Interactive Investor

Stockwatch: it’s all coming together for this AIM share

11th May 2021 16:24

Edmond Jackson from interactive investor

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A strong balance sheet, rising gold price and resumption of foreign travel make this one to track. 

Overall prospects appear to be conflating usefully for H&T Group (LSE:HAT), an AIM-listed financial stock that is the UK’s leading pawnbroker. At prelims last March, management said that social distancing and Covid restrictions would determine the extent the group could return to pre-pandemic activity levels. A successful roll-out of the vaccine programme would likely lead to increased demand for its services and ability to rebuild its pledge book. 

With those conditions being fulfilled, inflation fears are driving gold prices higher which help the group’s gold trading side (purchasing and jewellery scrap). And the prospect of travel steadily resuming is attractive for foreign currency supply which it also provides. 

Regulatory risks may be priced in 

There is an overhang however, of a Financial Conduct Authority (FCA) review of high-cost short-term loans, with the outcome due this current second quarter. On the basis the market typically fears uncertainty than the outcome reality, it adds to reasons why now is timely to have H&T in your sights. It also helps explain why the stock’s recovery from Covid-related volatility in the last year has been relatively cautious. 

This stock has traded between 140p and 390p over the past 12 years and currently sits at 290p, with substantial growth in cash flow capability (see table) to boot. Acquiring 65 stores and 29 pledge books for around £15 million nearly two years ago, has strengthened H&T’s position to some 253 stores lately. The stock has paid useful dividends during this period however, now offering a circa 3% yield. Strength of balance sheet lends scope to raise dividends while also backing the stock fully by way of net tangible assets.  

Weaker pledge book explains cautious 2021 forecast  

The 2020 results showed modest 20% declines in profit variables with diluted earnings per share (EPS) down 27% to 32.1p. Pre-tax profit of £15.6 million looked resilient however, despite Covid-19. Stores were closed from end-March 2020 to mid-May, then short-term credit was added to the government’s “essential services” list and jewellery sales shifted online also to click-and-collect. 

Hence, overall performance came in ahead of expectations, as government furlough measures helped pawnbroking customers continue to repay their loans. Demand for jewellery and watches rose, and higher gold prices helped gold purchasing.  

However, the pledge book – potentially viewed as an order book or “backlog” at some other companies – declined 33% to £48.3 million, and the personal loan book slumped 65% to £5.9 million. Demand for small-sum short-term cash loans is expected to remain modest until restrictions ease, as they are doing. 

It explains why the company appears to have guided for a fall in net profit this year to about £7.6 million and EPS of just over 19p. This temporarily negative scenario puts the stock on 15x earnings. 

Quarter of gross profit linked to gold and FX 

Segmental information shows pawnbroking accounted for 45% of H&T’s £76.4 million gross profit last year (after impairment charges), with gold purchasing at just 9% and pawnbroking scrap (linked to gold prices) at 8%. Foreign exchange and other financial services also represented 8%.  

A total 25% of gross profit therefore relates to gold prices and resumption of foreign travel. 

The market forecast is for net profit to recover to £13.5 million in 2022, which as a mean reversion would be 8% ahead of 2020, albeit 19% down on 2019. It would imply a medium-term forward price/earnings (PE) ratio sub-9x. If this at all reflects company guidance, H&T appears to be leaving scope to get lucky as the post-pandemic macro context improves, and if gold continues to rise. 

Note also how last year’s 114% growth in net cash flow from operations to £55.4 million was impressive during the pandemic, despite being helped by the July 2019 stores/pledge books acquisition. It compared with investment needs of just £6.2 million and the table shows free cash flow continuing to radically advance in 2020, well ahead of earnings per share. This augurs well for dividend growth. 

Balance sheet strength augments dividend potential 

Recent cash generated has been significantly applied to eliminate £26 million of borrowings, although £20.6 million lease liabilities remain after reducing 16% from 2019. H&T continues with an undrawn £35 million credit facility. 

