Interactive Investor

Stockwatch: An AIM share well-placed to weather a recession

18th August 2017 08:50

Edmond Jackson from interactive investor

Do strong interims from pawnbroker H&T Group portend an upgrade in forecasts and rating? The AIM-listed firm, which used to be listed as Harvey & Thompson, has achieved a 62% advance in pre-tax profit to £6 million for the six months to end-June, on revenue up 15.7% to £49.1 million.

Management says "the results reflect a series of initiatives beginning to bear fruit and a favourable gold price", although the macro context - of tighter lending criteria by high-street banks - looks also to be driving customers towards H&T for loans.

The stock jumped 10% in response to test 300p, sensing potential. While the interim numbers look consistent with a consensus for £11.1 million profit in the full year, last year's profit weighting was about 40% first half, 60% second. Although the narrative doesn't guide up full-year forecasts, it creates room to do so.

Meanwhile, at 290p currently the stock trades on about 11 times the 12-month forward earnings consensus, which looks as if upgrades are starting to creep in (comparing recent days) and is cheap if current growth is reasonably sustainable.

A circa 11p per share dividend expectation implies a prospective yield of about 3.8% covered 2.3 times by earnings, and 217p net tangible assets per share as of end-June. Both underpin the stock.

Macro context looks medium-term supportive

H&T is wholly UK-oriented, but whichever turn the economy takes it looks capable of progress. In the short term, the Bank of England is encouraging banks to tighten unsecured lending criteria to mitigate risks of rising consumer debt. This is aiding H&T's personal loans book, which soared 87.3% to £11.8 million.

"A combination of competitive pricing and increased awareness has seen us establish ourselves in this market and customers are now actively seeking us out."

Loan offers have been broadened, also, for existing customers who are now accessing longer-term, lower-cost loans.

If the UK economy turns down during Brexit years, respecting also a very long up-turn since 2009, pawnbroking should benefit as people become forced to raise cash - especially luxury items bought on credit or a leap of abandon in easier times.

Even a scenario such as a shock rise in interest rates - say if inflation was to humiliate the Bank of England governor's low interest rate stance - would seem to benefit pawnbroking, even if lending drops.

Strengthening gold prices have also benefited H&T as tensions over North Korea prompted a surge of buying in the Far East. Sterling weakness quite encourages gold buying here since the ultimate gold price is based in US dollars; thus, gold's sterling price is up about 15% this year, which boosts gold trading and enhances pawnbroking scrap profits.

Not to assert a "golden future" whatever happens, as jewellery sales could well ease with discretionary spending, but H&T has various strands able to thrive in different scenarios.

Company actions are taking advantage

Management has "redefined the pawnbroking model" and expanded the offering of high-end watches, having invested in the est1897.co.uk website (pre-owned watches and jewellery), and proclaim "a milestone year" with enhancements across the group and its 181 high-street outlets.

Thus, the main retail business has interim sales up 12.5% to £15.3 million and gross profits by 22.9% to £5.9 million, amid higher inventories and margins. Jewellery sales leapt 45% as new ranges complemented pre-owned. Improving the est1897.co.uk website means over 500 high-end, pre-owned watches online, which will rise further.

On the personal loans side, revenue is up 46.7% to £2.2 million as loans expand 87.3%. Management says this is principally due to developing the store business as well as online sales and via third parties.

They claim the H&T personal loan product is one of the most affordable and flexible, with two new lower interest rate and long-term products launched.

Visits to handt.co.uk soared 129% in the first half of 2017 like-for-like, mostly from loan and brand-related searches. In gold, profits rose 20% to £1.8 million, mainly due to a 48% rise in gold volume scrapped to £6.5 million.

For pawnbroking, scrap gross profit rose from £600,000 to £1.2 million on revenue up 20.4% to £5.9 million. "Other services" were flat at £2.7 million amid varying performance by currency exchange operations.

H&T Group - financial summary      Consensus forecasts
Year ended 31 Dec 2012 2013 2014 2015 2016 2017 2018
Turnover (£ million) 130 99.3 87.7 89.2 94.2    
IFRS3 pre-tax profit (£m) 17.0 6.7 5.5 6.8 9.7    
Normalised pre-tax profit (£m) 17.1 7.7 5.8 6.9 10.3 11.5 12.5
Operating margin (%) 14.3 8.4 7.3 8.3 11.3    
IFRS3 earnings/share (p) 35.5 13.4 11.8 14.9 20.9    
Normalised earnings/share (p) 35.9 16.1 12.7 15.1 22.7 24.5 26.6
Earnings per share growth (%) -26.0 -55.1 -21.2 18.6 50.6 7.9 8.5
Price/earnings multiple (x)         12.6 11.6 10.7
Historic annual average P/E (x) 6.2 10.2 14.6 15.7 12.6    
Cash flow/share (p) 31.9 42.7 39.8 31.0 3.6    
Capex/share (p) 17.5 6.8 3.0 3.3 5.1    
Dividend per share (p) 10.8 10.2 4.8 6.2 8.4 10.4 11.4
Dividend yield (%)         3.0 3.7 4
Covered by earnings (x) 3.3 1.6 2.6 2.4 2.7 2.4 2.3
Net tangible assets per share (p) 186 187 196 205 218    
Source: Company REFS

FCA regulation on high-cost credit

This appears a potential googly that regulators could bowl, although H&T looks well-poised anyway.

In July, the Financial Conduct Authority maintained its price cap for high-cost, short-term credit; H&T's personal loans being all below the current cap and the majority significantly so.

Lower interest rate products are enabling customers to migrate from high-cost credit, which would appear to compromise margin but "is in the best interests of customers and is a more sustainable product for our business".

Thus, management wrests some virtue from a regulatory shadow that may also explain the stock's modest rating. At least its lending operations are not being compromised and the outlook statement cites "demand for small-scale, short-term cash loans remaining strong".

Gold price volatility has been an historic check

In 2013 the stock more than halved as a (post-)recessionary boom in gold buying faded and gold prices plunged; this being just one modest leg of the business is shown by a progressive stock recovery from 127p. Also, profits from gold were ploughed into expansion, achieving twice the number of stores pre-recession.

Sentiment, therefore, over-reacted on the downside in 2013, although admittedly revenue has yet to re-gain the £130 million achieved in 2012.

Gold seems less of a bubble nowadays, enjoying firm demand as a means to hedge against risk assets, although it will always be a speculative market based on sentiment.

The more likely risk of a check lurks in consumer credit, although the Bank of England appears well-attuned and a sudden hike in interest rates seems unlikely. UK inflation smoulders but there's no current prospect of an external shock to bump it up like oil prices did in the 1970s, causing mayhem.

Net positive risk/reward profile

H&T isn't immune from setbacks - jewellery sales may be exposed - but conditions are opportune for a commercial mix of lending, pawnbroking and gold trading.

Should they deteriorate overall, group debt remains a £21 million long-term bank loan implying net gearing of 11.4%, its cost shaving just 4.1% of interim operating profit, thus ample leeway should profits fall and/or interest rates rise.

This stock is therefore potentially useful as a modest hedge against a UK slowdown, also for exposure to gold without worry as to inherent volatility in mining stocks or gold ETFs.

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