S&U — Experienced specialist lender performs well

Exhibit 1 provides a summary of S&U’s results for H123 with comparative figures for H122 and H222. We highlight a number of points from this, comparing the H123 result with H122 unless stated.

S&U’s revenues were up 15%, within which motor finance revenues increased by 13% on 9% higher average net receivables. Property bridging revenues rose 35% on a 68% increase in the average loan book.

Total impairments were up 28%. There was a 13% increase for motor finance reflecting the net effect of increases in stage 1 provisions accompanying receivables growth and higher macroeconomic overlays, offset by strong collections and lower than expected realised bad debt. This left the profit and loss charge at 13.9% of revenue, compared with 4.8% for FY22, when there was a writeback in the second half, but still significantly lower-than-normal compared with pre-pandemic levels of around 20%. The charge at Aspen was equivalent to 7% of revenue and up 90% reflecting the rapid growth in the loan book.

Other cost of sales, which includes broker commissions, increased by 25% as a result of increased activity levels in both businesses. In motor finance the per-transaction cost at £883 was 3% higher than the prior year period, mainly reflecting mix change between introducing brokers and product categories. Advantage noted that it has reduced its dependence on its three main brokers to 34% compared with 44% two years ago, part of its policy of diversifying its channels to market. Administration costs increased by 17% while the finance expense increased by 46%, reflecting the combination of increased average debt (+26%) and a funding cost of 3.9% versus 3.3%. The result was a pre-tax profit of £20.9m, up 5% on the prior year period. Analysing the pre-tax profit by company, Advantage contributed £19.0m (+3%), Aspen £2.0m (+32%) and there were central costs of £0.1m. Net profit and EPS were up nearly 6%. Reflecting this performance and the board’s objective of a twice covered dividend, the first interim dividend was increased from 33p to 35p.

Looking more closely at Advantage’s operational figures, a key feature was a better-than-expected collections and bad debt performance even as cost-of-living pressures began to increase. Advantage indicates that bad debts and voluntary terminations were 93.8% of the H121 level, while the average loss per bad debt was at 80.9% of the prior year period. Factors here include: the still-high level of employment, the importance of having transport to get to work, strong second-hand car prices and, importantly, where customers do have financial difficulties, a prompt and supportive response from Advantage that seeks to keep customers in their cars and making payments they can afford. Otherwise, we would highlight that post-pandemic Advantage has returned to servicing customers with lower credit scores and its average customer score has therefore declined from 892 in FY22 to 866 for H123. In tandem with this, the flat interest rate charged has ticked up from 16.3% for FY22 to 16.7% for H123, while annualised revenue as a proportion of average receivables was 32.4% in H123 versus 31.1% for H122.

Sales and marketing developments have included amendments to affordability calculations to address cost-of-living pressures, the implementation of a new scorecard in July, integrating the scorecard with key brokers and linking to the Credicar decisioning system that points customers to an appropriate lender. Prospectively, work is underway to link with HD Decisions, another decisioning system that would allow Advantage to expand in the aggregator website market. Other initiatives include a re-engineering of customer renewal activities and a redesign of the Advantage website.

On the regulatory front, Advantage highlights three areas of FCA focus currently:

At Aspen there were 73 bridging loans made during the period (66 in H121) and the average value of loan increased from £618,000 for FY22 (ex-CBILS1 loans, which are now all repaid) to £873,000. The average maximum gross loan to value has been stable at 72% as has the original term at 11 months. In H121 the average original blended yield was 0.88% compared with 0.95% for FY22, partly a reflection of an improvement in the quality of borrowers. As at Advantage, collections were strong with 47 repayments in the half year, leaving 128 live loans outstanding. There are only six in default and they are seen as likely to settle in Q323.

In this section we update the charts we usually include to provide background indicators for Advantage and Aspen. On this occasion the very recent developments in government economic policy and the negative reaction this has received in markets mean that the outlook is particularly clouded and the data we show is yet to reflect the potential implications of this.

For completeness, Exhibit 2 shows independent economic forecasts collected by HM Treasury in early September. As highlighted, these forecasts were made before the most recent government moves to soften the impact of energy cost increases, tax changes and the significant market interest and exchange rate moves. Since July, GDP forecasts continued on a downward trend with the averages for 2022 and 2023 standing at 3.5% and 0.2% in the September report. Reflecting risks seen in the economic outlook, the low end of the range of GDP forecasts for 2023 showed a GDP contraction of 1.9%. The expected levels of unemployment have seen only minor changes, which is understandable given this measure tends to be a lagging indicator and the starting point in the labour market is tight. In its August Monetary Policy Report, the Bank of England looked for unemployment to increase to 5.5% and 6.3% in 2024 and 2025, given a weaker growth outlook, potentially introducing greater slack in the economy. On inflation, the independent forecasts had already increased in previous months but saw a further rise in September.

