Join our community of smart investors

Begbies Traynor to gain ground from debt market mayhem

With borrowing costs on the fly, we’re bound to witness a significant increase in the amount of delinquent debt for sale over the coming months, as creditors assign a growing volume of obligations (at below face value) to debt purchasers.

That’s hardly a revelation. We have been privy to a succession of non-performing loan sales across Europe since 2014, when the European Central Bank intervened to support potentially insolvent banks, particularly those in Italy.

We also know that consumers who are overly reliant on credit purchases are finding the going tough as real household incomes shrink. As if to bear this out, the Wall Street Journal recently revealed that US consumers with poor credit histories are increasingly falling behind on their sub-prime credit card and personal loan repayments. US delinquencies hit an eight-month high in March, a potential harbinger for the UK consumer credit sector – the largest in Europe. It is perhaps significant that Experian (EXPN) is set to include buy now, pay later data in customer credit files. With runaway inflation, along with the attendant fall in real wages, it is worrying to think that a sizeable proportion of consumer debt in the UK could have been generated through non-discretionary purchases.

The servicing of corporate debt also promises to be a more fraught affair going forward. Figures from the government’s Insolvency Service show that the number of registered company insolvencies in April was double the rate from the 2021 comparator and 39 per cent in advance of the pre-pandemic level.

The ability to service existing debt arrangements has been imperilled by supply chain issues and spiralling energy costs. And there are other indirect factors that are influencing decisions linked to corporate treasury.

The latest Corporate Debt and Treasury Report – a FTSE 350 business survey compiled by professional services group Herbert Smith Freehills – suggests that corporate capital expenditure and working capital commitments are likely to increase through the remainder of 2022 and perhaps beyond. It also concludes that the rising tide of negative macro effects, no doubt exacerbated by events in Ukraine, “are not expected to curtail the supply of debt but may impact on terms, pricing and the timing of raising debt”. 

With the cost of capital increasing, it’s interesting to note that over 70 per cent of respondents to the survey expect to include sustainability features within their next financing terms due to the ongoing adoption of environmental, social and governance protocols. Compliance in this area might increasingly be woven into the lending criteria for companies engaged in sustainable financing, but it would do little to reduce borrowing costs.

Many public companies took the decision to shore up their balance sheets when faced with the commercial disruption brought about by the pandemic. But analysis from the Bank of England indicates, somewhat surprisingly, that large UK companies had lower debt in aggregate by the second quarter of 2021 than they did prior to the outbreak of Covid-19.

The analysis notes that companies may struggle to meet loan obligations when their interest payments are equivalent to 40 per cent or more of their income. By the end of last year, the debt-weighted share of companies with interest coverage ratios below 2.5 stood at 37 per cent – well below its historical peak. The bank claims that an increase in borrowing costs of “almost 400 basis points would be needed for this share to reach historical highs”. However, the review of corporate indebtedness was undertaken prior to the recent rate rises and it doesn’t apply to companies further down the food chain.

We outlined the investment case for Begbies Traynor (BEG) in late 2019, when shares in the business recovery and financial advisory group were changing hands at 88p apiece. They’ve appreciated by 51 per cent in the intervening period, but we envisage further potential upside, not only because corporate insolvencies are set to increase, but also because analysts are recalibrating forecasts following release of a trading update “comfortably ahead of market expectations”. Revenue and adjusted profits are now expected to increase by 30 per cent and 55 per cent respectively, while operating margins are also heading in the right direction.

Management noted that insolvency numbers – up by 50 per cent over the period – have returned to pre-pandemic levels as government support measures have been gradually lifted. Unfortunately, administrations – which usually generate more fees – have yet to fully recover. That’s the only drawback for the business recovery and financial advisory division, although deteriorating macro conditions certainly provide fertile ground for insolvency practitioners. In any event, there isn’t a surplus of counter-cyclical options for investors presently, so it could be worth running the rule over the Aim stock again.