Disclaimer: This is not investment research, and you should not consider it as such. It is commentary based on publicly available information. I have a very material personal interest in S&U Plc shares. A portfolio I help to manage has a very large weight in S&U Plc shares. Hence, I cannot help but be biased. Please do your own work – my projections are mine alone.
I first wrote about S&U, the specialty finance business, two years ago. In that time the stock is up about 10%. This is a failure in performance terms – my hurdle rate is a lot higher than that – though I’ve received ~10% extra in dividends in that time.
Fundamentally, though, it’s far from being a failure. In fact, it’s been an unmitigated success:
- I had projected that the company would earn £22.9m in 2022. They actually earned £38.0m.
- I thought they would earn £30.2m in 2023. Brokers currently forecast that they’ll do £32.6m, 8% higher, and I’m pretty sure they’ll beat that.
- I thought they would earn £34.4m in 2024 and, again, I now suspect it’ll be more like £37-38m.
It’s not as if I was setting easy targets, either. My forecasts, at that time, were way ahead of the market. The sell-side was, predictably, panicking about economic impacts and doing what they do best – extrapolating short term trends indefinitely into the future.
We did have a brief interlude of sanity in this journey. S&U ran up from ~£16 to ~£29, but we’ve ended up right back where we started: with the market terrified that S&U’s days are numbered. It is the energy price crisis and the impending recession which has spooked everyone now.
This is a business which, I need not remind investors, grew profits through the GFC. That’s right – it’s a non-prime financial business that grew profits through the worst recession in living memory. Average net profit for 2021 and 2022, the two COVID-impacted years, was £26.3m: within spitting distance of the £28.4m they made in the two prior years. They are more resilient than the market gives them credit for.
You don’t even have to take my word for it: they released a trading update a few weeks ago, noting that:
“Although it is only just over two months since our last trading update, S&U is pleased to report that both its motor and property bridging divisions continue to outperform its expectations, both in transactions growth, and in the quality of its book and the new business it is writing. Current Group receivables now stand at approximately £370m against £340m in May, and profitability exceeds that of H1 last year. “
H1 last year was their best H1 ever. They are now beating that. The business is – if you’ll forgive the pun – motoring.
You have visibility for continued growth, too: those £370m of net receivables compare to £322.9m at the start of the year. Like any finance business, the more you lend, the more interest you earn. Without wanting to oversimplify, this is an excellent indicator that earnings will keep going in the right direction.
And I know, I know what you’re thinking: Lewis, it doesn’t matter that the business is growing. We’re about to go into a recession! Consumers are going bust! The energy crisis will cripple everyone!
Well… maybe. As I said, S&U’s average profits in the two-COVID impacted years were pretty similar to their prior profits. Anyone who tells me with a straight face that the current situation is as apocalyptic as a total shutdown of society is, in my view, completely bonkers.
Investors, who overwhelmingly come from quite a narrow strata of society, tend to have a rather fixed view of the sort of people who take out non-prime car loans. Obviously, they muse, they must be living hand to mouth, paycheck to paycheck, struggling to keep their heads above the parapet, with zero flexibility in their budgeting.
It’s a patronising assessment, frankly, and it’s also completely wrong. If you look at S&U’s historic results, you will see that the only thing that severely damages their repayment trends is rising unemployment. When people lose their jobs, they stop paying for their car, because they have no choice. If they have a job – and they need their car to get to work – they pay for it. People find a way to cut back and make priority payments.
This is, of course, leaving aside the fact that in the next six weeks we will get a bazooka of cash blasted at the people of Britain. Relief from record energy bills is too popular, and too politically attractive, not to happen. It is also – frankly – the right thing to do, unless we want to live with massive economic scarring from what is (hopefully) a temporary phenomenon.
If you’re with me so far, you’ll see that I think:
- Performance at S&U in the last three years has been excellent: better than expected. That’s coming after a two-decade track record of superb growth and management
- The current economic woes are overstated. The business’s own history shows that they deal well with difficult times, and their customer base is perennially underrated
- And that I expect them to continue to grow profits, even in the face of a challenging environment
So what has the market done?
