The Business
The group has four main businesses that are all somewhat
integrated:
- Largest UK Pawn broking Business– secured short-term loans on jewellery and gold.
- Retail jewellery
- Third party cheque cashing
- Personal unsecured loans up to £1000
The pawn broking business is a very traditional business
having been around since 1800’s. They take gold and jewellery as collateral for
providing loans to cash strapped consumers. HAT have 191 high street stores
around the UK and have started various other businesses that are synergetic
with pawn broking such as selling unredeemed pledges through retail and gold
purchasing.
Twenty-five percent of HAT’s total assets are receivables[1];
a majority of what mature within a year, twenty-five percent
is inventory[2],
gold and jewellery, used for retail and gold scrap upon unsuccessful
redemptions. This gives the group a large amount of current assets, which are
fairly liquid, and upon a fire sale would not take much of a haircut to the
current market value. However, these assets are directly exposed to the price
of gold, which has been in a downtrend for a few years and is one reason the
company has been out of favour with investors.
The group accept collateral of a notional value marginally
higher than the loans they provide. They claim that this collateral is worth
more than the loans provided even at gold prices near 5 year lows today.
Therefore, even if customers do not repay the loans, HAT still make a profit as
the collateral is of even higher value and can be sold through their retail
business. Although the group redeem, on average, 80% of loans, “if the
redemption rate decreases by 1%, i.e. the customer defaults on loan, the
profits of H&T actually increase by £90,000”[3]
at year-end 2014 pledge book values.
The business has suffered in the last 5 years due to a
depreciating gold price and new strict regulation on payday loans. New UK
regulation in 2013 capping interest on short term unsecured loans led lots of
competitors to close down stores and investors dumping shares in companies
relating to the business. Price of HAT fell from around £3.5 in 2012 to £1.5 even
though personal loans only accounted for 3.9% of gross profit last year. The
price is trading below NAVPS of £2.47 and seems to offer a low risk opportunity
on any future growth of the business. However, the high margin business of
payday loans is over and management is adopting a new business strategy.
Change of Business
Strategy
Below shows the change in revenue composition and business
mix in the last 8 years. This company has changed its strategy due to new
regulation, the increased use of the internet for commodity linked loans and
services and more importantly to reduce exposure to gold prices. They have
introduced retail in 2008 to diversify their revenue stream and this has proved
a success growing to around 30% of total revenue today.
They have reduced net debt
considerably with D/E decreasing from over 40% in 2008 to around 19.5% today. Management
claimed in 2014 that they’re concentrating on ‘developing new profitable
products in the retail shops’ to boost revenue. HAT has rebranded their retail
business and retail sales have a CAGR of 9.5% over the last 5 years and grew
25% last year.
The market is still partially valuing an old business with
no potential growth. These future earnings streams do not have to be large for
this company to outperform the current implied growth rates by the market. Not
much capex is required to roll out the new business plan. They mainly lease
their high street stores and space so just branding and marketing the retail
business is necessary expenditure in the next 2 years.
Management and
Financials
CEO is ex RAF – he pledged to decrease net debt by 50% in
2013, delivered 54% and then reduced it in 2015H1 further by 34%. Seems very
regimented in cost control, which is a key factor for changing business mix
efficiently.
Margins are depressed and far below their 5-year average of
15% and 10% for operating and net income margin respectively. Today they are
trading at 7% and 5% today due to the natural low margins of a more retail
based business. ROE, ROA and ROC have all decreased as the business mix shifts
more to retail and therefore future growth is now determined by sales growth
and asset efficiency.
The balance sheet is strong. They have halved net debt in 2
years to a D/E ratio of 19%, interest coverage ratio is sufficient at 12x and
the company is £16m drawn on a £50m debt facility at 125bps above LIBOR. HAT
has compounded book value at 18.56% a year over the last 10 years showing how
prudent management are at managing the balance sheet and creating value. The
Altman-Z score – a measure of the likelihood of bankruptcy within 2 years - of
HAT is 4.21 is considered far from in distress (anything above 2.6 is
considered safe).
FCF is very high relative to comparables and has been
positive and increasing since 2011 even though the industry has been struggling
and business mix changing. The FCF yield is currently around 16% and has been
consistently above 10% for the last 10 years.
Risks
The main risk of this business is the dynamics of the
business itself, the supply and demand of alternative credit. This is somewhat
cyclical although the competitive landscape of the pawnbroking business ensures
that when demand returns, HAT are in the position to gain market share. The price of gold has proven to have little
risk to the underlying performance of HAT as they do not lend too much at such
high prices. An external risk is the use of Internet taking the service away
that pawnbroking retail shops provide although H&T and cash converters are
still around dominating the high street pawn broking market today.
Catalysts/Unlocking
of value
The market is pricing a company in a dying industry with
virtually no future growth. The gold price is at a 5-year low and HAT is still
showing a healthy FCF yield and profit. Potential catalysts come mainly from
two sources, growth in revenue from the retail segment or an increase in the
underlying gold price. Price will follow as earnings grow upon potential:
- Improvement in the dynamics of the core pawnbroking business
- Increase in gold price
- Success of new retail revenue stream
Valuation
Rearranging P/B = (ROE – g) / (re – g) from the current P/B
ratio of 0.8 and using the new lower 5% ROE shows the markets implied earnings
growth rate of 1.4%. The company consistently retains earnings and looks to
reinvest in the company. The 5-year average dividend pay-out ratio is 16.75%
and therefore with the fundamental growth rate in earnings g = b*roe, using
HAT’s new lower ROE of around 5% gives an average fundamental EPS growth rate
of 4.16%.
The FCF/mkt cap has been consistently over 10% for the last
5 years. The business does not require the expenditure to purchase and roll out
new stores it has in the past and therefore future capex will be lower.
Capex per share was around 20p in 2012 and 2013 although last year, and after recent 2015H1 results, capex per share is now around 4p or 2%
of revenue. OCF in 2015H1 was slightly lower than in the past due to increasing
inventories (although management claim this stock will be cleared in H2) and therefore
FCF was 24p per share. This prices HAT at around 8.25x FCF.
Discounting FCF at a 10% cost of equity gives a price target of around £2.4. Regardless of technical valuation I think this offers a low risk opportunity to benefit from any pick up in a traditional business, with liquid assets as protection, plus a cheap option on any future gold price appreciation.
This analysis was wrote on 20/08/15.
[1] All receivables on balance sheet are stated at nominal
value as reduced by appropriate allowances for estimated irrecoverable amounts
[2] Inventories stored for re-sale are stated at the lower
of cost and net realisable value which is valued at spot gold prices.
[3] Annual Report 2014
[3] Annual Report 2014
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