S&U — Confident but remaining prudent in approach

S&U is an established specialist lender with businesses addressing the non-prime motor finance and the property bridging markets. Advantage motor finance has a record of strong, profitable growth; it was affected by the pandemic but has bounced back strongly. 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 and making a more significant contribution to the group while maintaining a conservative underwriting approach. Both businesses focus on sustaining high levels of individual customer service and refinement of underwriting processes as competitive differentiators. The Coombs family owns c 53% of the equity and management takes a long-term, sustainable approach to the development of the group. The shares are valued at 1.3x book, a level that would be consistent with a return on equity (ROE) of 12.4%; this is below the 14% or more we estimate for FY24 and FY25 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 is based in Grimsby with over 200 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 £311m, net customer receivables have grown at a 10-year compound growth rate of 19%, even after a pandemic-affected period in FY21–22. The company has over 65,000 live customers and recorded 23,922 new transactions in FY23. Advantage focuses on the non-prime/near-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 CarFinance 247, 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 8% 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.

Most loans range from £5,000 to £9,000, with a maximum loan amount of £15,000; the average advance in FY23 was £7,799. The average original term was 54 months with a flat interest rate of 16.3% (on a typical loan of £7,800, c £14,000 is repayable including interest and fees). The provisional approval rate for the more than 2.5m loan applications in the last financial year was approximately 33% and the actual sign-up rate in FY23 was equivalent to about 3% of approvals or just below 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 overly 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. Exhibit 1 shows the development in net receivables, revenue and profit margin at Advantage since 2013. Growth accelerated in the post financial crisis period 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 transactions and revenues was magnified for profitability as increased provisioning almost halved the pre-tax 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%. In FY23 there was some normalisation in the level of impairment, although it remained relatively low, and the pre-tax margin was over 40%, comparable to FY19–20.

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 and in February 2023 Ed Ahrens, who has led Aspen since its formation, was appointed as an executive director to the board of S&U, signifying the progress achieved by 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. Residential is the largest category with 95% of collateral being housing. About a third of projects involve planned refurbishment during the loan term. The average original term is 11 months with an option for Aspen to extend the term 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 Aspen team. Since launch 517 secured property bridging loan facilities have been provided with an average gross value of c £700,000 and an average maximum gross loan to value of 72%. At end FY23 net receivables stood at £113.9m and during the year there were 148 transactions with a gross average loan size of £905,000.

Exhibit 2 shows the development of the loan book, revenue and pre-tax profit margin. The business moved into profit in FY19 and the loan book has been expanded in a controlled way as the Aspen team gained experience and broadened its network of relationships in the market. This was aided by involvement in provision of CBILS loans in FY22, which gave access to larger, higher-quality borrowers. The growing customer base provides a source of increasing repeat business in addition to introductions from broker relationships that have strengthened as Aspen has become more established.

As it has grown, Aspen has developed and added to its staff (now 21 compared with 18 a year ago) and occupies a larger office, ensuring it has the capacity to support further growth.

Exhibit 3 provides a summary of the results for FY23 compared with the previous three years, including the pre-pandemic FY20 period. We highlight a number of points from this period, comparing the FY23 result with FY22 unless stated.

Looking at the level of customer receivables, the number of new motor loans was up by over 20% and was just above the FY20 level. This growth with still-strong collections left motor finance receivables up 18%. Property bridging continued its development with receivables up 78% in the year. Contributing to its growth was a move towards larger, higher-quality loans to experienced borrowers and the launch of a new bridge-to-let product, which accounted for nearly £23m of the £134m of advances made during FY23. Taking the two businesses together, the average level of customer receivables increased by 22% and, reflecting the mix of revenue margins (32% at Advantage and 14% Aspen), group revenue increased by nearly 17%.

A major feature of the profit and loss account over the FY20–23 period is the fluctuation in motor finance impairments driven by the pandemic and prudent forward-looking provisioning under IFRS 9. As noted earlier, the sharp rise in FY21 impairments was followed by a very low loan loss charge in FY22. In FY23 there was a degree of normalisation in the impairment charge although this was still relatively low in historical terms at 14% of revenue (in the five years to FY20 the average charge was 20%). In absolute terms, this was the largest single contributor to the £1.9m or 4% reduction in operating profit, with other notable factors including the transaction-related increase in cost of sales and a partially inflation-related increase in administrative costs.

