Interactive Investor

Stockwatch: why I have serial affections for this AIM company

5th July 2022 12:14

Edmond Jackson from interactive investor

Risk/reward profile looks attractive for this small-cap set to benefit from tough times, believes companies analyst Edmond Jackson. 

How seriously should you take a bullish update from the UK’s largest pawnbroker H&T Group (LSE:HAT)?  

Strains on households are implicitly rising, given the way the company’s end-June pledge book is up 74% year-on-year, or by 26% in the last six months “with growth across the group’s customer base and in all geographies”. Lending volume is now 40% above pre-pandemic levels.  

Perhaps the question for buying the stock now is whether such behaviour ingrains – as stagflation or even recession take grip – such that H&T could enjoy say two years of prosperity. 

Pawnbroking constituted 59% of 2021 gross profit versus 22% for jewellery/watch retail; hence H&T should be a net beneficiary of a chastened consumer environment despite the risk of lower consumer spending affecting jewellery sales. 

I suspect buoyant trading in jewellery has been significantly helped by loose monetary policy boosting collectibles. Soaring watch prices help explain why H&T has just announced the acquisition of a watch servicer.  

In which case, and as global monetary policy now tightens, might this temper demand for jewellery? For now, H&T says retail jewellery sales are “consistently strong and in line with expectations”- but this could mean flat (albeit in line with budget), given a challenged environment for discretionary spending.  

Valuation is ostensibly cheap but mind moving parts within profits 

The stock has edged up 3% to 333p in recent days, as if acknowledging the progress, warily. 

It would appear forecasts deserve upgrading – potentially for 2023 also – where recent consensus for near £13 million net profit this year and £15 million in 2023 implied 5% earnings per share (EPS) growth, rising to 16%.  

Say we take the 2023 target (pre-update) as a benchmark, then EPS of 38p implies a forward price/earnings (PE) ratio sub-9x. Possibly, the multiple could be lower if pawnbroking continues to do well.   

The update also cites foreign currency revenues more than doubled as international holiday travel resumes. That could be a rebound effect liable to temper if Covid infections continue to worsen, but, overall, it does not look like a return to lockdowns and domestic holidays. Foreign currency trading is within “other” services, accounting for 7% of 2021 profit. 

Mind, however, H&T has withdrawn from unsecured high-cost short term lending, after a regulatory review. However, an extent of personal lending will continue, and the table shows anyway comprised barely 11% of gross profit. 

Moreover, gold purchasing constitutes 8% of profit and is tricky to project, although if gold prices remain strong in an inflationary era, then it is another side of H&T that’s able to surprise on the upside. 

Otherwise, a prospective yield over 4% - assuming recent consensus for a dividend per share of around 13p, rising to 15p in 2023 – is supportive. Similarly, net tangible assets per share was 289p at end-2021 (subtracting £21.2 million goodwill/intangibles from £137 million net assets). 

H&T’s risk/reward profile therefore looks medium-term attractive if this latest update is portentous. 

Long-term financial summary table conveys a growth company 

I have included numbers back to 2014 to show how, were it not for Covid disrupting 2020 and to an extent 2021, H&T shows respectable progress. 

The chief quibble is return on capital only flirting with double-digit percentages, then dropping below 6% in 2021. This needs to recover for the stock rating also to improve. 

Going back decades, when this listed company had a full name of Harvey & Thompson, its stock was typically seen as a recession play – quite like business insolvency advisers Begbies Traynor (LSE:BEG) – on the basis people would turn to “selling the family silver”.  

My recollection in the wake of the 2008 crisis, however, was soaring gold prices boosting group performance but then also attracting competition – if you recall a plethora of “sell your gold” street signs and commercials. Gold prices later fell, which also reduced pawnbroking loan amounts. 

H&T’s performance thus has mercurial aspects that probably help explain its modest stock rating.  

Disclosure: I have been a serial fan of this stock 

I rated H&T shares a “buy” at 260p at end-2018; then 290p in March 2019. Back then even, all its operations showed progress, and a well-managed pawnbroker looked an appropriate core business for an already challenged consumer environment. 

