Aim-traded specialist bank PCF (PCF:36p) has delivered shareholders the bumper set of annual results I had anticipated when I included the shares, at 27p, in my 2018 Bargain Shares Portfolio. In fact, the company has overdelivered. PCF increased full-year pre-tax profits by 44 per cent to a record £5.2m, all of which was organic growth and beating house broker Panmure Gordon’s forecast by 7 per cent, to lift earnings per share (EPS) by a third to 2p and support a 58 per cent hike in the payout per share to 0.3p.
Having gained a banking licence in the summer of 2017, the challenger bank ended the financial year to 30 September 2018 with retail deposits of £191m, up from £53m at the same stage of 2017, from 4,500 bank customers who receive an average interest rate of 2.1 per cent on their money. PCF’s retail deposits have an average term of 2.5 years and by offering market-leading rates boast a high retention rate in the order of 70 per cent, thus providing a reliable low-cost funding source to ramp up the bank’s lending portfolio and target higher-quality prime customers.
PCF also tapped the Bank of England’s Term Funding Scheme before it closed in February, which has given it an attractive four-year line of credit at a base rate of 0.75 per cent. Other wholesale funding costs average 4.75 per cent a year and PCF ended the 12-month period with balances of £49m outstanding on them, down from £79m in 2017. Expect these wholesale credit lines to run down materially over the course of the coming year as they are replaced by cheaper retail deposits.
The bank’s loan book is growing strongly, too. Receivables increases by 50 per cent to £219m in the 12-month trading period, reflecting a 75 per cent rise in new business originations to £148m, of which 70 per cent is to the prime market. Around 60 per cent of the loan portfolio now represents loans to the small- and medium-sized enterprises (SME) market, principally for asset finance, and the balance is consumer lending. Interestingly, the company has been diversifying its customer base by targeting specialist markets within consumer finance, including lending on horse boxes and motor homes, a sensible decision given that these customers put down big deposits, have a good-quality asset and borrow for longer, around seven to eight years, according to PCF’s chief executive Scott Maybury. Around a third of the £62m new business originations in the financial year were from consumer specialist markets.
Importantly, the company has no exposure to Personal Contract Plans (PCPs) within its consumer motor finance business, nor lends to the subdued new car market, and is focused on lending into the far healthier used car market. The fact that the impairment charge was unchanged at 0.5 per cent of loan portfolio highlights a low level of delinquencies and underlines strict financial discipline in making lending decisions.
Diversifying the product mix mitigates execution risk
The post-period-end acquisition of Azule, a specialist funding provider to individuals and businesses in the broadcast and media industry, looks a smart deal and one that’s immediately earnings enhancing. Initial consideration of £4.1m (split £3.3m cash and £800,000 shares) and performance-related earn-out of £1.5m equates to seven times Azule’s pre-tax profits of £800,000 on revenue of £3.1m in its last financial year. Azule has capacity to generate north of £50m-worth of annual asset finance originations with very low impairments given the nature of its lending. It’s well on its way to achieve that target as Mr Maybury says that since acquisition Azule’s "like-for-likes are very good and can do even better".
Mr Maybury also sees an opportunity to enter the direct to market property bridging finance market and is looking to achieve £20m of lending to this segment in the coming year. The risk weighting of property is lower than on its current lending lines, but it should achieve net interest margins of around 8 per cent, in line with PCF’s existing loan portfolio. Moreover, by limiting loan-to-value ratios to 70 per cent and taking a first charge on the client’s property, the bank can protect itself from defaults and impairments.
The combination of originations from both of these new credit lines and ongoing strong new business originations from PCF’s business and consumer segments explains why Mr Maybury believes that his company can hit its £350m lending target one year ahead of the 2020 target date. On this basis, Panmure Gordon anticipates another step change in the profitability by pencilling in a 50 per cent hike in pre-tax profit and EPS to £8.1m and 3.1p, respectively, in the 12 months to the end of September 2019 to support a 33 per cent hike in the dividend per share to 0.4p.
This means that PCF’s shares are rated on a forward price-to-earnings ratio of 12, offer a prospective dividend yield of 1.1 per cent and are priced on 1.6 times forward price-to-book value. That’s not expensive for a fast-growing challenger bank that is over-delivering and diversifying its lending lines to de-risk execution risk. It’s also a low rating for a bank that’s just reported a post-tax return on equity of 10.3 per cent and has a 12.5 per cent target, and one that also boasts a common equity tier 1 ratio of 19 per cent to support the 50 per cent-plus lending growth targeted in the coming year.
PCF’s Aim-traded shares have produced a total return of 27 per cent in the 10 months since I included them in my 2018 Bargain Shares Portfolio during which time the FTSE Aim All-Share Total Return index has declined by 15 per cent in value. I expect the shares to continue their outperformance and have a 12-month target price of 50p. Buy.
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