Finance expense nearly doubled as average debt increased by 40% and the cost of debt rose from 3.4% to 4.8%.

This left pre-tax profit and fully diluted EPS down 12% and 11%, respectively, at £41.4m and 277.5p. Given the pandemic-driven volatility in impairments highlighted above, it is perhaps more useful to compare FY23 pre-tax profit with the FY20 level (against which it increased by 18%) or the average for FY21–22 (+27%).

The group has proposed a final dividend of 60p giving a full year total of 133p (+6%), in line with the group’s aim to pay twice-covered dividends.

Exhibit 4 shows how the pandemic affected the payment profile in Advantage motor finance and the further improvement seen in FY23. Here accounts on payment holiday are 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). The proportion of net receivables where payments are up to date increased to 75.1% in FY23 compared with a low point of 60.8% in FY21. The profile is now more comparable to the pre-pandemic figures shown for FY20.

In this section we update the charts we use to provide background indicators for Advantage and Aspen.

From February 2022 the Treasury-collected compilation of GDP forecasts for 2023 followed a downward trend until December (Exhibit 5), but the readings in the last four months have been essentially stable, with the latest average of forecasts being for a modest GDP reduction of 0.6% (Exhibit 6). Average annual inflation (CPI) expectations for 2023 peaked at 5.0% but have since moderated to 3.9% with 2.4% estimated for 2024. The forecast for annual average unemployment has risen modestly to 4.4% over the period shown in Exhibit 5. Medium-term forecasts (not shown) collected in February this year include 2025 and 2026 GDP growth of 1.8%, unemployment of 4.5% and inflation of c 2%, suggesting a relatively benign, if low-growth, background.

Exhibit 7 shows how consumer confidence has fluctuated since 2019. Confidence recovered strongly following the onset of the COVID-19 pandemic, 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. Confidence was sapped further in the second half of 2022 as inflation hit harder and interest rates rose. The most recent reading, for March, has shown a continuation of the somewhat surprising uptrend since January with most index components increasing, although consumers’ confidence about their personal financial position has weakened. The absolute level of the overall index remains low in historical terms and pressures on consumers, including Advantage customers, remain elevated. S&U has previously noted in mitigation that wages are likely to adjust and that its customers tend to depend on their vehicles for transport to work. Advantage continues to make allowance for the rise in inflation within its affordability calculations and to fine-tune its credit criteria.

In Exhibit 8 we can see that, after an increase in 2020, the unemployment rate moved below prior levels and has been broadly stable since the middle of 2022. The level of redundancies, a more immediate measure, saw a very sharp spike as the pandemic took hold, but then fell rapidly before picking up again in the second half of 2022. Even so the rate of redundancies is still only just approaching pre-pandemic levels.

Next, we look at data on used car transactions and used car finance. Exhibit 9 compares the monthly sales pattern in the three years from 2020–22. This highlights the sharp drop in used car transactions in April 2020, but volume recovered very well following the initial lockdown. From April 2021, activity did begin to approach pre-pandemic levels although supply limitations resulting from constraints on new car production tempered volumes and, in 2022, the number of transactions was 13% below the 2019 level. Exhibit 10 shows a similar pattern in used car finance, with seasonal dips evident in addition to lockdown impacts. There were year-on-year increases in the value of loans in each month in 2022 until November, which saw a 6% decline with 4% reductions also seen in December and January. In March the Finance and Leasing Association said that its research indicated that the value of new loans to consumers for used car purchases in 2023 may fall by 12%, a more cautious outlook than Advantage sees for its own business currently (see below).

Used car prices (see Exhibit 11) experienced a very sharp increase from mid-2021, with strong consumer demand and reduced supply pushing prices up. From February 2022, the index showed small month-on-month decreases (see Exhibit 12), suggesting a slight softening of demand and/or easing of supply constraints. However, prices have shown limited change since then and remain at a historically high level. At the margin, a fall in auction prices, prompted by reduced demand or greater supply, would be a negative for Advantage, but its exposure here through repossessed car sales is moderated by the relatively low value of the vehicles it finances. In its calculations for impairment provisioning for FY23, the group assumed that used car prices would fall by 13.5%; changing the assumption to 8.5% or 18.5% would decrease provisions by £2.8m or increase them by £2.7m respectively (see preliminary release for further detail).