Well, frankly, the market has done very little. Since March this year, 370k shares have turned over, or around £8.9m in value terms. That’s peanuts on a company this large.
But those peanuts precipitated a fall in share price from £27 to £20. £8.9m of trading created an £84.7m loss of value, in market cap terms.
It’s an illiquid, family controlled business. The day-to-day valuation of the shares is driven by retail investor trading activity. A small swing in sentiment has a magnified impact in the value of the firm.
So where we stand today, on a price-to-book basis, we are basically back at the lows we saw in March 2020, in the depths of the COVID crisis. That’s before furlough, when the world was panicking about how much damage the pandemic would do. I know it’s easy to minimise it in hindsight, but people were genuinely terrified.
I don’t think the situations are comparable.
We’re in a better position today than then, too. You can think of provisions on the balance sheet as being like a ‘buffer’ that S&U puts aside for future losses. You make provisions when you expect loans to go bad, and if they do go bad, you’ve already taken the hit.
S&U went into COVID with a relatively small provision buffer. The world was going just fine, so they didn’t have large expectations of future losses. During COVID, though, they battened down the hatches and assumed the worst. Net provisions compared to receivables in the key car finance business went from 18.4% in 2020 to 26.1% in 2022, as last reported. That’s despite a loan book which actually had fewer late payments and better overall collections statistics.
In short, the lending book went from ‘adequately provisioned’ to ‘well provisioned’. It’s a hidden asset, if you’re being optimistic, or a prudent buffer against this year’s uncertainty, if you’re being conservative.
I believe the company will make £34m+ this year. That’s a price-to-earnings ratio of around 7x.
I believe prospective returns for investors buying today, without multiple expansion, are well into the mid-teens. They distribute a 6% dividend yield, and tend to grow by 10% per annum, which they can manage with retained earnings. They never issue shares.
I look forward to interim results later this month. I remain a massive fan. As we’ve seen in the last three years, the share price is unduly volatile for what is an incredibly stable and resilient business. It’s a brilliant opportunity that institutional investors can’t touch.
Hi Lewis,
Thanks for the writeup and the audio version, well read. I hold S&U and have done since mid-2019 when the shares were at a similar level. I think the valuation is more attractive now, given the company’s continued excellent progress over those three years, despite the obviously huge impact of the pandemic.
Unless the price goes to the moon then I’m happy to hold for dividends and growth, and I think Maynard Paton holds it as well, so keep an eye out for his occasional update.
Thanks John!
Agreed. I think this will be a super long-term hold. They keep executing, and me and the market are a long way apart on how it should be valued!
Can’t disagree with any of this. It’s kinda hard to understand the valuation of SUS shares right now.
What’s your take on how interest rates affect SUS? I don’t think SUS is directly interest rate sensitive in the way a bank with cheap deposit funding, or an insurer with a short duration investment portfolio, is. But I do think a rising rate environment (and in particular an environment with less plentiful credit) would be very positive for S&U in the medium term.
Phil
It’s a really interesting question, and not one I have an easy answer to. I think we have to split it up into first and second order effects.
On a first order basis, it’s negative. Unlike banks, which are funded with low cost/free deposit bases, S&U has only its own equity and traditional borrowings. Those traditional borrowings are floating rate. Every 1% increase in rate means ~£1.5m less profit. Advantage’s loans are ~5 years in duration, so they’re making less profit for the whole period if rates rise higher than at the inception of the loan.
On a second order basis, many (but not all) competitors are similarly funded with either traditional borrowings or private equity style debt stacks, which don’t tend to be fixed rate. S&U is much less levered than most. Hence, in a rising rate environment, S&U should be a relative winner: each incremental rate increase hurts S&U less than its competitors. This is compounded by the fact that they have best in class quality metrics for their debt, with a huge risk adjusted spread. They can much more readily eat these increased interest costs.
