Moreover, the share price has risen by over 50 per cent since I reiterated my buy advice in March this year when I highlighted H&T as a smart way of riding on the coat tails of the surging gold price (‘A golden opportunity’, 8 Mar 2016). I also concluded they were still worth buying at 262p little over a month ago (‘A golden performance’, 7 Jul 2016). The question is whether they are still worth holding onto now? To answer that it’s necessary to consider the factors that have driven up the gold price, and with it shares in H&T.
Factors underpinning demand for gold
It has not been difficult to find bull points to warrant gaining exposure to gold this year. Plunging global government bond yields, prospects of quantitative easing from the Bank of England, European Central Bank and Bank of Japan, and the increasing possibility of the US Federal Reserve keeping rates on hold for the rest of the year, is undoubtedly good news for the price of gold, the primary asset on which pawnbrokers offer pledges on. That’s because a zero interest rate environment, and one where over 35 per cent of global government bonds now offer negative yields, reduces the opportunity cost of holding a zero yielding asset like gold.
The yellow metal is also denominated in US dollars so is an effective currency play on the ongoing strength of the greenback and one predicated on US economic growth continuing to outpace that in Europe, UK, and Japan. It’s a safe haven asset during periods of economic and geopolitical uncertainty too. The US election, the UK referendum on EU membership and implications of the ‘Brexit’ outcome, the increasingly parlous state of Italy’s banking sector, and geopolitical unrest in the Middle East have proved a potent combination as far as gold investors are concerned. In the circumstances, investors have not been short of reasons to increase their exposure to the yellow metal. And that’s exactly what they have been doing.
Indeed, investment demand rocketed to a record 1,063 tonnes in the first half of 2016, or 16 per cent higher than the previous first half record in 2009, in the midst of the global financial crisis. For the first time ever, investment demand has been the largest component of gold demand for two consecutive quarters. And this has been in no small part due to demand from Western investors across the spectrum, from retail to institutional and for bars, coins and ETFs.
The 13 per cent plunge in sterling since the result of the EU Referendum was announced eight weeks ago is having an impact too as it has dramatically increased the sterling denominated value of gold. Having started this year at £719 per troy ounce, the price is up around 44 per cent to £1040. It’s hardly surprising that some UK investors have recycled their cash into gold.
Impact on H&T
This positive pricing environment is rather good news for H&T. The company has just reported a 42 per cent hike in its first half pre-tax profits to £3.7m to boost EPS to almost 8p and underpin an 11 per cent hike in the dividend per share to 3.9p.
In the six months to end June, H&T’s gross profits rose 10 per cent to £25.2m. Of this increase, £500,000 came from pawnbroking scrap, a reflection of the higher margin gains to be made in a rising gold price environment. Gold purchasing profits also increased by £500,000, highlighting how margins are getting a boost between purchasing gold from customers in store and then realising the value in the market through a higher price. Of course, once the gold price stabilises, then gold purchasing margins will return to normal, but for now the risk here looks to the upside.
The half year results also showed that H&T’s strategy to diversify activities into personal loans, foreign currency and non-gold and jewellery lending is paying off. All three activities increased their gross profits and accounted for around two thirds of the improvement at the group level. It’s worth pointing out though that H&T’s personal loan book is less than a sixth of the size of its £39m pledge book and the pawn service charge of £14.1m is almost 10 times higher than the gross profit earned on personal loans, so H&T’s overall profits are still highly dependent on its income from pawnbroking, a market where trading conditions remain challenging. That said, the diversification is clearly working and the company is well placed to continue to ramp up these other smaller but growing activities, having significantly reduced gearing on its balance sheet.
Period-end net debt of £6.9m equates to only 7 per cent of shareholders funds of £95m, so offering H&T’s board the firepower to increase lending both on the fast growing personal loan side and in pawnbroking. Indeed, the company is opening a new high-end operation on Old Bond Street, in London’s Mayfair to cater for a more affluent customer base. It looks a smart move. And investment in a new underwriting system to support an online lending platform is an exciting opportunity too.
Another bull point is that the 44 per cent increase in the sterling gold price this year obviously makes it easier for customers to raise more cash against their gold assets, whether they want to pledge them or sell them to H&T, and also enhances the profit per item H&T can earn too. It also significantly reduces the chances of H&T losing money on pledges that fail to be redeemed by customers.
Forecasts
True, analysts have maintained their full-year profit estimates post results. Andrew Watson at brokerage N+1 Singer predicts H&T should be able to increase pre-tax profits from £6.8m in 2015 to around £8.1m this year to deliver EPS of 17p, up from 14.9p in 2015, to underpin a 6 per cent rise in the full-year payout per share of 8.5p. However, if the gold price continues to hold firm, and sterling continues to weaken – the currency hit a 30-year low of £1:$1.288 this week – then this should lead to earnings upgrades later this year as it will not only boost pawnbroking scrap profits, but underpins gold purchasing activities too.
For the 2017 financial year, Mr Watson is pencilling in pre-tax profits of £9m on revenues of £91m to produce EPS of 19p and support a much higher dividend of 9.5p a share. This means that H&T’s shares are rated on 15 times next year’s earnings estimates and offer a decent current year prospective dividend yield of 2.9 per cent, rising to 3.2 per cent in 2017. A price-to-book value ratio of 1.1 times is still not stretched for a company with a rock solid balance sheet, and boasting a robust working capital position.
Moreover, with dollar strength and the negative interest rate policies being adopted by central banks underpinning the gold price, and potential for earnings upgrades later this year, I feel it’s worth running your bumper gains. Run profits.
