Interactive Investor

Woodford keeps the faith with Provident - should you?

23rd August 2017 13:51

David Brenchley from interactive investor

Tuesday's aberration for doorstep lender Provident Financial was a big blow to many in the City. The sub-prime lender stunned shareholders by reporting its second profit warning in as many months. The announcement triggered one of the largest one-day share price falls in FTSE 100 history and wiped £1.7 billion off the firm's value.

Shares in Provident ended yesterday trading at 589.5p, 66% below the closing price on Monday, after a plethora of bad news emerged that, unsurprisingly, cost boss Peter Crook his job.

Provident's Consumer Credit division (CCD) is now forecast to post a loss of between £80 million and £120 million this year, down from a £115 million profit in 2016, while its dividend has been scrapped.

Further, it also announced that regulator the Financial Conduct Authority (FCA) has launched an investigation into Vanquis Bank's repayment option plan. The plan currently contributes top-line revenues of £70 million per year.

While Provident won't be a blue-chip stock for much longer, its roll-call of major shareholders certainly is. That's down, in large part, to Neil Woodford. As at 27 July the star fund manager's eponymous investment management company and his former employer, Invesco, owned a combined 40.07% of the business.

Woodford certainly stands by his investment decisions, and he kept the faith in Provident after its first profits warning in June, claiming its decision to bring its self-employed CCD agents in-house would "prove highly beneficial for the business in the medium and long term".

As a result, June's 18% share price fall was an overreaction, he said; the long-term investment case was still intact. In fact, he "took advantage of share price weakness to add to the [his] position" in the firm. That position is split between his Equity Income and Income Focus portfolios.

Yesterday's further fall, then, will have been even more painful. Shares have ticked up slightly this morning to 605p, but the stock is still down almost 80% since 20 June.

Woodford's view

Of course, Woodford has seen this all before. In the short time since he left Invesco back in 2014, he's suffered through G4S's 50% slip through 2015 and the first half of 2016. Since falling to a post-EU referendum low of 145p, the security firm has doubled.

Similarly, Capita fell 57% through 2016, but has rebounded year-to-date to trade up 25% today.

Conversely, Next continues to disappoint, while Allied Minds continues to trade at record lows.

Now, clearly it's too early to tell which way Provident will go. Just last month we asked whether Crook could turn its fortunes around. While "no" is the answer to that question, the follow up just replaces Crook's name with successor Manjit Wolstenholme's.

Woodford had a further say on the matter, calling the announcement "extremely disappointing". "I am surprised that the transition [in its CCD] has failed so significantly," he said.

However, Woodford notes that Provident's three "highly valuable franchises" of Vanquis, Moneybarn and Satsuma are still performing well and that the group overall is still expected to post a profit of at least £80 million this year.

He expects a pre-tax profit of £300 million in 2019, assuming some stabilisation in the CCD with a smaller consumer base and other conservative forecasts in the wider business.

"This equates to approximately 160p in earnings per share in 2019, which at the time of writing represents a price/earnings ratio of around 3 times," he added. "If we assume the resumption of dividends with a 50% pay-out ratio, an 80p dividend would equate to around 15% dividend yield."

He re-iterated his view that share price moves are an over-reaction and that the group is still under-valued. "I continue to believe that it will ultimately get back on track. When it does so, Provident Financial's share price deserves to be appreciably higher than it is today."

The broker view

It seems the stock splits opinion with brokers. While JPMorgan Cazenove is siding with Woodford and sticking with its investment thesis, Liberum reckons the pain is far from over.

Gurjit S Kambo, analyst at JPMorgan, still reckons the shares are worth 3,200p and expects to see continued strong earnings growth from Vanquis, Moneybarn and Satsuma as well as a predictable, high-return profit stream from the CCD.

"We believe the combination results in an attractive total shareholder return, with over 10% EPS growth over the next three years together with an attractive dividend yield."

Liberum's Portia Patel is much harsher and slashes her price target by three-quarters to 487p, from 2,000p, derived using the firm's net asset value.

Patel already had a 'sell' rating on the stock and sees "no reason to own the shares". She's less certain about the CCD's prospects and Liberum's analysis suggests that PFG could be facing a funding shortfall by June 2018 due to a £120 million retail bond maturity in October and £230 million of retail deposits maturing by the end of June 2018.

Patel has now cut her EPS forecasts by 67%, 39% and 41% for 2017, 2018 and 2019 respectively. Her EPS prediction for 2019 is 20% below Woodford's, at 128p, and the analyst thinks "it would be imprudent for PFG to declare a dividend in respect of 2018".

While Woodford was busy meeting with management in order to ease his mind back in June, Liberum was busy putting together a note to clients claiming that "another profit warning for home credit is likely since guidance remains too optimistic".

While it was surprised that came so soon, clearly it's called the event spot on so it could be worth listening to its views this time around, as well. That said, writing off 75% of your investment is going to be a difficult thing to do. Woodford will be hoping Provident is more G4S than Allied Minds.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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