Can H&T continue its sustainable recovery?

H&T is one of the UK leading retail pawnbrokers. It has 181 stores with a history going back to 1897.

Recently, optimism has crawled its way back to H&T with the shares sprinting to £3 (off their 2013’s lows of £1.30). One main reason for the collapse was the fast growth in pawnbrokers on the high-street. The saturation point came when Albemarle Bond, another pawnbroker went bust.

A second big factor was the fall in gold price affecting its gold trading margins.

To understand why pawnbrokers were fashionable in the first place, here is a quick backstory.

 

How did Pawnbrokers become Popular?

Britain is a consumer society, as the service sector makes up 70% or even 80% of the total UK economy.

So, when the 2008’s financial crisis came, it caused a liquidity crunch. (meaning banks stop lending or it is heavily reduced)

Pawnbrokers, alongside payday loans, were open for business.

Also, banks were calling their loans back from borrowers. And that created a cycle. Those who bought too much stuff before 2008 and were in debt had to sell their valuables for cash.

And, where else but the pawnbrokers that offer this service.  

That caused the pawnbroking industry to boom. And management went crazy by opening more stores, without realising how cylindrical their business model was.

Now, on to the main topic: H&T.

Topics covered on H&T Pawnbroking

The approach here is to bust some myths about high trade receivables and longer cash cycle.

Why lowering debt is a good thing?

The situation regarding its leasing of their stores.

And, how staff costs and productivity affect their revenue?

 

Let’s get started

 

Interesting Analysis on H&T that may surprise you

 

Extra-long cash cycle

In the pawnbroking business, assets take longer to convert to cash, and for H&T it resulted in this:

 H&T CASH CYCLE

Yes, it looks horrible when you see 400 days plus to complete a cash cycle.

The good news is profits or cash earnings aren’t affected. Also, the company manages to pay off most of their debts (Read section:  H&T has been deleveraging). So, what is causing the high cash cycle and why isn’t it damaging the company’s financial statements?

First, the rise in cash cycle is caused by Falling Revenue.

 

When you compare the company’s inventories and receivables, as a % of sales, you get this pattern:

H&T receivables and Inventories as % of sales

The 40% fall in revenue resulted in longer conversion days. But, why haven’t this destroy H&T balance sheet?

Answer: H&T don’t manufacture anything!!!

The eye of the beholder is to assess its payables. H&T owes its suppliers no more than between £6m and £9m or 3% of total assets.

So, does that mean H&T has no holes in their business?

Not, exactly.

Because inventories consist of retail scrap purchased from people who wants to raise cash. However, if more people sell their junk onto H&T, then bargain hunters buying them, this lower inventory turnover.

H&T Inventory Turnover

A possible inventory write down on the cards?

Some, looking at H&T’s balance sheet would immediately assume it has a receivable problem without reading their accounting notes.  

First, trade receivables are loans agreed upon to the borrowers. Also, the borrowers have pledged collateral if they fail to pay it back. (See screenshot below)

 

In 2016, receivables were £59m, and the value of its pledge book is £41m. But, you should be wary of rising impairments because the pledge book value may turn out to be less than its worth.

That depends on how H&T value their loans against the borrower’s collateral value.  

 

 

Shorter lease

The total lease has fallen.

 H&T Operating lease

And the duration of the lease has shortened. Let me explain:

In 2006, annual lease/total lease = 10%, this is an average equivalent of 10 years per store. (1/0.1 (10%))

Today, it is 19% meaning the average period of lease per store has shrunk to 5.2 years. The major change came from 2010.

Is this a good or bad thing?

The annual cost of rent is certainly taking up most of the company’s sales.

 H&T lease as a % of sales

Currently at 6.2% and dipping from the peak of 7.1% in 2014.

If you were to break it down to lease per store, it goes two ways; –

  1. The total lease has fallen to £177k from £278k, but the period has shortened.
  2. An accurate measure is an annual lease per store. Currently, at £35k, which is down from a peak of £41k.

(See the graphic below)

H&T Lease per store

 

Now, let talk about debt. 

 

H&T has been deleveraging

Earlier we allude to the fact that inventory is the cause of its lengthening cash cycle. 

That is why management needed to deleverage. Debt levels are at historical lows.

 

H&T Debt Ratio

This is a positive step, which gives management leeway to manoeuvre if things don’t go their way. That means the debt to net income ratio is back below 2 times from the peak of 5.9 times (2013).

 

H&T Wages Costs

Relying on bricks and mortar means keeping staff at their premises. That means wage bills is one of their biggest operating expenses.

H&T Wage costs chart

In fact, it accounts for 25% of total revenue. What is the main culprit for rising employment costs?

If it’s rising employment costs were to blamed for the rise in national wage, then this isn’t the case. 

Given that staff costs are unchanged in the last ten years, this can’t be growing wages costs vs. revenue.  Instead, revenue has fallen off the cliff, as revenue per staff is down 40% from £144,000 to £85,000.

H&T Wage and revenue per staff

The absolute employee costs stayed the same from 2010 to 2015 at £20m, before rising to £24m last year.

 

Final Assessment

Since Albemarle Bond reduced their operations from 230 stores to 110, due to going through administration. It has given H&T some breathing space.

Although profits are below the levels of 2012, it is making some progress. The gold price has risen from the lows of 2016, helped to boost their gold margins.

The best thing about H&T is the reduction in total debt. It played a big part in boosting its share price (which in my opinion would trade at around £2 per share price).

H&T is a good company, but at £3 per share, with a market cap. of £100m means, the valuation is near the high side. Secondly, investors should be wary of traditional banks getting back to health. And if they start lending to ordinary people at an attractive interest, then H&T pawnbrokers would come under pressure.

I, also mentioned lower inventory turnover isn’t helping to boost revenue and earnings.

The other minor factor is online payday loans.

Personally, I wouldn’t invest, unless the gold price was to zoom higher.

But, there is an aspect that could hinder H&T recovery, that is the crackdown on loan sharks by the FCA. If FCA passes a law similar to some European countries like Poland, which affected another London-listed company called International Personal Finance, then it would cause major problems to margins and the payday loan model as a whole. But the size of any benefit requires further research.

 

Do you agree with the opinions in this post?

Are there factors which would boost H&T or hinder their business?

Leave your comments below.

 

As always, please share, like and subscribe for future posts.

 

Disclosure

The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.

Finally, the writer does not own the company’s stock, unless stated otherwise.

 

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