Bargain Shares: Delivering secured returns

Aim-traded Vector Capital (VCAP:63p), a commercial lender offering first charge secured property loans to predominantly small property developers who buy properties to refurbish and then re-sell, is one of the top performers in my market-beating 2022 Bargain Share Portfolio. It’s easy to understand why.

The company changed broker to WH Ireland earlier this month, but full-year operating profit of £4mn easily surpassed the £3.73mn previous estimate of former house broker Allenby Capital. Moreover, the full benefits of the £46.3mn closing loan book will be seen in the current financial year when analysts expect both revenue and operating profit to increase by around 10 per cent to £5.8mn and £4.4mn, respectively. On this basis, the company is forecast to generate a post-tax return on equity of almost 10 per cent and free cash flow of £2.4mn to support a £1.2mn (2.6p a share) payout to shareholders.

These forecasts are predicated on a stable loan book, a conservative assumption given that Vector has been benefiting from a robust backdrop for short-term bridging finance. Lending in this market segment hit a record £5.07bn last autumn, driven by confidence in the property market, demand for alternative investments in a low-yield environment, and greater private refurbishment and maintenance spending. The ability to turn around loan applications quickly, a high level of customer service and transparent fee structure explain why Vector’s offering is proving increasingly popular. In fact, chief executive Agam Jain revealed during our results call that Vector’s loan book has since risen to £50mn across 90 secured loans.

Source: London Stock Exchange

Importantly, credit risk management is impressive. The company has incurred less than £100,000 of bad debts in the past four years. More than half of loans are secured on residential property (refurbishment, investment, buy-to-let), more than a quarter are on commercial property (retail, hotel, golf), with the balance of lending secured on land, development and mixed-use schemes (residential and commercial). Jain says the aim is to increase the residential weighting to 75 per cent or more by the end of 2023 by focusing on sub-£1mn residential transactions. It will enable the company to tap more of its £35mn wholesale funding facilities which at present are only £21mn drawn down.

That’s good news for profits given that Vector borrows at a fixed interest rate of 6.5 per cent from wholesale funders and lends to clients at an average interest rate of 11.84 per cent. Arrangement fees (1.3 per cent on an average loan duration of 14 months) cover broker commissions and administration costs. The economies of scale to be reaped from a bespoke IT platform and online portal means that the loan book could double without increasing fixed costs. In addition, Vector has scope to lower its own cost of funding, boost lending margins and market share as it scales up.

Vector’s share price has risen 29 per cent since initiated coverage 10 weeks ago, during which time the FTSE Aim All-Share total return index has shed almost 5 per cent of its value. Trading on a forward price/earnings (PE) ratio of 11.8, offering a prospective dividend yield of 4.2 per cent, and rated on a modest 12 per cent premium to 2022 net asset value estimates, the investment risk remains skewed to the upside. Jain expects to outperform WH Ireland’s profit estimates and it’s not difficult to see why. Buy.

Finally, I have published an updated article on AEW UK REIT following today’s announcement from the company of a major property disposal which has led to a material increase in pro-forma net asset value.

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