Aim-traded shares in pawnbroker H&T (HAT:301p) were marked down by 19 per cent this morning to marginally above the 289.75p entry price in my 2017 Bargain Shares portfolio after the company announced that it is working closely with the Financial Conduct Authority (FCA) following a regulatory review of certain aspects and files of its high-cost short term credit (HCSTC) unsecured loans business.
In particular, the review is focusing on H&T's creditworthiness assessments and lending processes for HCSTC loans (APR exceeds 100 per cent), in light of changes implemented 12 months ago to the Consumer Credit Sourcebook rules (regarding affordability assessments), and the Dear CEO letter issued to all HCSTC firms by the FCA in October 2018. The ongoing review will result in changes to policies and procedures surrounding H&T's provision of unsecured HCSTC loans.
H&T has ceased all HCSTC unsecured lending for the time being and is looking at its HCSTC unsecured lending practices over the past six years as part of the FCA review. The HCSTC unsecured loan portfolio peaked at £4m in December 2016 and has since been reduced to £3m. Customers made total interest payments of £24m over the six-year period, and H&T generated revenue less impairments of £11m. The HCSTC unsecured lending segment is expected to account for less than 4 per cent of H&T’s revenue in the 2019 financial year.
In light of the FCA review, and should any customer redress be payable, H&T expects to fund this from its existing financial resources. The directors also confirm that the business continues to trade well. Last month, house broker Numis Securities upgraded its 2019 pre-tax profit by 12 per cent to £19m (up from £13.9m in 2018) on revenue of £160m (£143m). Two-thirds of the pre-tax profit increase reflects the positive impact from the buoyant gold price, implying a 33 per cent year-on-year rise in earnings per share (EPS) to 39.8p to support a dividend per share of £11.5m.
| 2017 Bargain shares portfolio performance | |||||
| Company name | TIDM | Opening offer price on 03.02.17 (p) | Latest bid price on 18.11.19 (p) | Dividends | Total return (%) |
| BATM Advanced Communications (see note seven) | BVC | 19.25 | 42.1 | 0 | 134.8 |
| Kape Technologies (formerly Crossrider) | KAPE | 47.9 | 76 | 3.55 | 66.1 |
| Chariot Oil & Gas (see note one) | CHAR | 8.29 | 3.76 | 0 | 47.8 |
| Cenkos Securities (see note two) | CNKS | 88.425 | 106 | 9.5 | 30.6 |
| Avingtrans | AVG | 200 | 250 | 7.2 | 28.6 |
| Manchester & London Investment Trust (see note three) | MNL | 291.65 | 377 | 3.0 | 28.4 |
| H&T | HAT | 289.75 | 299 | 27.1 | 12.5 |
| Bowleven (see note four) | BLVN | 28.9 | 10.3 | 15 | 2.2 |
| Management Consulting Group (see note five) | MMC | 6.183 | 6 | 0 | -3.0 |
| Tiso Blackstar Group (see note six) | TBG | 55 | 23.0 | 0.54 | -57.1 |
| Average | 29.1 | ||||
| FTSE All-Share Total Return | 6485 | 7523 | 16.0 | ||
| FTSE AIM All-Share Total Return | 977 | 1017 | 4.1 | ||
| Notes: | |||||
| 1. Simon Thompson advised selling two-thirds of the Chariot Oil & Gas holding at 17.5p on 3 April 2017 ('Bargain shares on a tear', 3 April 2017). Return reflects the profit booked on this sale. Simon subsequently advised using some of the proceeds from the share sale to participate in the one-for-8 open offer at 13p a share in March 2018 which is taken into account in the total return ('On the earnings beat', 5 Mar 2018). Simon turned buyer of the shares at 4p on 17 April 2019 ('Chariot's North African adventure', 17 April 2019). | |||||
| 2. Simon Thompson advised selling the Cenkos Securities holding at 106p on 3 April 2017 and the 106p price quoted in the above table is the exit price on the holding ('A profitable earnings beat', 3 Apr 2017). | |||||
| 3. Manchester and London Investment Trust paid total dividends of 3p a share on 2 May 2017. Simon Thompson then advised selling half of the holding at 366.25p on 26 June 2017 ('Top slicing and running profits', 26 June 2017), and selling the remaining half at 377p ('Bargain shares second chance', 17 August 2017). The 377p price quoted in the table is the final exit price. | |||||
| 4. Simon Thompson advised banking profits on half your holdings in Bowleven shares at 33.75p, and running the balance ahead of drilling news at the Etinde prospect in Cameroon in the second quarter of 2018 (‘Hitting pay dirt', 9 Apr 2018). The company subsequently paid out a special dividend of 15p a share on 8 February 2019. The total return reflects this share sale. | |||||
| 5. Simon Thompson advised to sell Management Consulting's shares at 6p in February 2018 (‘How the 2017 Bargain share portfolio fared’, 2 February 2018). The price quoted in the table is the 6p exit price. | |||||
| 6. Tiso Blackstar has transferred its UK listing to the Johanesburg Stock Exchange. Price quoted is sterling equivalent bid price at current exchange rates. | |||||
| 6. Simon Thompson advised banking profits on half your holdings in BATM shares at 49.9p, and running the balance for free ('Bargain Shares: Exploiting pricing anomalies and top-slicing', 3 December 2018). Simon then advised reinvesting the profits back into the shares at 43.5p ('BATM armed for a re-rating', 11 July 2019). Total return takes into account these trades. | |||||
| Source: London Stock Exchange share prices | |||||
H&T is forecast by Numis to close the 2019 financial year with equity shareholders funds of £119.7m and net debt of £18m, so has significant headroom on the company’s £35m five-year banking facility with Lloyds. I estimate spot net tangible asset value is around £95m, so borrowings are modest in relation to hard assets held on the balance sheet.
Moreover, this morning’s share price mark down has reduced H&T’s market capitalisation from £148m to £119m, so the company’s equity is now only being priced in line with year’s estimated closing net asset value. Also, the £29m reduction in market capitalisation equates to more than 2.5 times the £11m net interest income H&T made from HCSTC unsecured lending in the aforementioned six-year trading period, a disproportionate mark down in relation to the profits the company actually earned.
I would also point out that Numis expects H&T to generate equity free cash flow of £14.8m from operating cash flow of £23.9m next year, the difference between the two cash flows being capital expenditure (£2.2m), corporation tax (£4.3m) and net financing costs (£2.6m). The point being that estimated free cash flow of £14.8m is more than three times higher than the £4.6m cash cost of the 2019 estimated dividend of 11.5p a share, effectively leaving £10m of free cash available to satisfy any potential customer redress (if the FCA deems actually deems this the appropriate course of action) from surplus cash flow rather than recourse to borrowings.
Clearly, investors are likely to take a more cautious stance until the FCA concludes its review, and I would expect a number of customer cases to be reviewed before the FCA makes a decision on the extent of any redress. But with H&T’s shares priced on a current year price/earnings (PE) of 7.5, falling to a miserly PE ratio of 6.4 in 2020 based on Numis’s held EPS forecast of 46.8p, I feel the bad news is already being fully factored into the company’s rating. There is a healthy prospective dividend yield of 3.8 per cent, too, highlighting the income stream this holding has generated since I included the shares in my market beating 2017 Bargain Shares Portfolio. Indeed, the board has paid out cumulative dividends of 27p a share since the portfolio’s launch in February 2017.
I would certainly not be selling H&T’s shares at this low point. In fact, I believe they have decent recovery potential which is why I continue to rate them a buy.
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