Trading update: understand the accounting

NSF has issued a trading update highlighting a 4%-5% reduction in consensus estimates due to softer trading in 3Q (primarily lower loan volumes in guarantor loans, a market which has been affected by adverse press coverage) and a 6%-8% reduction associated with a step change in provisioning policy. The latter highlights yet again the importance of understanding the assumptions in provisioning. For the same arrears, a higher assumed probability of downside has increased provisions. This reflects the known cyclicality inherent in IFRS9. A downgrade is unwelcome, but it does not reflect current customer deterioration, only the Board’s cautious approach. After today’s reduction’s, we still forecast 2021 adjusted profits at 2x the level of 2018.

• Outlook: NSF lowered its targets for loan book growth reflecting macro-uncertainty and a desire to position the group ahead of the next recession. The ongoing effect of the provisioning policy is less than the reduction in impairments from slower loan growth, so the forecast nominal provision charge is lower in 2020/2021. As a proportion of revenue, it is somewhat higher.
• Strategy: After today’s reductions, we are forecasting 2019 adjusted pre-tax profits of £15.8m (2018: £14.8m) rising to £23.3m in 2020 and £29.9m in 2021. Therefore, 2021 is still double the 2018 level. The fundamental strategy of building a franchise to deliver strong profit growth remains intact.
• Valuation: Our absolute approaches now indicate a range of 79p-85p. On the current price, the 2020 prospective P/E is 4.4x for a business whose impairment provisioning already reflects a significant downside scenario. The yield is now double-digit.
• Risks: Credit risk is the biggest threat to profitability but the sizeable increase in provisions in today’s announcement should mitigate this risk in the future. NSF’s model accepts more credit risk, where a higher yield justifies it. NSF is innovative, and may incur losses piloting products, distribution and customers. 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• Investment summary: Substantial value should be created, as: i) competitors have withdrawn; ii) NSF is well capitalised, with committed debt funding; iii) macro drivers are positive; and iv) NSF’s experienced management delivers operational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 strong loan book growth and 20% EBIT RoA appear credible, and investors are paying 6.6x 2019E P/E and getting a 11.1% yield.