In the medium term, one would have to expect that the interest rates S&U charges will reflect increased funding costs, as competitors either raise their rates to try to maintain profitability or exit the market. The last 5 years have seen a glut of new lenders backed by easy money. These folks leaving would be great news for Advantage. You might also expect to see it show up in a shift in S&U’s quality metrics. They might choose to keep rates flat, but instead improve the quality of the book (if competitors leave, you get the pick of higher quality borrowers, and you can choose either to write more loans or write the same amount, but better, loans).
I’m not sure I’d agree that a rising rate environment would be ‘very positive’. I don’t think the low rate environment has been disastrously negative: just mildly so. But I do broadly agree that S&U – like any great business – is helped by difficult conditions, in the fullness of time. Excessively cheap money has incentivised low quality, loss-making competition, and tighter financial conditions might bring an end to that.
Thanks Lewis. Yes, you’re right that there’s negative interest rate sensitivity (although I thought SUS had said a 1% rise in rates would reduce profit by £1m rather than £1.5m? Not sure the difference matters too much unless rates rise extremely rapidly, though). I’m not too concerned about that because SUS’s loans aren’t long enough duration to cause a permanent loss type of risk. Obviously it would be a bit different if they had written 15+ year fixed rate mortgages or something. Also, right now there doesn’t seem to be the regulatory / political will to raise rates quickly (dangerous in my view, I think central banks are taking a risk by being too timid, but that’s neither here nor there for investment purposes).
OTOH if rates do continue to rise and credit becomes scarcer I’d see that as very positive because (a) SUS will have more pricing power so might improve spreads, but more importantly (b) might be able to earn similar returns for less risk. I’m definitely sensitive to the risk of irrational competition (actually I’m not sure irrational is really the word, intense/harmful is probably more accurate). This is exactly what you say, I think. I suppose I view it as very positive not just from an earnings point of view but also a risk point of view. I’m not sure I do view SUS as high risk really, but I’m definitely aware of the possibility that competition can cause any lending business to make some very bad decisions, and so a reduction in that risk is very very welcome, to my mind.
I should add, in fairness (and supporting your point), that the historical record doesn’t really suggest high or low rates have a particularly big impact on the business, although it’s a bit difficult to tell as the SUS of 20 years ago wasn’t really that comparable in terms of its business segments to the SUS of today. It’s also true that the direction of change in the cost of money is important too, not just the absolute level.
Agree with everything you say. Would just note that the company announced borrowings had hit £154m in July, and I suspect they’ll be higher by the end of the year. So sensitivity to rising rates from that perspective is increasing.
Good job, Lewis. As a shareholder I have been not impressed by Graham. I thought his appointment would lead to a net improvement or some creative change, for ex. an acquisition. Maybe he needs time, I don’t know, but I only see gradual growth. It is nice, but not what I would expect from a company which considers itself a leader. It would be useful to speak to Anthony Coombs privately and get a sense of his feelings. He is about 70 and I don’t know if he is happy about the share price these days. The stock is undervalued, but liquidity does not help us at all. Thanks a lot.
Hi Forsi,
Thanks for the comment. I can’t say I agree with that. I think Graham has done a sterling job. The things I care about most – collections quality, a measured pace of growth, and better marketing to start to reduce the growing cost of sales – are going in the right direction. I would not call double digit receivable growth ‘gradual’ – it is as fast as I want, in a finance company! Rapidly growing lenders tend to blow up eventually. S&U focuses on sustainability over speed. I think that’s the right tradeoff.
I am sure Anthony isn’t happy with the share price, but he’s been around for decades and he knows this game. Sometimes the stock market loves you, sometimes the stock market hates you, but you just have to keep doing your job. I doubt he wants to sell or do anything like that: this is a long-run family business and I imagine his ambition is to leave it better placed for the next generation.
Couldn’t agree more with Lewis comments. I might add also to Graham’s accomplishments that H1 results reveal top 3 introducers now account for only 34% of volume vs 44% 2 years ago – something he has been specifically focused on since taking the role.