Exhibit 3 shows how consumer confidence staged a major recovery last year 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. The most recent reading shows a sharp decline as cost-of-living pressures and the prospect of higher interest rates weighed more heavily on confidence. More recent developments seem likely to weaken confidence further. Such pressures are potentially particularly relevant for Advantage customers, although the company has previously noted that wages are likely to adjust and that its customers tend to depend on their vehicles for transport to work. As mentioned earlier, Advantage has made adjustments for the rise in inflation within its affordability calculations. While government measures are set to mitigate cost pressures, it remains to be seen how consumer behaviour will adjust to the changing circumstances they face.

In Exhibit 4 we can see that, after an increase in 2020, the unemployment rate has since moved noticeably below prior levels. The level of redundancies, a more immediate measure, saw a very sharp spike as the pandemic took hold, but fell rapidly and is still clearly below pre-pandemic levels. As discussed above, some increase in these measures seems likely in due course given the trend in forecasts.

Next, we look at data on used car transactions and used car finance. Exhibit 5 compares the monthly sales pattern in the four years from 2019–22. 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 was close to pre-pandemic levels, as represented here by the 2019 monthly figures, although supply limitations resulting from constraints on new car production tempered volumes. This remains a factor in 2022 and first-half used car transaction volume was down 13% compared with the first half of 2019. Exhibit 6 shows a similar pattern in used car finance, with seasonal dips evident in addition to lockdown impacts. Calendar 2022 started strongly although the trend in Q2 was weaker than in Q1. The latest data available, for July, showed the value of advances up 13% on July 2021 while volume was up just 3%; the chart shows a recent flattening out in volume and value at a relatively high level.

Used car prices (see Exhibit 7) were buoyant in 2020 and then experienced a very sharp step up from mid-2021, with strong consumer demand and reduced supply pushing prices up. From February this year the index showed small month-on-month decreases (see Exhibit 8), suggesting a slight softening of demand and/or easing of supply constraints. Nevertheless, the last two monthly readings have shown a small increase and prices remain at a historically high level. Advantage has pointed out that with the supply of new cars still constrained there is not the volume of discounted cars being sold to rental companies that used to be the case. This may mean that used prices are sustained at high levels for longer than had been expected. At the margin a fall in auction prices, eventually 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.

Turning to the background for Aspen Bridging, Exhibit 9 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. The latest reading, for June 2022, shows an activity level similar to pre-pandemic levels. Reduced consumer confidence and higher interest rates may well affect prospective transaction volumes and Aspen itself reports a slight slowing in the residential market and that early loan repayments are starting to slow. Changes in stamp-duty land tax announced this month, raising the levels above which duty is payable, provide some support and with rates rising generally Aspen indicates that earlier competitive pressure on rates in the bridging market has eased and that pricing has begun to increase. 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 has significant scope for expansion now that it is more established in the market.

Following the results, we have adjusted our estimates, with the key figures shown below and further details given in the financial summary (Exhibit 12). The main changes we have made include increased assumptions for funding costs and revenue yield on receivables to reflect the rise in interest rates. While Aspen appears likely to be able to adjust its rates quite quickly to reflect funding costs, Advantage has less scope given the four- to five-year duration of its loans and the relatively high rates it charges its non-prime customers. Following the first half performance, our loan-loss assumptions have been reduced but we still allow for greater normalisation in the rate of impairment in FY24. We have factored in the cancellation of the planned increase in corporation tax so FY24 now has an assumed tax rate of 19%. The net result of these changes is modest; at the pre-tax profit level our FY23 estimate increases by 1.4% while for FY24 there is a 2.9% decrease. The increase in FY24 earnings per share reflects the reduction in the assumed tax rate.

The segmental cash flow analysis below shows how Advantage cash flow has turned negative as growth in advances has outpaced collections; Aspen has continued to expand its loan book while maintaining strong collections.

At end H123 net debt stood at £154.4m, giving a debt-to-equity ratio of 73% compared with 61% for H122. This is still well within the board’s comfort zone. To provide flexibility for further growth, £30m of revolving credit facilities have been added since the end of H123, taking total committed facilities to £210m. This includes revolving facilities of £160m with maturities in 2024, 2025, 2026 and 2027. In addition, there are two £25m term loans maturing in 2028 and 2029.

The shares trade on prospective P/E multiples of 7.2x and 7.1x for this year and next. The prospective yield is 6.7%. 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 (1,980p) would be consistent with an ROE of 11.3%, which is well below our estimates for FY23 (15.4%) and FY24 (14.5%). For the five-year period FY18–22, which includes both pre- and post-pandemic results, the average ROE was 15.8%, suggesting the share price builds in a substantial allowance for current macroeconomic threats.