In its comments on the outlook for the business, Advantage indicated that demand was still strong at the start of the year and it looks for growth in receivables in FY24, albeit at a lower rate than FY23 given the cost of living pressure on consumers. It characterises the year as one of consolidation and regulation as the FCA’s new Consumer Duty is implemented (end July for new and existing products). Advantage believes the regulation will play to its strengths given its traditional emphasis on treating customers fairly. It liaises closely with the FCA and is well on track to complete the tasks it identified as necessary to ensure compliance. The areas it is addressing include enhancing customer communications, generating further evidence of good customer outcomes and oversight of broker partners and their customer service protocols. During the year Advantage will launch its new branding, which will seek to highlight its philosophy of finance with a human face, encapsulated in the headline ‘We see more than your score’.

Turning to the background for Aspen Bridging, Exhibit 13 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. This is also evident in the number of mortgage approvals (Exhibit 14). The transaction data does not yet capture a marked slowdown, but mortgage approvals have slowed sharply.

Aspen itself notes that higher interest rates may mean that more restricted transaction activity will continue during 2023 and that expectations are for average house prices to fall by 5% (some estimates are for a larger fall). This could make it more difficult for borrowers to complete their projects in the expected timescale. In response Aspen has already increased its own rates to maintain margin and tightened both valuations and loan to value criteria. It has also moved towards higher-quality and less mortgage dependent borrowers and higher-value properties, which it expects will provide some insulation from wider market fluctuations. On a longer view, S&U continues to see 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 offers a bespoke service and has significant scope for measured expansion now that it is more established in the market.

Changes in key numbers from our estimates are shown in Exhibit 15 and further details are included in Exhibit 16. The table also includes actual versus estimated numbers for FY23. Changes in our overall FY24 estimates are modest and we have included FY25 estimates for the first time. The increase in corporation tax rate this year explains the small reduction in earnings per share for FY24; the effective tax rate increases from 18.6% for FY23 to our assumptions of 24% and 25% for FY24 and FY25 respectively.

The next table gives details of our other estimate assumptions. In the motor business we have allowed for receivables growth of nearly 9% and 7% for FY24 and FY25, respectively, and assume that impairments normalise further to 17.3% and 17.7% of sales, somewhat lower than pre-pandemic levels, reflecting the benefit of changes in the customer mix. The risk-adjusted yield (revenue less impairments as a percentage of average receivables) for the two years is c 26% (FY23: 27.3%, and FY18–20 average: 25.4%). Bridging receivables are assumed to reach £130m in the current year followed by £150m, a slower pace of growth than in prior years given the market background but still set to make a more significant contribution to group profitability.

Revenues for both businesses are expected to benefit from increases in rates implemented at end FY23 and early FY24, although we assume the revenue yield at Advantage will be stabilised by mix change to lower-risk categories. We have also factored in the cost of higher interest rates, which is a key driver of the doubling in the estimated financing cost in FY24.

The segmental cash flow analysis shows how cash flow at Advantage between FY21 and FY23 has changed as contraction was followed by resumed growth. The pattern was as expected, with collections outpacing advances in the pandemic period followed by higher advances and a £32m outflow in FY23, mirroring the inflow in FY21.

Aspen property bridging expanded further in FY23 with higher advances driving the increased outflow of £47m. At the group level this left an outflow of £79m compared with the inflow of £19m in FY21 and outflow of £15m in FY23.

Net debt increased to £193m (including lease liability; £192m excluding this). Committed debt facilities available total £210m and the group will look to add further capacity in the current year. The net debt/equity ratio of 86% is well below the covenanted limit of 120%. On our estimates, net debt could rise to c £240m by end FY25 with net debt/equity at 93%.

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 (2,400p) would be consistent with an ROE of 12.4%, which is below our estimates for FY24 (14.0%) and FY25 (14.5%). 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 below 9x and the yield above 5%.