S&U has smart approach to motor finance
Small cap stock looks attractive despite market worries about its industry
Motor finance specialist S&U (SUS) offers a decent 5% prospective yield and trades at an attractive valuation. Restrictions over the type of borrower it accepts as a customer and the types of finance it offers mean it is less exposed to the risks associated with the current credit boom in the car market, in our view.
The company’s recently released results for the six months to 31 July make for encouraging reading. S&U’s pre-tax profit reached £14.3m, a 20% increase year-on-year. Its motor finance business enjoyed its 17th consecutive year of increased profit.
Chairman Anthony Coombes says of all loan applications, 70% are declined straight away due to S&U’s strict acceptance criteria. Of the remaining
30%, only 3% will be given finance.
The benefit of this robust underwriting approach is reflected in the company’s strong track record.
AGGRESSIVE LENDING PRACTICES ELSEWHERE
There are well founded concerns about aggressive lending practices in car financing, although these tend to be at the prime end of the market.
Gary Greenwood, an analyst at Shore Capital, says manufacturers’ finance companies continue to offer cheap personal contract plan (PCP) deals in order to help sell new cars.
He adds: ‘By contrast, (S&U-owned) Advantage Finance does not offer PCP, with all of its loans made on a hire purchase basis with full repayment made over the life of the loan thereby meaning that there is no residual risk to S&U at the end of the deal.
‘A loss would therefore only be incurred to the extent that customers were to default, with the latter requiring a sharp rise in unemployment in our view, which is not currently our central case.’
PCP involves a customer paying a lower monthly amount during the contract period, typically between 24 and 48 months, leaving a final ‘balloon payment’ at the end of the agreement. At this point they either buy the car outright or switch their PCP agreement to a new car.
Advantage Finance’s loans are not PCPs and are made on the basis that full repayment will be made over the loan period, usually up to four years.
One potential long-term risk for the business is the evolution of the electric vehicle industry. If conventional combustion engine cars are replaced by hybrids and electrics which need less maintenance, there may be lower vehicle turnover and hence less demand for car finance.
Ben Thefault, analyst at Arden Partners, says the company is ‘significantly undervalued’ as it is weighed down by sector sentiment.
Using Thefault’s forecasts, at £20.75 S&U is trading on 10.3 times January 2018 earnings per share of 201.5p. (DS)
The company is ‘significantly undervalued’