H&T is a classic Benjamin Graham recovery play on whose investment style I base my annual Bargain Share portfolios. The company's equity shareholder funds of £88m are more than 40 per cent more than the company's market value of £62.5m, so even taking an ultra cautious approach and writing down all the goodwill and intangible assets on H&T's balance sheet, then we are still getting almost all of the company's plant and equipment, worth £11m, in the price for free.
And it is the robust nature of the company's balance sheet that prompted me to advise buying the shares for recovery at 158p six months ago even though the trading backdrop was hardly ideal. But I was convinced the business would be able to trade through the tough times supported by its sound finances, and ultimately reward shareholders as and when better times prevailed. That belief is unchanged.
I was also reassured that the company had embarked on both debt and cost reduction programmes, the evidence of which was for all to see in yesterday's half-year results to end June 2014. In the past year alone, net borrowings have been cut from £28.5m to only £13.5m, or the equivalent of 15 per cent of shareholders funds of £88m. This means H&T is trading comfortably well within its £50m four-year credit facility. So with finances strong, there is every reason to expect the full-year dividend to be at least maintained at last year's level of 4.8p a share, implying a yield of almost 3 per cent. The interim payout has been held at 2.1p a share and will be paid on 10 October (ex-dividend of 10 September).
Cost reductions and retail growth cover profit shortfall
Operationally, the company has been trading resiliently through a difficult period during which profits from pawnbroking scrap and gold purchasing both declined. A £2.1m reduction in half-year operating costs, combined with a 20 per cent boost from retail's gross profits, helped to almost entirely make up for a £3.6m shortfall in gross profits from pawnbroking scrap and gold purchasing. This resulted in H&T reporting relatively flat pre-tax profits of £2m in the first half compared with the performance in the second half of 2013.
It was pretty much as analysts had expected given the gold price was 21 per cent less in sterling terms in the latest half year, so impacting the gross profit on each transaction. Purchasing margins were also affected by competitive pressures. The board’s decision to close the GoldBar pop-up shops in retail malls also contributed to the profit shortfall from gold purchasing activities, but nonetheless made complete sense in light of the volume declines during the course of 2013.
That said there are clear positives to think that H&T is now over the worst and the shares are worth buying for recovery. For starters, the company's retail offering is going from strength to strength; revenues here surged almost 50 per cent to £13.3m in the latest six-month period, following on from a 45 per cent sales hike in the second half last year. The retail segment accounted for 30 per cent of H&T’s first-half turnover of £43.9m. In turn, gross profits from retail rose 20 per cent to £4.9m, representing well over a fifth of the total of £22.2m. The contribution is likely to increase further as the company trialled a 'discount second hand jewellery' offering in a number of underperforming stores during the second half of last year. This concept has since been refined and launched as the est1897 brand into 36 stores across the estate and a transactional website - www.est1897.co.uk - will be launched by the end of next month. Other web-based initiatives for the second half include the launch of an online personal loans product.
The company is also taking decisive action to improve investment returns in its high street estate. Four underperforming stores were closed in the six-month period to take the chain to 191 outlets and a few more will be closed in the second half, too, as the tail of the estate is churned.
Positive impact for H&T of tighter regulation
There are opportunities from a tightening of regulation, too. That's because regulation of Consumer Credit moved from the Office of Fair Trading to the Financial Conduct Authority (FCA) in April. Following the change of regulator, four weeks ago the FCA published its proposals relating to a cap on the interest rate and charges that apply to 'High Cost Short Term Credit'. The proposals provide for: a maximum daily charge of 0.8 per cent on the amount borrowed; a maximum of £15 fees on default; and a cap on the total costs incurred over the life of the loan of 100 per cent of the amount borrowed.
Although the definition of these new proposals is pretty broad, they provide a specific exemption for pawnbroking and certain other credit products at present. H&T's board do not expect the cap to apply to pawnbroking in the near term. The obvious upside for H&T is that a number of alternative lenders will be unable to comply with the tighter regulation which in turn is likely to provide the company with new customers.
Indeed, the pricing of H&T's loan products is amongst the lowest in the sector, particularly versus larger chains. And H&T's management team stresses that "almost without exception the 1.6m customers of pay day lenders would be substantially better off taking a loan with H&T". Moreover, the wider alternative credit market is likely to undergo significant changes in the coming year due to the impact of the FCA's proposed interest rate cap. I view this as a major positive for H&T.
Improving trend in the pledge book
I also see potential for H&T to cherry pick distressed profitable pledge books off rivals in the pawnbroking sector now that the company's pledge book has stabilised. Although H&T's pledge book was down a fifth to £38.5m year on year, since the June half-year end it has been maintained and is currently around £38.3m. Furthermore, the interest component of the pawn service charge was only down from £15m to £14m in the first half of this year, indicating an increase in the yield on the pledge book due to an improved ageing profile and higher rate of interest charged. And with H&T's borrowings a little over a quarter of the company's £50m debt facility, there is ample funding available to boost lending through selective earnings enhancing acquisitions.
Taking what is in my view is a conservative approach, analyst Andrew Watson at brokerage N+1 Singer predicts H&T will report a 6 per cent decline in revenues to £93.3m this year to produce pre-tax profits of £5.5m and EPS of 11.6p, in advance of a strong recovery in 2015 when he predicts pre-tax profits of £7.1m and EPS of 14.9p. However, if the gold price continues its recovery - the yellow metal has risen 8 per cent since the start of the year - then these earnings estimates could well be exceeded if the recovery takes hold sooner. There is also potential for a boost to profit as stocks are turned. That's because the majority of stocks were accumulated at much lower gold prices meaning that end June 2014 inventories of £29.5m on H&T’s balance sheet understate their true worth.
In the circumstances, I feel that we are rapidly approaching the time when investors will start to buy into the profit recovery forecast by analysts in 2015 given that there are clear signs of a stabilisation in the market. With this in mind, I can still envisage a scenario where this process starts to unfold in the second half of this year.
So trading on a 30 per cent discount to net asset value of 241p, I still feel that H&T's shares are worth buying on a bid-offer spread of 168p to 170p.
■ 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'
