The Morses Club share price (LON:MCL) slipped by almost one third today as the doorstep lender downgraded profit expectations for the year. The share price was marked down as soon as it opened:
This sector has been extremely untidy for some time. Morses Club specialise in ‘doorstep’ loans, typically smaller amounts of cash made at high interest rates. This type of lending has attracted much controversy and no doubt many investors will give it a wide berth on ethical grounds. In the past few years we have seen former poster-boy for the industry Wonga collapse, the FCA crackdown on standards, and a messy tug of war between Non-Standard Finance and Provident.
As with many in this sector, an investment hasn’t seen happy times for investors. Morses Club IPO’d into the market in 2016 at an initial price of 108p. The share had performed well until this time last year when things started to unravel, and todays warning pushes the Morses Club share price to all-time lows.
What’s gone wrong at Morses Club?
The bad news comes in a trading update released this morning. On the face of it, it sounds OK:
The performance of the Home Collect Credit (HCC) division during the period has been very strong in a sector that continues to face headwinds and is expected to maintain like-for-like profitability. Total credit issued of £174.2m was slightly lower at -2.4% year-on-year (FY 2019: £178.5m). We continue to make operational efficiencies as a result of our investment in technology and agent recruitment over the last four years.
There was good news regarding the FCA:
As anticipated, the change in the FCA regulations on the non-solicitation of loans has had a minimal impact on our business, demonstrating the prudent and tight credit controls employed by Morses Club.
It sounds like the Digital division may be where the problems are at:
2019 was a year of significant change for the Group’s Digital division, following substantial acquisition activity, incorporating Dot Dot Loans and U Account. The businesses have undergone significant re-engineering and are now better positioned to take advantage of the opportunity in the wider non-standard credit market. Although losses in the Digital division have been higher than initially expected, we have focused on ensuring that we ultimately create a customer journey with high quality lending and operational routines, resulting in a digital product set that is best suited to our addressable market. The Digital division is still on track to deliver a substantial improvement in losses during FY21, and to reach run-rate break-even during H2 FY21, reflecting the significant investment Morses Club has made in line with its strategy of diversifying its product offering.
This is quantified in the profits:
Although we anticipate a robust overall profit performance, the adjusted profit before tax for the Group will be reduced by 18% – 23% against consensus. The Company intends to maintain its existing dividend policy.
The last research note was on 15 January (available on Research Tree) and gave adjusted profits as £19.9m, so this is quite a miss.
Morses Club: A difficult change
Loaning money is perhaps one of the oldest professions in the world, so this business is not too difficult to understand. Morses Club’s point of view is that they provide an essential service: providing credit to customers who are unable to get credit anywhere else. With an average income of just £15,000, they serve some of the poorer customers in society.
The doorstep type of loan may be dying out. Technology can replicate virtually all parts of this process and at a cheaper price, unless for some reason a customer has no bank account. The ‘benefits’ of a face-to-face collection seem rather marginal. It is here where the FCA are regulating, with standards on conduct and costs.
Morses have begun to take steps to move away from this and are expanding their digital offering. It has done this by means of acquisitions, the latest being U Holdings. These acquisitions have given them a range of different online brands and a foothold into the market.
Profitable, but can it be sustained?
A clip from their annual report shows the scale of profitability:
Things have moved on since then, and the interim results mask that this is a business really split into two halves: the Home Collect side is making money, and the digital side is losing it. The reasons for this at the moment are not operational, but the cost of integrating acquisitions into the business. The payback was not to be seen until 2021 at least, where revenues would exceed £150m.
One of the issues regarding loan lenders is that profits may not necessarily relate to cashflow, as the date of recognition can differ from the date when the money is actually received. And with money needed initially to satisfy the loan contract we may have a business which is paper profit rich, but cash poor. Customer receivables for these loan companies are also not equal to standard receivables, as customers are much less likely to pay out. Amigo Loans scored poorly on these metrics, leading to a company that seems superficially cheap (market cap £100m, profits £85m).
Morses Club are better in this respect. There is a high level of provisions: £42m of the £115m receivables implies that many loans will not repay. There is also a very high current ratio: there are not many current liabilities relative to assets. However, it should be noted that the loan receivables make up the bulk of the assets of the business.
In terms of debt, the major item is a bank loan for £14,5m. There is plenty of headroom on these facilities, which go up to £50m. However, with finance costs in the last year of £1.75m these facilities do not look cheap.
Is the Morses Club share price good value?
This sector has taken a rather hard clobbering over the past few years and most of the companies trade at very low earnings ratios. The rationale is perhaps that they should: there is certainly a good chance that legislation could be passed which makes many of these businesses unprofitable.
Specifically in the case of Morses Club, the standard Home Credit segment is declining: the prospect of this being re-ignited seems slim. This trend seems clear from the Non-Standard Finance profit warning last year. So most of the bets here will be going onto their digital products. It may seem the case that these products could be cross-sold, thus accelerating the decline of physical contact. That puts the likes of Morses Club into fierce competition with others: there are few real barriers to entry.
More recent events offer more headwinds. The coronavirus threatens a recession, which leads to higher level of defaults on the loans. Many companies have given priority to quality over quantity, but it may be too late for previous loan cohorts. Loan provisions may need to be increased. If the virus gets any worse, it may be the case that knocking on doors is discouraged for a while.
Perhaps this could be a case of cigar butt investing. The price is cheap and even a cut dividend would still be a very good percentage return. But this is off a business whose main sector is in decline, and its new sector is competitive and open to disruption and potential legal changes. My own opinion is that the value is finely poised but there is not much upside. 2/5.