A resilient property play with a 7% yield

Commercial lender Vector Capital (VCAP:34p) is maintaining a cautious approach given the challenging property market conditions and the squeeze being placed on customers by rising interest rates and inflationary pressures. The company offers secured property loans to mainly small property developers who buy properties to refurbish and re-sell.

Reflecting net redemptions in the first half, Vector’s closing loan book has declined by 8 per cent to £48.8mn since the start of the year. The lending portfolio is spread across 103 live loans with an average loan size of £473,000, down from £532,000 at the same stage last year. Vector holds security of £84mn to back up these loans, implying a conservative loan-to-value ratio of 58 per cent.

Although net provisions increased from £200,000 to £367,000, representing 0.75 per cent of the loan portfolio, chief executive Agam Jain points out that the company expects to recover its full capital in almost all cases, albeit with a delay of around four to 12 months. He also notes that Vector has not written off any debts in the half-year period under review, but the board is taking a prudent view due to the more challenging macroeconomic environment. The increase in the bad debt provision accounted for almost three-fifths of the £282,000 fall in first-half pre-tax profit, with higher finance costs and inflationary increase on overheads making up the balance.

Well-funded balance sheet

That said, the company reports strong levels of new business enquiries and, with only £20mn of its £45mn wholesale banking facilities currently drawn down, it has ample capacity to increase lending as and when market conditions improve. In the meantime, over half of the loan book is being funded by shareholders' own capital, earning them an average annual interest rate of 10.2 per cent, which in turn supports an attractive dividend yield.

The board maintained the half-year payout of 1p a share and house broker WH Ireland is pencilling in a slightly higher final dividend of 1.58p a share, implying a prospective dividend yield of 7.6 per cent. The payout is still covered 1.6 times by forecast full-year earnings per share (EPS) of 4.1p, down from 5p in 2022. On this basis, the shares are rated on a forward price/earnings (PE) ratio of 8.3 and on a deep 39 per cent discount to book value. It means that £10mn of shareholders' equity of £25.4mn (56p) is in the price for free, a sum that equates to more than 20 per cent of the loan book. That’s a huge margin of safety.

So, although the shares have drifted 10 per cent in a weak market since I covered the annual results, I feel that the reversal in this year’s profits is now more than priced in and that investors are ignoring the possibility of an easing in market conditions next year when WH Ireland expect EPS to bounce back 10 per cent. Recovery buy.

■ Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com at £16.95 each plus P&P of £3.75, or £25 plus P&P of £5.75 for both books.