November 2019 Investor Forum

Franchises now built, profits to follow

NSF has reached the turning point in its strategic development. Having invested heavily in infrastructure, controls and people, it has built a substantial franchise. The pace of investment will now slow, at the same time as payback from historical investment becomes more visible. Lending has been curtailed to match the economic outlook. Despite this, we expect profit growth to accelerate sharply, driven by wider jaws between revenue and costs in the branch business and guarantor loans, efficiency improvements in home collect, and improving credit. NSF looks likely to secure additional lower-cost funding; we expect funding costs to relatively reduce, and the funding mix to improve.

• Strategy: After the aborted bid for Provident Financial, NSF is now all about delivery of profit growth from its market-leading franchises in branch-based lending, guarantor loans and home collect. We expect strong loan growth driving revenue, costs to rise at a much slower pace and well-controlled credit quality.
• Outlook: The 15 November trading statement saw 2020/2021 estimates cut by 16%-18% due in large part to an accounting assumption change and tighter loan growth. Investors should not lose track of the fact that the 2021 adjusted profit before tax is still 2x the 2018 level. Exceptionally strong real growth is still expected.
• Valuation: Our absolute approaches now indicate a range of 86p-97p. On the current price, the 2021 prospective PE is 3.3x (2020E 4.3x) for a business whose impairment provisioning already significantly reflects a downside scenario. The yield is now double-digit.
• Risks: Credit risk remains the biggest threat to profitability. NSF’s model accepts higher credit risk, where a higher yield justifies it. NSF is innovative, and may incur losses piloting new products, customers and distribution. Regulation is a market issue; management is acting to mitigate this risk.
• Investment summary: Substantial value should be created, as: i) competitors have withdrawn; ii) NSF is well capitalised, with committed debt funding; iii) macro drivers are positive; and iv) NSF’s experienced management delivers operational efficiency without compromising the key face-to-face model. Management targets of 20% loan book growth and 20% EBIT RoA appear credible, and investors are paying 6.4x 2019E P/E and getting a 11.5% yield.