I doubt very much the Coombs would start running the business differently simply to jolt the share price. At least I hope not. Eg ratcheting up borrowing to grow the book by making loans they wouldn’t otherwise make. But at today’s price you’re getting a 7% dividend yield. Add to that a 20 year track record of 10% CAGR book value growth. And at some point the shares will rerate from 1.1x book to 2x. Let’s say that takes 5 years. That’s a 27% annualised return over that time or a money multiple of 3.3x. Not too bad. I might add that given the low gearing and the collections track record, that comes with very little downside.
On interest rate exposure, also echo comments above and would add that because Advantage’s loans have such a high yield and amortise fully, they recycle their cash very quickly vs for eg a lower rate PCP loan – they get the advance and commission back inside 30 months and can put it back out there at a higher rate sooner.
I wonder if you are willing and able to help with an accounting question about S&U – I see big changes in the free cash flow figure and I’m not sure which set of accounts are going to tell me when the most recent change from positive to negative occurred, or why it has happened.
Figures from Stockopedia:
Year End 31st Jan 2017 2018 2019 2020 2021 2022 TTM
Free Cashflow ps (p) -231 -369 80 39 261 -20 -197
I hold S&U in my SIPP and am thinking of adding.
Thanks for reading even if you don’t reply!
Hi Michael,
Personally speaking, I don’t even look at the free cash flow of S&U. For most businesses, free cash flow is a useful metric – it’s a sanity check for net profit, and a way of making sure that profitability is really reflected in cold hard cash that comes back to the business.
For financial businesses – like S&U, or banks – I don’t think you can do the same exercise. Because cash is their ‘raw material’ – they make loans with it, after all – all free cash flow really tells you is whether they are making lots of new loans (and hence growing) or are shrinking. So you’ll see that in COVID-impacted 2021, the free cash flow figure looks very good. The reason it’s good is because that year they made relatively few new loans, but collected well on existing loans. Is it a good thing, though, that their loan book shrunk and they wrote few new loans?
This is one of the reasons that understanding the accounting in financial businesses is tricky: cash flow is all over the place, and if the business is good and growing it never really ‘generates any cash’ because it is all consumed by new loans. I think you have to go a bit deeper into the specifics of the way they account in the income statement to get a good grasp of what’s going on.
One ‘shortcut’ I take is the fact that the Coombs family own so much of the business. I find financial companies basically uninvestible unless there is a significant management stake. There is so much ‘discretion’ in their accounting that, without some incentivised and aligned people around the board table, things can go wrong quite quickly.
Thanks Lewis. I agree with what you say and it’s made me look back at some very old notes I made years ago (1990!) when I was trying and failing to understand banks as investments. It does seem that the people who actually own and run S&U can be trusted so perhaps this is one share I ought to have in my income portfolio even if I don’t fully understand the figures!
Hi Lewis, bit late to comment on this post but I have been thinking about value in this sector (am currently a SUS shareholder considering adding) and looking at alternatives. Question to you was whether you have ever looked at Close Brothers? Feels like a type of business you would be interested in / comfortable owning (albeit maybe a bit large) and noticed after the recent drop due to the Novitas issues it is trading below/around book value, which feels fairly odd for a business with its track record of growth / decent ROE. PS thanks for the writing you do here, always expressed really clearly and lots of food for thought
Hi Mike,
Thanks for commenting. I remain a big SUS shareholder and a huge fan.
I like Close Brothers. I will say that I am very much a small cap expert and don’t often venture above £300m, so it’s outside my typical stomping ground. As as result I’ve only read the annual report and done some cursory work, but I like what I see and agree with your points: they seem to have a genuine lending franchise with a few niche angles. I like the premium finance business (I once looked at Orchard Finance, a microcap premium financer, and I love their lending book). Winterfloods is a market leading non-lending business. And wealth management is…. wealth management: boring, but sticky, and their inflows record is strong.
Perlican – a very smart investor – wrote about both S&U and Close Brothers and, I believe, owns both. Links to his writing below:
S&U – https://perlican.substack.com/p/s-and-u-plc-margin-of-safety
Close Brothers – https://perlican.substack.com/p/close-brothers-group-cbg
He knows a lot more about Close than I do, so you might find his thoughts useful!
Best,
Lewis
Thanks Lewis, you have reminded me I had read the Perlican write up, will revisit now.