Neil Woodford backs this promising tuck-away
Is this recently-floated, circa £100 million acquisition vehicle Non-Standard Finance 'the next Provident Financial'? The prize in non-standard consumer lending is substantial: Provident has evolved into a £4.3 billion FTSE 250 company with strong earnings and dividend growth (see table) despite the recessionary years, explaining its low-volatile five-year chart.
Reasons include British addiction to debt as a means to achieve the consumer lifestyle, with many people shunned by banks. This has followed banks' de-risking after the 2008 financial crisis, but also societal changes: an estimated 12 million people don't meet mainstream credit criteria because their incomes are too low, they are self-employed with variable income, their credit is impaired by way of Court judgments, or they are recent immigrants.
Such 'non-standard' lending allegedly constitutes 40 per cent of secured and 30 per cent of unsecured lending in the UK, involving a variety of niche operations with specific risk/reward profiles, another reason banks are deterred. Sums lent, tend to be relatively small and for relatively short periods. The opportunity is very substantial - the UK unsecured non-standard credit market is estimated to be worth about £70 billion and secured lending about £75 billion. We're talking 'sub-prime', a dirty word since ructions originating in the US rocked international finance, likewise the collapse of the US junk bond market in 1989/90. It persists because there will always be low-quality borrowers, capitalism will find a way to 'help' - at a price.
Supernormal profits anticipated
I came across one investment fund's rationale, why it participated in Non-Standard's circa £100 million placing - a proven management team includes chairman John van Kuffeler who led Provident Financial for 22 years as chief executive then chairman, during whose tenure the share price increased 44-fold with an annualised return of 19 per cent. Over the last 10 years it has generated an average return on equity of more than 30 per cent. This is due also to good quality companies earning supernormal profits from lending in niche areas that don't attract a lot of competition.
Another reason for the fund buying stock is Non-Standard's ability to charge average annual interest rates of 50 per cent to 100 per cent while maintaining a lean cost base. This may appear extortionate but is consistent with the acquisition criteria on page 53 of the prospectus e.g. 'ability to grow lending balances by at least 20 per cent a year on average' and 'strong yields underpinned by APR's of at least 50 per cent to 100 per cent' - APR being the annual percentage rate. That's some political hot potato a left-winger might fling, or a bishop morally crusade against in the media, in terms of what capitalism does to vulnerable sections of society. Realistically human nature isn’t going to change: people want material goods and business will enable that.
Specific acquisition areas identified
The board has some 20 companies in mind, towards a return on equity of 20 per cent to 30 per cent, although none has yet been approached. They encompass four areas of non-standard unsecured lending: consumer loans guaranteed by a friend or family member who is generally a home owner; smaller loans of £200 to £600 over 1-3 years; weekly instalments to buy consumer durables; and low-value loans with weekly instalments that are physically collected (where Provident Financial enjoys two-thirds of the market). The likes of 'physically collected' can summon fears of where such business can lead, although the directors should know what they are getting into. Included in the acquisitions criteria are 'a focus on good customer outcomes' and 'treating customers fairly' which ought to limit social risks.
Another aspect in this regard is the Financial Conduct Authority (FCA) insisting on 'good owners' partly to avoid loan-shark scandals - any change in ownership of an FCA-authorised company requiring its approval. Non-Standard's top three executives have worked together previously - the finance director and a third executive director were involved at Marlin Financial, a consumer debt purchasing group chaired by van Kuffeler which achieved a 42 per cent internal rate of return over four years to sale in February 2014. Positive upshots of the FCA's regulation may include limiting rivals for acquisitions, hence prices required, and creating something of a barrier to entry.
The directors also seek 'strong cash flow generation, allowing for the payment of regular and growing dividends over time' (again see Provident Financial's record as testimony). They own 2.5 per cent of the company - mainly the chairman with 2 per cent - which will grow if performance targets are met.
Just over 20 per cent of market value constitutes 'goodwill'
Relative to a placing price of 100p, a current market price of 109p implies a capitalisation of £115 million against some £95 million raw value by way of net funds raised and considering medium-term running costs. So buyers in the after-market are paying a near 15 per cent premium for goodwill linked to the investment case - that a proven management will acquire an attractive range of niche businesses. Don't hold your breath though: 'The directors intend to make the first acquisition within six months of admission, but this is only if in their opinion a suitable target can be found.' If one is not made in a year there will be the chance for shareholders to vote on termination with capital returned. Yet fund managers enabling this operation via the placing - e.g. Woodford and Invesco each with about 19 per cent of the stock, and Marathon and Legal & General with about 5 per cent - implicitly assume it's worth tucking away patiently. While early days, overall this looks a promising situation.
|Year ended 31 Dec||2010||2011||2012||2013||2014||2015||2016|
|IFRS3 pre-tax proft (£m)||142||162||194||182||225|
|Normalised pre-tax profit (£m)||145||162||270||194||232||279||309|
|Normalised earnings/share (p)||78.4||89.8||162||108||128||153||168|
|Earnings growth rate (%)||19.3||14.5||80.3||-33||18.3||19.2||10|
|Price/earnings multiple (x)||22.9||19.2||17.5|
|Cash flow per share (p)||25.7||20||-22.2||54.8||75.1|
|Captial expenditure per share (p)||13.3||5.5||5.5||6.5||12.9|
|Dividend per share (p)||63.5||64.8||71.1||79.4||88.1||115||128|
|Dividend growth (%)||2||9.7||11.7||11||31.1||10.7|
|Yield (%) ||3||3.9||4.3|
|Covered by earnings (x)||1.2||1.4||2.3||1.4||1.5||1.3||1.3|
|Net tangible assets per share (p)||214||227||264||293||312|
|Source: Company REFS.|
For more information see nonstandardfinance.com.