Shares in alternative finance provider Non-Standard Finance dropped to their lowest level ever as a trading update revealed that profits would be lower than anticipated this year. The performance of shares has dragged on throughout the day:
This has been a rather sorry state of affairs for investors. Only listed in 2015, the share price saw a little success in the first year, but since then has struggled to go anywhere near its listing price. Instead the trajectory has been mostly downward since then and the price now is almost a quarter of what it was.
NSF specialise in consumer credit, particularly the smaller, unsecured loans. It has an interesting history, being created by a former executive of Provident Financial who set up for himself backed by investors, and used the newly generated cash to buy up other loan providers. Things almost came full circle last year when NSF mounted a hostile takeover of Provident, but this was abandoned this year.
What’s gone wrong at Non-Standard Finance?
We have an extremely detailed trading update today, including an extra one which states that the current CFO is to leave.
We start with the warning:
Trading overall in the quarter to 30 September 2019 has been softer than expected with solid performances by both branch-based lending and home credit, offset by lower volumes in guarantor loans. As a result, it is expected that the Group’s normalised full year operating profit in 2019 will be lower than expected but still well ahead of 2018.
There is a large difference between normalised and statutory, as normalised results ignore amortisation costs. For a company entirely built on acquisitions this is fairly relevant.
Helpfully, we also have a rationale for the reduction in profit:
However, the expected impact on normalised operating profit of the step-change in provisioning (6%-8% impact) and the trading performance to-date (4%-5% impact ), is that in aggregate, normalised operating profit for 2019 is now expected to be between 10-13% lower than current consensus of analyst forecasts, although still well ahead of 2018.
In a double whammy, the group has also revised its growth targets in all its division downwards, although it expects margins to be roughly the same.
A tough company to appraise
There is quite a lot going on here and it is quite likely that a company such as NSF would polarise opinion. On one hand, there are clearly terrific margins on all its products. A user taking out such a loan would pay a very high level of interest, and as such perhaps get access to finance that they may not have been able to get elsewhere.
On the other hand, there could be an argument that these type of companies give out loans to people who can least afford it, and for things that they do not really need. But for now, we have to ignore the ethical questions.
The play for Provident was a huge one – valuing it at £1.3bn to be paid for by the issuance of new NSF shares. From today’s market cap of £80m we can see that the size of it was colossal.
Traditional valuation metrics don’t really explain the company that well. For instance, cash flow here is entirely negative, as money is lent out in full and is repaid over a much larger period of time. If the business is growing this metric always is negative.
Perhaps the discussion can be summed up from the annual report:
The company has used monies raised to purchase loan books. Monies loaned to customers are funded by debts, the interest rate differential provides for the margin. The second column relates to amortisation costs and exceptional items. We can see why these are excluded, in the first case they are non-cash, representing cash that has already gone and in the case of exceptional costs, not repeated.
It is difficult to appraise a good level of amortisation for acquired loan books. If it is the case that the economy ends up not doing as well, then bad debts increase giving rise to a larger provision fund, meaning that the current loans are worth less. On this point, it may be difficult to forecast, but the reduced anticipated growth may reflect a desire to write better quality loans instead of more of them.
The group carried something like £270m debt at the time of the last annual report, from a limit of £285m. It is mentioned today that there is an additional debt facility, that will be used to fund further growth. Crucially though it does not say how much this will be for, but looking at the interest charge it seems that NSF are paying a high interest rate. This correlates with the experience on Wisealpha where many consumer lending bonds are charged accordingly. Amigo Loans, for instance pays a yield of 7.625% and there are even higher yields such as Lowell (11%).
Are Non-Standard Finance shares good value?
Clearly this may depend upon perspective. The finance cost of the business looks high, but this is split between discretionary and non-discretionary costs. The firm continued to pay a dividend, costing £7.2m which looks very costly in the scheme of things.
There is cash being generated by the loan book as customers repay their loans, but a look at the cashflow statement shows that as the firm continues to write more loans, the cash consumed by operations continues to grow, and is funded by debt. Whether this is sustainable or not thus really depends on debt, but there has not been an issue so far in getting it. This can continue for some time – Provident owe something like £1.7bn, much higher than the debts here. Unlike many other businesses, higher debt does not have to imply greater risk, as on the other side of the coin the firm has an asset generating cash at a much larger rate than the interest rates. It is more the quality of those assets that count.
Impairment thus remains the biggest risk to the business and a big downturn in the cycle could eventually threaten the viability of the whole thing, as debt holders will still want to be paid. Currently the margin for error looks fine for a year or so, but the longer that continues the more uncertain it looks.
Another unknown is legislation, and it is rare that these measures benefit companies, with the exception where other firms are forced to quit markets, reducing competition.
It goes without saying this is quite a risky investment, but not one without a good upside, and if business does recover it may be a better option than holding the debt instrument considering the dividend. It is easy to sit on the fence here, particularly when there are many other competitors to evaluate. 3/5.