My interest was sparked when I noted that Arbuthnot is in the process of offloading 1.04m shares of its majority shareholding at 2,400p each to generate £25m of proceeds. At the same time Secure Trust has raised £48.8m at the same price through an institutional placing, the details of which I will explain below. These transactions follow on from the disposal of 580,000 shares by Arbuthnot last year which generated a non-taxable gain of £14.4m. The share placing and sales are subject to shareholder approval at a general meeting on Tuesday, 8 July. Assuming they are approved then Arbuthnot will own 9.48m shares in Secure Trust, or 53 per cent of the enlarged share capital. At the current market price, that stake is worth around £227m, or 33 per cent more than its own market value.
The clear implication being that either Secure Trust’s share price is woefully overvalued, or Arbuthnot’s is chronically undervalued. It is not difficult to conclude that the latter is the case and there is a clear buying opportunity in the shares of Arbuthnot to exploit the valuation anomaly. Let me explain.
Financed for profitable growth
Secure Trust may have only listed less than three years ago, but the business is well established and has been lending for over 35 years. The company has operations in four key areas: personal lending; motor finance; retail finance; current accounts; and savings. And unlike some of the lenders that got into trouble in the 2008 financial crisis, all this lending is fully backed by customer deposits so the company is not reliant on money markets to fund its business. Indeed, customer deposits of £436m at the end of last year covered customer loans of £391m, so offering scope for the company to increase lending further even without needing to attract extra capital from savers.
Moreover, the company has actually benefited from the financial crisis as savers spread their deposits across different financial institutions to mitigate risk of a bank failure. And given the low interest rate environment, it’s hardly surprising that depositors are turning to price comparison websites to find the best rates available on their deposits. This has played straight into the hands of Secure Trust because by offering marketing leading savings rates, the company can attract the capital required to support its lending operations.
In fact, last year it managed to raise seven-year money at 3.52 per cent, well below the money market rates at the time.
The search for yield by savers is unlikely to change anytime soon given that Bank of England base rate is at a record low and interest rate rises, when they finally happen, are likely to be modest and protracted. To capitalise on the current favourable back drop, Secure Trust has also been raising the amount of fixed-term deposits to lock in savers. These now account for 44 per cent of the deposit book, up from 39 per cent at the end of 2012.
It’s worth noting too that the company is one of the best capitalised around: its Tier 1 Capital Ratio is just shy of 20 per cent and its leverage ratio (calculated as total customer lending divided by equity capital) is only 6.7 times. And it’s this robust capital position that is enabling the company to grow its lending operations strongly.
Motoring ahead
For instance, revenues earned from Secure Trust’s Solihull-based motor finance business have more than doubled from £9.9m in 2011 to £23m last year as the loan book surged by 80 per cent in the two-year period to £114m, or the equivalent of 29 per cent of the company’s total loan book. Net new lending was £60.3m last year, sourced from an established network of UK motor dealers and brokers. Growth on this scale may be eye-catching, but it is understandable given that the UK new car market has recorded 27 consecutive months of growth, breaking the record set in the late 1980s. This is clearly good news for the used car market finance which is Secure Trust’s main area of speciality.
Importantly, lending is on a fixed term basis with loans granted between 24 to 60 months with a maximum loan size of £15,000. Although the target demographic is socioeconomic groups C1, C2 and D, impairments are being kept in check due to rigorous credit assessment and only represent 3.1 per cent of the motor finance loan book.
It’s a similar story for Secure Trust’s retail finance operation which has grown its loan book from £42.6m to £114m in the past two financial years. The company does not pay retailers commission and lending is restricted to UK residents in full-employment which mitigates risk. Musical instruments, cycles and leasing of computer equipment are the largest sub-markets for this niche lending operation although furniture, jewellery and funeral finance are also proving popular.
Evans Cycles, PC World and furniture retailer DFS are some of the household names through which Secure Trust sources its customers. Sales of bicycles have been racing ahead, driven by the success of our athletes at the 2012 Olympics, and of British cyclists Bradley Wiggins and Chris Froome in the Tour de France in the past couple of years. The company even offers finance for dental work and sports season tickets. It’s very profitable too as retail finance revenues have quadrupled to £14.5m in the past two financial years.
The unsecured personal lending operation accounts for the remainder of Secure Trust’s loan book and boasts the best margins: the division generated revenues of £41.8m on a loan book of £159m last year. This is partly down to the fact that the division includes EveryDay Loans, a lender to the lower income segment. APRs here are around 75 per cent and loans are up to three years at fixed rates. It’s worth pointing out that EveryDay is not a payday lender and whereas specialist lenders generally rely on an internet business model, Secure Trust’s loan managers have the added advantage of being able to assess the risk of applicants on an individual basis through the branch network of 31 offices.
Robust earnings growth underpins Secure Trust's rating
Secure Trust Bank is clearly operating in a sweet spot given that UK employment is at record levels, and the UK economy is resurgent. Only this week, Goldman Sachs raised its GDP estimate for this year and next, predicting that the UK economy will grow by 3.4 per cent in 2014 (up from 3 per cent previous forecast), and by 3 per cent in 2015 (a 30 basis point upgrade). It is a benign environment where Secure Trust’s double-digit lending growth rates, funded mainly by low-cost credit lines sourced through customer deposits, is resulting in a strong tailwind for profits.
Last year, the company’s operating income shot up by two thirds to £79m and customer lending rose by 31 per cent to £391m. In turn, this led to a 52 per cent rise in pre-tax profits to £25.2m. On this basis, EPS soared by a third to 118p and enabled Secure Trust’s board to increase its dividend by 10 per cent to 62p a share. I expect a similar outcome this year and next too. And so do analysts Mark Thomas and Martyn King at equity research house Edison who predict operating income will rise by almost a quarter to £98m in the 12 months to December 2014 to boost pre-tax profits to £29.2m. If these targets are hit then expect EPS of 136p and a dividend of 65p. The respective forecasts for 2015 are operating income of £121m, pre-tax profits of £35.8m, EPS of 163.3p and a dividend of 68p. On this basis, the shares are priced on a prospective PE ratio of 15 for 2015 and offer a 2.8 per cent yield. That hardly seems a punchy rating for a company forecast to generate 19 per cent average annual earnings growth this year and next.
In the circumstances, I feel that Secure Trust Bank’s shares are not overpriced and the 2,400p placing price – the new funds raised by the company will be used to further grow the business including a new small and medium enterprise invoice finance operation – represent good value for the institutions buying into this growth story. It also means that shares in Arbuthnot are woefully undervalued, so much so that the company’s 180-year old private banking arm, Arbuthnot Latham, is in the price for free.
That particular business unit is forecast by Edison to produce pre-tax profits of £2.5m this year, rising to £3.5m next buoyed by further fee income from assets under management and the pay-off from new offices including one that opened in Dubai. Edison’s EPS estimate for Arbuthnot of 90p this year and 111p next is not unreasonable. Moreover, the company has just raised £25m from selling down its stake in Secure Trust so is well capitalised to grow its business. It’s also worth flagging up that Arbuthnot could yet make further share sales as it has only agreed not to sell any further ordinary shares in Secure Trust before 19 December 2014. Further disposals can only highlight the valuation anomaly even more.
In my opinion, a fairer valuation for Arbuthnot’s equity is around 1,500p a share, or 25 per cent above the current offer price of 1,190p in the market right now. If achieved the shares would be trading on around 13 times earnings estimates for fiscal 2015. That certainly looks a realistic outcome on a 12-month basis. Needless to say I rate Arbuthnot shares a buy on a bid-offer spread of 1,150p to 1,190p.
■ Simon Thompson's new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'
