increased more than twofold to £6.8m (H123: £2.6m), as subsequent interest rate increases by the Bank of England made borrowing more expensive. The average rate per year paid on S&U’s borrowing surged from 3.9% in H123 to 7.1% in H124. Despite this headwind, PBT was reported at £21.4m, slightly higher than the £20.9m in H123.

In April 2023, the corporate tax rate in the UK increased to 25% from 19%. Consequently, the tax charge was 37% higher than the previous year, amounting to £5.2m (H123: £3.8m). Y-o-y profit after tax was down 5% to £16.2m as a result. Annualised return on equity (ROE) slipped 2pp compared to H123 but is still healthy at 14.3%. Furthermore, in line with H123, an interim dividend of 35p was declared.

In Exhibits 2 and 3, we highlight the risk-adjusted yields for Advantage and Aspen. Operating in the non-prime sector has permitted Advantage to earn a strong average risk-adjusted yield of 21% between 2017 and 2023, even considering the turbulent period of COVID-19.

The only major interruption was in H121 as the onset of COVID-fuelled provision charges. Government intervention such as the furlough scheme prompted downward revisions in impairments and eventual releases at end-H222 as excessive credit losses did not materialise. Impairments currently remain below 2017 levels, further emphasising consumer credit strength despite S&U’s focus on the non-prime sector. We anticipate a modest uptick in lending volumes and project gradual growth in revenues. We expect yields to rise slightly as lending readjusts to higher rates.

In Aspen, however, the risk-adjusted yield has been in steady decline since the company’s inception in 2017 as market interest rates fell. From the outset, Aspen has adhered to a prudent lending approach, serving seasoned and affluent borrowers. The company also maintains the practice of conducting in-person property surveys as part of its risk assessment survey. The reduced LTV ratio of 65% on new loans (FY23: 72%) is evidence of the conservative approach. Tighter underwriting and reduced demand translated into lower volumes in Q124 but they have since recovered in Q224 (Q224 reported gross new advances of £35.5m, two-thirds higher than Q124), as Aspen attracted higher-quality borrowers. Management remains optimistic about the ongoing trend, which it reports has continued into Q324. We anticipate an upturn in revenues driven by growing yields, as the loan book reprices to the current higher interest rate level.

Although S&U continues to trade well in both Advantage and Aspen, the macroeconomic background remains challenging. Our macroeconomic indicators suggest that momentum in the motor and real estate markets is slowing. Base rates in the UK are expected to rise further, which makes S&U, alongside other specialist lenders, susceptible to further margin pressure as its liabilities tend to reprice faster than its assets.

New lending at Advantage has slowed as it continues to underwrite more conservatively. At Aspen we take note of declining house prices and lower receivables in H124 (£104.8m) compared to FY23 (£113.9m). Additionally, we also draw attention to the increased volume of clients facing technical default in Aspen’s operations. However, management expresses confidence in its ability to successfully recover all assets. Consequently, as we envision a slowdown in growth as a result of the wider market environment, we have lowered our total net receivables expectations for FY24 and FY25 to £430.1m and £449.3m from £453.3m and £506.4m, respectively, with shortfalls predominantly made in Aspen.

We expect yields to gradually appreciate in both Advantage and Aspen as new lending at higher rates increases the book average. Despite impressive impairment performance in H124, we have broadly maintained our impairment estimations (as a percentage of revenues) for the rest of FY24 and FY25 given the uncertain macroeconomic environment. Additionally, we have increased administrative expenses by 14% and 12% in FY24 and FY25 to reflect likely continued inflationary pressure.

As a result, our PBT estimates for FY24 remain broadly flat but have been reduced by 9% in FY25 to £44m. We have maintained our dividend expectations as S&U remains a very profitable and cash-generative business.

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

To summarise, GDP growth expectations for 2023 have marginally improved, while average forecasts for unemployment and inflation have both edged upwards. Markets now expect GDP growth of 0.4%, unemployment of 4.3% and inflation of 4.6% by the end of the current year. Consumer confidence is climbing upwards towards its 2021 level but remains broadly in line with sentiment expressed shortly after the 2008 financial crisis. The UK used car market remains resilient but is starting to signal a slowdown in momentum. Meanwhile, UK residential transactions continue to soften and mortgage approval rates continued to fall to levels not seen since 2010 (excluding the COVID-19 era).

Despite sticky inflation, S&U’s management has expressed ‘cautious optimism’ for the outlook, with credence underlined by the company’s resilient performance historically. Management is confident in the strategic positioning of both Advantage and Aspen, which remain well positioned in their markets for the long term.

