S&U growth portfolio candidate

S&U plc is engaged in the provision of consumer credit and motor finance operating as Loansathome4U and Advantage Finance respectively.  I do not have a holding in this company (epic code: SUS).

Market/Index	FTSE Small Cap	Industry	Banking Services
Sales	£55.0m	Earnings	£10.9m
Market Cap	£183.7m	Share Price	1565p
Norm. EPS	91.7p	Historic P/E	17.1
Est. 2014 growth	19.6%	Prospective P/E	14.2
Est. 2015 growth	21.7%	Prospective P/E	11.7
Rolling PEG	0.56	SGR	9.8%
PBV	2.87	Historic Yield	2.95%
ROE	19.8%	Operating Margin	28.7%
5 yr BV + Div return	14.4%	5 yr FCF return on BV	11.1%

The Business
S&U was founded in 1938 and floated on the stock exchange in 1961; the company is a consumer and motor finance provider, with over 140,000 customers.  Loansathome4u provide valued home credit facilities to customers via over 500 agents across the UK and Advantage Finance provides non-prime finance for motor vehicles through brokers and dealers.

S&U appears to have been a conservatively run business, with the levels of impairment on loans made, being at an acceptable level and well under control.  It is not uncommon for operators in non-standard personal lending to see impairment levels in the mid to high 30 per cent of revenue range:

Click on graph to enlarge

S&U typically will charge interest rates that would appear very high compared to standard lending, but is a fraction of that charged by payday lenders.  A typical customer may have had some credit problems in the past, but a recent good history and an income in the range of £17-27k pa., borrowing £500 from Home Credit over 9 months or £5,000 over 4 years from Motor Finance, for interest rates that may range between 40-90% pa.  Home Credit is managed by local agents who visit borrowers on a regular basis, many are repeat customers over many years.  Motor Finance is managed through brokers and agents and approximately 20% of applicants for loans are approved and of those about 20% agree to convert.

Competition for the Home Credit division is Provident Financial, Shopacheck, Morses and a large number of small localised operators.  The largest competitor for the Motor Finance Division is Secure Trust Bank.

Home Credit represents 57% of group revenue and 36% of pre-tax profits and Motor Finance 43% and 64% respectively.  Motor Finance is the growth engine in the business, with Home Credit supplying steady profits and cash generation.

The management of the business is conservative in nature and the consistency of this approach & culture is made possible by the tenure of the members of the board, who have been with the business from 14 to 38 years.  The directors own just over 13% of the business, although the Coombe family in total own a declared 52% with a charity (Wiseheights Ltd) owning just over 20%, so the level of free float is quite small and therefore low levels of liquidity.

The company does run a small defined benefit pension scheme, but at their previous year-end at 31 January 2013 had a small surplus of £20k.

Quality
S&U's trading performance has been consistent, with earnings & EPS increasing by almost 13% pa over the past 5 years and just over 18% pa over the past 3 years.  Over the past 5 years ROE has improved each year from 13.7% in 2009 to 19.8% for the trailing twelve months to 31st July 2013.

Free cash flow has historically been strong, but over the past 18 months has decreased, this is due to the substantial expansion in the Motor Finance loan book increasing from £55.6m in 2011 to £82.8m at their interim results, with the loan loss provision increasing by just £3.6m.

Operating margins have consistently been above 20%, increasing from 21.9% in 2009 to 26.9% last year and 31.8% at the interim stage this year.  This increase is due to an improving impairment charge, most especially in the Motor Finance division (see chart above) and good cost control on admin costs supporting the rising income.

Gearing is just 39% and interest is covered almost 30x; this low level of gearing offers the business the ability to leverage additional business over the coming years and bridge the expected 20% growth from a sustainable growth rate (SGR) of 9.8% (see table above).

I would judge that the Home Finance business has a narrow economic moat due to switching costs associated with moving to a new provider of finance and network effects due to "word of mouth" locally and the positive effect of the local agents within a community.  The Motor Finance business has a narrow economic moat due to switching costs associated with moving to a new provider of finance.  These switching costs provide a very narrow economic moat as it only applies while the loans are in place.

Value
On a prospective P/E for the year ending 31 January 2015 of 11.7, a P/BV of 2.87 and EV/EBIT of 12.8, S&U is reasonably priced for a stock that is growing EPS at 20% pa (2009 to 2015 estimates).  Compared to Provident Financial on a P/E of 12.8 for 2014 earnings growing at 12% pa (2010 to 2014 estimates)

On a discounted cash flow valuation I would judge that the business has an intrinsic value of 1850p an 18% premium to today's price.

Add to this an expected dividend yield of 3.6% for next year and it makes for an interesting prospect.

Momentum
As with any stock, if there is little SP momentum, then it may take some time for demand to exceed supply and push the SP up to its true value.  S&U does seem to have good momentum though with a 1yr relative strength of 54% and good SP momentum over the past 2 years as demonstrated by the chart below:

Click on chart to enlarge

Summary
A reasonably priced share, with good growth prospects and strong financial returns.  They have a committed management team with a good stake in the business, but the family ownership along with a long standing investor in the form of a charity, does create an illiquid share.  One to ponder on as a long-term investment.