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Buckle in high yield S&U

The car finance specialist operates in a well-defined and profitable niche
December 9, 2021

Today’s investor is spoiled for choice. Within a couple of minutes and a few clicks, he or she can get exposure to the luxury tastes and spending habits of the super-wealthy, bleeding-edge technology used by governments to protect their citizens or management teams looking to build a better world.

Tip style
Income
Risk rating
Low
Timescale
Long Term
Bull points

 

  • Improving collections
  • Good provisions
  • Fast-growing bridging loan division
  • A rebounding market
Bear points
  • Rising interest rates
  • Non-prime lending

In this panoply of potential investments, the car finance sector is a byword for neither glamour and excitement nor impact investing. What it does offer is an in-demand product and exposure to a market that benefits from information asymmetry: on the one hand are lenders with time and a deep understanding of credit risks, on the other are time-poor borrowers who underprice long-term costs and lack a real knowledge of the cheapness of the credit they are buying.

This isn’t to imply the sector doesn’t provide an important service that customers value. Take Advantage Finance, the Grimsby-based car finance trading arm that accounts for about nine tenths of the lending activity of specialist finance group S&U (SUS). As of this week, the business has a score of 4.7 out of 5 on independent consumer review website Trustpilot. S&U has been in business since 1938, while Advantage has provided motor finance to more than 200,000 customers since 1999.

In short, S&U has a long track record as a good operator. And its track record as a public company suggests it has also been well-aligned with the interests of shareholders too, who have seen a 21 per cent average annual total return from the stock over the past decade. Over the same period, the FTSE All-Share returned an average of 7.4 per cent a year, while the FTSE’s largest banks just about scraped a 21 per cent total return over the entire decade, including all those dividends (see table).

 

10-year comparisonPrice change (%)Total return (%)
 CumAnn (CGR)CumAnn (CGR)
S&U32815.759221.3
FTSE 350 Banks-15-1.620.91.9
FTSE All-Share433.61047.4

 

By contrast, in sticking to its knitting, the Solihull-headquartered lender has avoided the complexity, costs and interest-rate-sensitivity of the high-street banks. In doing so, it has managed to achieve a very impressive 9.4 per cent average return on assets over the past five years, which when boosted by its own rather modest balance sheet leverage translates to a return on equity of 15 per cent. Put simply, this is a business model that works.

 

 

Simple maths     

Advantage’s bread-and-butter product is the medium-term vehicle hire purchase agreement, which allows borrowers to 'hire' a car and pay off the cost in monthly instalments at a fixed rate of interest. When the loan is paid off, only then does the vehicle become the property of the borrower.

In its customer and corporate literature, S&U gives the example of a 48-month loan at a flat rate of interest fixed at 14 per cent. Against a typical car purchase price of £7,500, and assuming no upfront deposit is provided, the borrower will incur £4,200 in interest over the life of the loan, as well as a £300 acceptance fee and a £200 purchase fee, which is wrapped into the final monthly repayment.

These additional charges mean the average annual interest rate has trended above 17 per cent over the past five years. In the six months to July, this slipped slightly to 16.2 per cent, as the company agreed to 9,697 new loans – a big rebound on the same period a year ago – advancing an average of £7,000 across an average original term of 53 months.

A quick scan of price comparison websites and other car finance lenders shows there are more competitively priced lending products out there. But S&U’s higher rate of interest is in part a reflection of its niche customer base, which management characterises as “decent, hardworking and well-intentioned”, but often shut out of mainstream finance products owing to impaired credit histories.

Car ownership through upfront payment is not an option for many people in this position, which means a permanent source of demand for Advantage products. Although it is on track to write more than 20,000 loans this financial year, this is a tiny fraction of the 1.5m applications the business receives annually. In short, it can afford to finance only those customers that represent the lowest loan loss risk.

S&U can do this thanks to better tracking of cash collections and a growing understanding of borrower repayment habits. For example, the identification of a strong historic correlation between first repayments and end outcome loss ratios has helped improve underwriting standards and rates of early repayment, while lowering credit risk.

 

Market recovery

Even if Advantage couldn’t afford to be picky, the UK’s car market provides a benign backdrop. In the 12 months to September, the value of advances for new and used cars increased by 6 and 12 per cent respectively, according to the Finance & Leasing Association. The Society of Motor Manufacturers and Traders expects next year’s sales of cars and light vehicles to eclipse 2019 and calculates that 2021 used car transactions are very close to their pre-pandemic levels despite a weak start to the year.

Nevertheless – and with perhaps one eye on the effect of longer-term bans on petrol and diesel cars – S&U is sensibly adding diversification to its lending book via a property lending business. Although it is growing fast, bridge finance arm Aspen is starting from a low base and is already profitable. The division agreed to 66 loans and generated a £1.5m profit before tax in the half-year to July. Like Advantage, it approves just a small percentage of the applications it receives. But like here too, demand from property owners for short-term financing is only likely to grow over the long term.

Investors tend to price banks and other lending firms on a mixture of earnings and asset quality. In the case of S&U shares, both the forward price/earnings and price-to-book value multiples are in line with five-year averages of 10 and 1.6, respectively. This also means prospective shareholders have the chance to buy into a stock forecast to yield 5 per cent and with a long history of well-managed and rising dividends (covered twice over, with last year marking the first dip in distributions in decades).

Two strong pandemic-era appearances that Investors' Chronicle's low-risk high-yield and cheap small-cap screens provide further evidence that the fundamentals stack up well. Against all of this are the normal health warnings that accompany a finance stock. Inflation, for example, could be an issue – particularly if it marches much higher or leads to a ratcheting up in competition – but it is a far more marginal concern than it is for other credit markets.

Throw in strong alignment between ordinary shareholders and the Coombs family – whose member-directors include chairman Anthony Coombs, deputy chairman Graham Coombs and Aspen founder Jack Coombs, and who account for more than 40 per cent of the company’s ownership – and this is a stock that ticks a lot of boxes. On balance, S&U should keep on driving returns.

Last IC View: Buy, 2,890p, 28 Sep 2021

Company DetailsNameMkt CapPrice52-Wk Hi/Lo
S&U (SUS)£311m2,560p2,950p / 1,810p
Size/DebtNAV per shareNet Cash / Debt(-)Leverage ratio5yr NAV CAGR
1,491p-£116m1.6 x6.8%
ValuationFwd PE (+12mths)Fwd DY (+12mths)FCF yld (+12mths)P/BV
105.0%-1.6
Quality/ GrowthRoAROE5yr Sales CAGR5yr EPS CAGR
5.0%8.1%13.1%-5.5%
Forecasts/ MomentumFwd DPS grth NTMFwd DPS grth STM3-mth Mom3-mth Fwd EPS change%
17.4%6.6%-4.5%22.4%
Year End 31 JanSales (£m)Profit before tax (£m)EPS (p)DPS (p)
201989.234.6232118
202089.935.1239118
202183.817.612190
f'cst 202286.539.0260113
f'cst 202396.038.7257131
chg (%)+11-1-1+16
Source: FactSet, adjusted PTP and EPS figures 
NTM = Next Twelve Months  
STM = Second Twelve Months (i.e. one year from now)