Headline inflation for August was 6.7%, down from 6.8% in July due to declining food inflation. Core inflation, which excludes energy, food, alcohol and tobacco, was reported at 6.2%, down from 6.9% in July. Average regular pay growth for the public sector between May and July 2023 was 6.6%, the highest regular annual pay growth rate since comparable records began in 2001. For the private sector, this was 8.1% – one of the largest annual regular growth rates seen outside of the COVID-19 period. This pay growth has helped support consumers during this difficult period.

In Exhibit 5, we show GDP growth, CPI and unemployment forecasts for 2023 collected by HM Treasury and released on a monthly basis. With wage growth expected to be above inflation, UK consumers should be able to weather rising rates and persistent inflation more easily. The market currently expects at least one more base rate rise and, in its World Economic Outlook report released on 10 October, the IMF expects the Bank of England to eventually raise rates to 6%, 0.75pp above current levels. Examining HM Treasury’s most recent data release, we find that all three indicators have ticked up by 0.1pp. Average forecasts for GDP growth, unemployment and inflation are now 0.4%, 4.3% and 4.6%, respectively (see Exhibit 6) compared to the average forecasts of 0.3%, 4.2% and 4.5% released in August.

The 2024 forecasts collected in September remain broadly intact compared to August assumptions (see Exhibit 6). GDP growth expectations decreased 0.1pp to 0.5%, while unemployment rates increased by 0.1pp to 4.5%. Inflation expectations remain unchanged at 2.6% compared to August.

Exhibit 7 shows the consumer confidence indicator of personal finances and the economic outlook between now and the next 12 months.

Consumer confidence has been climbing back towards pre-pandemic levels, having reached decade lows at the end of 2022. The resurgence in optimism among British consumers can be attributed to several factors, including moderating food prices, declining inflation and a return to real wage growth. While robust wage growth is certainly a positive, it also raises concerns about persistent inflation and potential additional interest rate increases to bring inflation down to the 2% target.

After a streak of 14 consecutive rate hikes, we are beginning to see a small upward shift in unemployment (see Exhibit 8). Following the most recent lows of 3.5% in August 2022, unemployment has risen to 4.3% as of July 2023, marking consecutive increases since April 2023. Redundancies are following a similar trend. In July, for every 1,000 employees, 3.6 were made redundant, 1.3 people higher than in July 2022. We expect this pattern to continue as rate rises continue to permeate into the economy.

Exhibit 9 shows the of value of advances and number of cars that were bought on finance through dealerships. In data reading to August 2023, we find that y-o-y both the value and number of cars have fallen 13% and 11%, respectively, in comparison to August 2022. Commenting on the recent data, Geraldine Kilkelly, director of research and chief economist at the Finance & Leasing Association (FLA) attributed the fall in new business to higher interest rates and the prudence consumers are showing when considering major purchases, despite real earnings growing again. However, in the FLA’s Q323 Industry Outlook Survey, she adds that almost three-quarters of respondents expected ‘some increase in new business over the next 12 months.’

The ongoing climb in oil prices – Brent Crude was $86.82 per barrel at the time of writing – and an upward trend in overall expenses linked to the purchase and financing of vehicles are starting to elicit some strain in demand. Exhibit 10 shows the used car price index currently oscillating between c 120 and 125 as prices remain resilient. Furthermore, as seen in Exhibit 11, there have been three consecutive negative month-on-month price changes for the first time since February 2022 (where negative month-on-month price changes lasted until June 2022). However, Advantage has benefited in this environment, reporting record average advances of £8,040 in H124 (FY23: £7,799).

Exhibit 12 shows a comprehensive view of both non-residential and residential transactions in the UK, with the latter more relevant for Aspen. Transactions fell 16% against August 2022, to 95,000 (provisional estimate). The drop coincided with a substantial increase in interest rates, marking the steepest rate hike since the beginning of the century. In effect, lenders have responded by tightening credit standards, making it challenging for first-time buyers to enter the property market. We notice this crippling effect in Exhibit 13 where the number of mortgage approvals has dropped to levels not seen since 2010 (excluding COVID-19).

According to Nationwide, as reported on 2 October, house prices fell across the whole of the UK between July and September, for the first time since 2009. On average, house prices fell by 4.7% in the quarter compared to the same period last year. Robert Gardner, chief economist at Nationwide, explained that ‘someone earning an average income and purchasing the typical first-time buyer home with a 20% deposit would spend 38% of their take-home pay on their monthly mortgage payment – well above the long-run average of 29%’.

Nevertheless, Aspen is well positioned to navigate the property landscape. Its short-term loan portfolio enables it to adapt its lending criteria swiftly in response to any market changes. Moreover, while not guaranteeing the recovery or profitability of its advances, Aspen’s exclusive focus on sophisticated and financially stable borrowers may offer some form of mitigation against losses in a depressed market.