PCF lending targets support accelerated profit growth

Business lending to SMEs, mainly for vehicles, plant and equipment, was the key driver (loan book up from £96m to £147m) and there is no shortage of demand from a segment of the market that continues to be shunned by the major banks. The consumer loan book is concentrated on nearly new and used cars, so it’s reassuring to know that PCF is highly selective on its lending and has never lent on personal contract plans (PCPs). This strict discipline is not holding back growth though, as the consumer loan book still increased by more than a quarter to £106m even though only one in 20 applications convert into loans.

Last autumn’s acquisition of Azule, a specialist funding provider to individuals and businesses in the broadcast and media industry, has diversified the lending portfolio, a sensible move and one that contributed £19.7m to receivables.

Credit quality sound

Importantly, credit quality remains sound. First half impairments of £1.2m accounted for 0.9 per cent of receivable balances on annualised basis, a satisfactory level of write-downs at this point of the credit cycle after taking into account the accelerated portfolio growth rate. The fact that PCF’s net interest margin (NIM) only declined from 8.4 to 8 per cent in the six-month period was impressive given the higher proportion (75 per cent) of lower margin prime lending. In fact, post results, analysts at Panmure Gordon actually raised their full-year NIM estimate from 8 to 8.2 per cent.

Over £200m of the loan book is funded by tapping into a deposit base of 4,600 retail savings accounts on which PCF pays an average interest rate of 2.1 per cent. It also has access to a £25m low-cost facility with the Bank of England. Only £27m of funding comes from wholesale funding markets on which PCF is charged an interest rate of 4 to 5 per cent. These credit lines are being unwound as they expire, so expect further downward pressure on cost of funding.

Sensibly, having tapped shareholders for £10.75m in a placing and open offer priced at 30p a share earlier this year (‘PCF equity raise worth buying into’ 20 February 2019), PCF is in the process of raising £15m from a Tier 2 Capital facility at a post-tax cost of 6.4 per cent, well below the company’s 11.5 to 12 per cent cost of equity. Reassuringly, chief executive Scott Maybury informed me during our results call that PCF’s capital structure [once the Tier 2 Capital facility is in place] means that it has almost enough capital to fund growth to its 2022 portfolio lending target of £750m without the need to return to shareholders.

That’s important because as PCF’s lending and income ramps up – first half operating income rose by half to £10.1m to deliver a 57 per cent hike in pre-tax profit to £3.3m – the operational gearing of the business will lead to further improvements in profitability and return on equity. Indeed, the first half weighted after-tax return on equity of 11.4 per cent, up from 8.7 per cent at the same stage last year, is well on course to hit management’s target of 12.5 per cent by the September 2019 year-end, and should continue to make decent headway towards the 15 per cent 2022 target rate.

Forecasts and target price

For the financial year to end September 2019, analysts at Panmure Gordon predict annual operating income of £23m, 50 per cent higher pre-tax profits of £8.1m and a 33 per cent increase in both earnings per share (EPS) and dividend per share to 2.8p and 0.4p, respectively. Looking further ahead, and based on a closing loan book of £450m in September 2020, expect 2020 pre-tax profits of £10.9m on operating income of £29.6m, EPS of 3.6p and a dividend per share of 0.5p. On this basis, the shares are priced on a forward price/earnings (PE) ratio of 9.5, and 1.24 times September 2020 book value forecasts.

Those multiples are really not expensive for a fast-growing challenger bank that is maintaining a high level of credit quality, targeting prime lending markets, has over-delivered to date and is diversifying its lending lines – PCF’s lending also includes a small residential bridging loan business. Moreover, the bank has a healthy common equity tier one ratio of 19.7 per cent which supports plans to more than double the loan portfolio in the next three years without further recourse to shareholders.

So, having included PCF’s shares, at 27p, in my 2018 Bargain Shares Portfolio, and banked dividends of 0.49p a share to date, I feel that my 50p fair value of the equity  – equivalent to a September 2021 price-to-book value of 1.64 times and a PE ratio of 10.5 for the 2020/21 financial year – is a sensible target price. Buy.

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