Strong profit growth path confirmed

Until the F2017 results, NSF was, to a certain degree, a ‘jam tomorrow’ story, with infrastructure investment holding back returns. This is significantly complete and, with its market-leading franchises and payback from historical investments starting to come through, its target 20% EBIT ROA and minimum 20% loan book growth should start to be achieved in 2018 for Loans at Home, and in 2019/20 for the other divisions. Rolling forward the valuation base year has a big effect due to the strong forecast profit growth (2019E P/E ca.10x vs. ca.17x 2018E). The average of our absolute measures (see assumptions in valuation section) is now 101p.

• 2017 results detail: Like-for-like (LFL) loan book growth was 30% (21% in branch business, 53% in home collect, 35% in guarantor loans) and drove underlying revenue growth of 48%. Impairments were up 22%, administration costs rose 57% and finance costs trebled. Normalised operating profit growth was 71%.
• Outlook post results: On a LFL basis, we have increased LAH investment forecasts, reflecting 2H17 costs. NSF guided on the IFRS9 impact in 2018: it will significantly reduce profit estimates and, to a lesser degree, receivables and NAV forecasts. However, there is no impact on cash or the profitability of each loan.
• Valuation: Rolling forward our base valuation year to end-2019 increases our absolute valuation measures by more than the effect of estimate reductions (range now 100-102p vs. 91-100p per share). Until consensus adopts a uniform IFRS9 approach across companies, peer comparisons have limited value.
• Risks: Credit risk remains the biggest issue, and part of NSF’s model is to accept higher credit risk where a higher yield justifies it. NSF is innovative and may incur losses piloting new products, customers and distribution. Regulation is an issue, and we note management is taking appropriate action to mitigate this risk.
• Investment summary: Substantial value should be created, as i) competitors have withdrawn, ii) NSF is well capitalised, with access to significant debt funding, (iii) macroeconomic drivers are positive, and iv) NSF has an experienced management team, delivering technological efficiency without compromising the key F2F model. Targets of 20% loan book growth and 20% EBIT ROA appear credible, and investors are paying 9.8x 2019E P/E and getting a 5.0% yield.