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Questor: high yield, low valuation – either something’s about to go wrong or this is a buy
Questor share tip: this column is in the latter camp when it comes to S&U, the specialist lender, although we must acknowledge the risks
You would think that any firm that had a record of increasing its dividend in each of the past 10 years was doing something right, especially if it could also point to a stretch of 19 consecutive gains in annual pre-tax profits.
Motor finance expert and specialist lender S&U is just such a company – yet shares in the firm, a constituent of the FTSE SmallCap index, have fallen by a third from their highs of a year ago.
That decline leaves the stock on a forward price-to-earnings ratio of less than eight and a yield of more than 6pc.
Investors must now decide whether this is a case where the numbers are just too good to be true, as that combination of a lowly earnings multiple and fat yield is often the market’s polite way of saying that it does not believe the forecasts. The full-year results released last month suggest instead that the stock may simply be underloved and undervalued.
S&U operates in two niches that the big banks appear content to leave alone. Through its Advantage Finance arm, S&U provides non-prime loans for cars, while the fledgling Aspen Bridging operation offers property loans for individuals and commercial borrowers who wish to buy or refurbish an asset.
Some investors may instantly recoil if they have concerns over the economy and the car and property markets in particular. Provisions against loan losses did rise at S&U last year and a downturn in the economy and any associated jump in unemployment could jeopardise customers’ ability to repay their loans.
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But S&U does manage risk in a disciplined manner, as you would expect of a company that dates back to 1938 and can point to three generations of management by the founding family, which still has a major shareholding.
Group-wide lending dipped by 8pc to £152m last year and annual collections rose by more than a quarter to £200m as S&U prudently adapted to the uncertain economic environment.
The number of annual advance transactions fell by 14pc to 21,053 at Advantage in 2018 as management tightened underwriting policies, helped by its Dealflo system, and maintained its focus on the second-hand car market, which has continued to grow.
There is no exposure to the personal contract purchase (PCP) financing packages that served to drive new car demand to what could prove to be unsustainable levels and leave the finance provider exposed to the risks posed by the significant payments due when the plans end.
Instead, Advantage offers hire purchase plans that are repaid over an average of four years and come with an average loan size of just over £6,000. Full repayment also means there should be no residual car value risk to S&U at the end of the deal.
At Aspen, the average loan size is £375,000, a sum too small to interest larger mainstream lenders, but one that is allowing S&U to establish a profitable business. In just its second year of operation Aspen grew its loan book by 60pc to £18m and broke into the black, encouraging management to make further investments.
A new £25m credit facility means that S&U’s £108m net debt figure compares with available funds of £160m, so there is plenty of headroom available to bankroll future growth. Aspen will be a particular focus, given plans to increase revenues here by 50pc in each of the next two years.
And even if Advantage pauses in its growth trajectory again this year, that plump yield, twice covered by forecast earnings per share, means that investors are being paid to wait. Note that S&U usually pays two interim dividends and a final during the year.
The final dividend for 2018 of 51p a share will be paid on July 12 to investors on the share register on June 21, assuming approval at the annual meeting next month.
In this column’s view the share price weakness of the past 12 months reflects wider market sentiment and economic fears, not the company’s underlying performance.
There are clear risks but the attractive valuation and yield mean they could be worth it.
Questor says: buy
Ticker: SUS
Share price at close: £18.05
Russ Mould is investment director at AJ Bell, the stockbroker. For the best of the Telegraph's investment analysis, advice and expert opinion, sign up to our weekly newsletter.