Interactive Investor

Stockwatch: Golden opportunity or AIM stock to avoid?

17th August 2018 10:51

Edmond Jackson from interactive investor


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Gold price weakness has pegged back shares in this AIM company, prompting companies analyst Edmond Jackson to ask if its recent drift offers an opportunity.

A broadly drifting 2018 share price for AIM-listed pawnbroker and gold trader H&T Group points to two possible explanations.

One is weakness in the sterling gold price – in which case "add". Or is it due to concerns that "high-cost credit" for people rejected by banks is coming under closer (regulatory) scrutiny; in which case might the stock be signalling "sell"?

H&T needs a review given that I last drew attention in January at 345p after the company had twice upgraded prospects, rating it "Buy" and targeting 400p given that only needed a modest price earnings (PE) multiple of 12 times forecasts.

I'd previously drawn attention exactly a year ago at just below 300p, post-interims, suggesting H&T's underlying momentum made upgrades likely.

These duly followed after a November update guided profits higher – not only due to firm gold prices benefiting pawnbroking scrap and gold trading, but also personal lending helped by "several years’ investment in products, people and systems to address the new consumer and regulatory landscape".

So when the board raised expectations for the 2018 results further, in a January update, citing the personal loans book nearly doubled to £18.3 million, the company was looking good for the medium term.

Its stock drifted slightly in the following months then rallied to 370p in June but is now 316p, having dropped to 303p in July.

Still a need for higher-risk consumer credit

From a macro perspective it's a concern how UK consumer borrowing appears once again high, as if 2007/08 will end up repeated.

But on a human level, a more unequal society with growth in work on zero hours contracts makes it likely more people will get rejected by banks – for credit just to get by, than discretionary buying - hence demand for small-scale, short-term cash loans will remain strong.

Note 2 on segmental reporting within H&T's latest interims show personal loans constituting 15.4% of group revenue and 24.8% of gross profit, which looking back a year I see compares with 4.4% and 7.7% respectively - growing fast in significance, as shown also by the personal loan book up 78% to £17.8 million.

This is said in part due to more customers being offered lower interest rate products which sounds attractive for competitiveness and longevity, higher revenues potentially more than offsetting margin loss.

Moreover, in terms of existential risk to this type of lending e.g. from adverse media coverage or regulatory actions:

"We have made progress in delivery of the longer-term strategy of helping our customers to rebuild their credit rating, with more customers accessing lower interest rate and longer-term products; hence loans defined as high-cost short-term credit have fallen from 71%."

Some might say this kind of lending is ethically questionable, others that it fills a supply gap the banks have created. I tend to think it is legitimate - a higher interest rate for higher-risk borrowers – so long as it doesn’t result in debt dependency becoming more widespread.

Mind an off-chance, the FCA's current consultations with these lenders could still result in actions that check profits: while H&T's personal loan book margin has fallen from 44.5% to 37.5%, that’s still a very good margin.  But I doubt the FCA will strike an existential blow.

Share price fall broadly reflects gold prices

Having twice hit 370p in June the stock then fell 18% which compares with a 9% fall in gold prices albeit in US dollar terms, hence sterling's recent weakness accounts fairly enough for the rest of the fall.

Possibly some investors opted to lock in gains after a very good run from 150p some 4-5 years ago, if applying a trailing stop loss to protect profits. Yet gold prices broadly account for the drop in H&T, and they shed a further 1% on 15 August, as concerns about the mounting crisis in Turkey and also China's economic health, weighed on emerging market currencies.

Not for the first time, gold isn't always a sound insurance policy against financial turmoil; e.g. and especially in the 2008 crisis it plunged along with most other asset classes. Yes it then set the stage to rally, but so did stocks. 

On this basis H&T rates "Add" although if you are wary of gold's behaviour on its price then watch it for the time being - see whether this Turkish crisis is contained as a mid-summer sensation, or morphs more seriously into contagion, and how gold prices respond.

H&T Group - financial summary           Consensus estimates
year ended 31 Dec 2013 2014 2015 2016 2017 2018 2019
Turnover (£ million) 99.3 87.7 89.2 94.2 110    
IFRS3 pre-tax profit (£m) 6.7 5.5 6.8 9.7 14.1    
Normalised pre-tax profit (£m) 7.7 5.8 6.9 10.3 14.7 14.2 16.5
Operating margin (%) 8.4 7.3 8.3 11.3 13.7    
IFRS3 earnings/share (p) 13.4 11.8 14.9 20.9 20.9    
Normalised earnings/share (p) 16.1 12.7 15.1 22.7 30.9 33.7 36.3
Earnings per share growth (%) -55.1 -21.2 18.6 50.6 36.3 8.9 7.7
Price/earnings multiple (x)         10.2 9.4 8.7
Historic annual average P/E (x) 6.2 10.2 14.6 15.7 13.2 10.9  
Price/earnings to growth (x)         0.3 1.1 1.1
Cash flow/share (p) 42.7 39.8 31.0 3.6 -9.5    
Capex/share (p) 6.8 3.0 3.3 5.1 4.7    
Dividend per share (p) 10.2 4.8 6.2 8.4 9.6 11.0 11.5
Dividend yield (%)         3.0 3.2 3.5
Covered by earnings (x) 1.6 2.6 2.4 2.7 3.7 3.1 3.2
Net tangible assets per share (p) 187 196 205 218 287    

Source: Company REFS         Past performance is not a guide to future performance

Robust interim results overall

Pre-tax profit is up 10.9% to £6.1 million, on revenue up 18.7% to £68.5 million, with EPS up 15.4% to 13.5p although the interim dividend only by 0.1p to 4.4p. 

This follows 2017 results last March that delivered headline/normalised pre-tax profit figures over £14 million versus £12.6 million as was the company broker's forecast last January, alongside one for £14.2 million in respect of 2018.

That hadn't changed as of end-July but given the 2017 results were about 60% weighted to the second half, the full-year 2018 outcome ought to show growth (than a presently implied, flat scenario). 

An amber light in that respect is a vague caution that's crept into the narrative, citing a trading environment that's "become more challenging with high street footfall reductions and localised competitor activity."

Retail – as a category distinct from pawnbroking, scrap and gold purchasing – constitutes 23.9% of interim revenue and 14% of gross profit, with H&T continuing to talk bullishly about its "est1897" website that specialises in selling high-quality jewellery and designer watches without hefty price tags.

It's hard to guess the extent this could be compromised by lower discretionary consumer spending, or benefit from switching from new-bought.  

Websites have been upgraded and H&T continues to invest in digital as its pawnbroking business model is refined to "clicks and bricks" retail and lending, leveraging the store estate.

Balance sheet offers resilience to downturn

This isn't a strongly cash generative business, e.g. £2.3 million paid out as dividends during the first half broadly equated to gross cash from operations, though after tax and finance costs it was £0.5 million.

Thus in the recent timeframe under consideration, end-June cash edged down slightly to £9.3 million and growth is being financed by long-term debt – up 24.4% to £25.8 million – amid higher working capital needs, including the personal loan book. 

However a 1.0x ratio of net debt to EBITDA (close to operating profit) is ample versus a covenant test of 3.0x and the group has £9 million headroom on a £35 million facility. This means H&T can continue to invest organically and is sound to withstand more challenging trading, but don't expect anything transforming by way of acquisitions.

So whether an existing shareholder or with fresh money, you might prefer to watch and wait rather than jump straight into the market, though H&T is one to buy when sentiment is against and already its forward PE is a modest 9 times. Thus broadly: Add.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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