Management had broadened its strategic goal towards becoming “the premier provider of alternative credit in the UK, helping customers protect and re-build their credit rating”. There definitely is a need for consumer finance outside of credit cards or bank overdraft.  

In January 2020, I reiterated “buy” at 380p as gold prices rose and a trading update cited 2019 EPS likely higher than consensus for 26% growth. Even before this update, the forward PE had looked around 8x and the prospective yield quite material at 3.6%. 

But Covid forced the network of 253 stores to close until a phased re-opening from mid-May, resulting in 2020 EPS nearly halving and the stock falling to 260p by the year end. 

Group performance continued to fall in 2021, but by year-end the pledge book had risen 39% to near £67 million, with demand fully recovered to pre-pandemic levels. 

The story became tainted by a regulatory review of H&T’s unsecured high-cost short-term loans business – covering April 2014 to October 2019. It was deemed that nearly 12% of such loans should not have been made, hence total customer compensation of £2.1 million, recognised as a provision in the 2021 accounts. Costs of £600k have also already been accounted for. 

I make these points to show how a bullish case has existed for some time, yet got hit by events – Covid an obviously heavy one. 

H&T Group - financial summary
Year ended 31 Dec

  2014 2015 2016 2017 2018 2019 2020 2021
Turnover (£ million) 87.7 89.2 94.2 125 143 160 129 122
Operating margin (%) 7.1 8.4 10.6 10.0 11.4 14.0 13.1 7.5
Operating profit (£m) 6.2 7.5 10.2 12.5 16.2 22.5 16.9 9.1
Net profit (£m) 4.3 5.4 7.6 9.5 11.0 16.7 12.6 6.0
Reported earnings/share (p) 11.8 14.9 20.9 25.9 29.6 43.8 32.1 15.4
Normalised earnings/share (p) 17.5 14.9 21.4 25.9 85.4 89.3 46.4 31.0
Price/earnings multiple (x)               10.4
Operating cashflow/share (p) 39.8 31.0 3.6 -9.5 19.4 67.8 141 -7.8
Capex/share (p) 3.1 3.3 5.3 4.8 9.1 23.4 15.8 24.2
Free cashflow/share (p) 36.7 27.7 -1.7 -14.3 10.3 44.4 126 -32.0
Dividend per share (p) 4.8 7.6 9.2 10.5 11.0 4.7 8.5 12.0
Dividend yield (%)               3.7
Covered by earnings (x) 2.5 2.0 2.3 2.5 2.7 9.3 3.8 1.3
Return on total capital (%)     8.9 10.1 10.6 13.2 11.0 5.8
Cash (£m)     9.6 8.7 11.4 12.0 34.5 17.6
Net debt (£m) 9.4 2.0 5.1 13.1 37.4 38.6 -13.8 1.4
Net asset value/share (p) 247 255 267 266 276 309 338 343

Source: historic company REFS and published accounts. Past performance is not a guide to future performance.

Vertical integration into watch repair 

The acquisition of Swiss Time Services for £4.3 million is being made from existing facilities. A large proportion of watches sold by H&T are already sent to this repairer/servicer:  around 4,000 expected this year. The deal is expected to be group earnings-enhancing and appears to make strategic sense. 

The chief appeal of H&T, however, and why I re-draw attention, is “the worst consumer environment in 50 years” – likely to get even more difficult this autumn when another energy cap is removed. 

Pawnbroking and specialist lending look set to benefit – indeed are essential services – to an extent that they should easily offset lower discretionary spending on jewellery and watches. 

So, despite a risk, H&T becomes a story of contrasting performance, the balance of probability looks to favour tucking its stock away as a medium-term investment.  

A canny purchaser is FIL Limited of Bermuda, which raised its stake from 8.7% close to 10.0% on 28 June - a few days before the trading update. That shows strong confidence because if things go awry, then a 10% stake can only be cut at a discount to market price for a £133 million AIM company. 

Call me out for having serial affections for H&T if you like, but its risk/reward profile looks attractive. Buy. 

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

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