Year-end cash soared from £12 million to £34.3 million; admittedly, due also to less pawnbroking/lending activity. 

Trade receivables – the pledge book – therefore fell 39% to £55.8 million, which tempered the improvement in year-end net assets to £134.5 million, or by 10%. Yet subtracting £22.1 million goodwill/intangibles means the stock currently trades at a slight discount to net tangible assets of 295p a share. 

Such a balance sheet implies capability to re-rate dividend payouts once the pawnbroking/lending trend becomes clearer, unless there is swingeing regulatory intervention that compromises margins. In low-teen percentages (see table) however, H&T’s operating margin in no way looks usurious. 

Expectations (or guidance) for a 7.5p a share payout this year imply only a modest 2.6% yield, but if the 11.6p target for 2022 is fair, then it rises to 4%. While earnings cover is being kept at around 3x, free cash flow cover has been substantially more in the last two years. 

Admittedly, the board appears cautious and sensitive about dividends in relation to underlying trading, for example omitting the 2019 final payment, although many companies did likewise from March last year. 

H&T Group - financial summary
Year ended 31 Dec

  2014 2015 2016 2017 2018 2019 2020
Turnover (£ million) 87.7 89.2 94.2 125 143 160 129
Operating margin (%) 7.1 8.4 10.6 10.0 11.4 14.0 13.1
Operating profit (£m) 6.2 7.5 10.2 12.5 16.2 22.5 16.9
Net profit (£m) 4.3 5.4 7.6 9.5 11.0 16.7 12.6
Reported earnings/share (p) 11.8 14.9 20.9 25.9 29.6 43.8 32.1
Normalised earnings/share (p) 17.5 14.9 21.4 25.9 85.4 89.3 46.4
Price/earnings multiple (x)         6.3
Operating cashflow/share (p) 39.8 31.0 3.6 -9.5 19.4 67.8 141
Capex/share (p) 3.1 3.3 5.3 4.8 9.1 23.4 15.8
Free cashflow/share (p) 36.7 27.7 -1.7 -14.3 10.3 44.4 126
Dividend per share (p) 4.8 7.6 9.2 10.5 11.0 4.7 8.5
Dividend yield (%)           2.9
Covered by earnings (x) 2.5 2.0 2.3 2.5 2.7 9.3 3.8
Net debt (£m) 9.4 2.0 5.1 13.1 37.4 38.6 -13.8
Net asset value/share (p) 247 255 267 266 276 309 338

A particularly good stock for inheritance tax relief 

The inheritance tax (IHT) wrapper was significantly introduced to respect AIM companies’ high-risk profile, but, despite H&T’s weak capital growth record (ie no high return either), it is a solid stock with a good dividend record. Unless the FCA thoroughly disrupts high-interest lending, H&T is very useful to capitalise on AIM’s principal tax relief.  

Cautious investors may prefer to wait and see if any fine might be applied instead, but unless severe, it is possible the market would see it as clearing the air and mark the stock up anyway. 

A hedge against inflationary concerns 

Gold exposure is now helping. After the gold price fell from £1,575 equivalent an ounce last August, to £1,220 early last March, it has risen 8% to £1,317 as fears of inflation grow.  

Economists are divided as to whether this is due chiefly to supply bottlenecks as the pandemic eases in major economies; or an era of higher inflation beckons, and governments and central banks welcome it as a means to temper colossal public debts. 

Whatever outcome, inflationary fears are definitely rising, as reflected by the gold price, which could attract momentum buying now its chart looks bullish. 

Relatively out-of-favour but able to gain attraction 

H&T’s long-term record tempers enthusiasm for serious capital growth, but its overall risk/reward profile appears attractive, especially versus many stocks that have already soared in anticipation of better results to come. 

Averaging in could be a sensible tactic given H&T is currently priced partly to reflect regulatory uncertainty. Given clearing the air could (more than) offset any financial hit, I suggest: Buy. 

 

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