H&T GROUP PLC LON:HAT. Defensive / Growth investment. 265p. 350p. 370p m. 13.3m m MARKET LEADER IN PAWNBROKING MAJOR SHAREHOLDERS

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1 CONSUMER FINANCE 02/07/2018 Defensive / Growth investment MARKET LEADER IN PAWNBROKING H&T Group PLC is the UK market leader in pawnbroking, with a chain of 182 high street stores across the county, offering consumers secured credit against items such as gold, watches, and jewellery. In addition to the core pawnbroking activity and related jewellery and watch retailing, H&T Group offers a range of other financial services, detailed in this report. SHARE PRICE 350p MARKET CAP 131.8m NET DEBT 13.3m 52 WEEK LOW 265p 52 WEEK HIGH 370p NAV 107.6m A key element of H&T s business model is the retention of high-quality staff, to deliver good customer service in its branches. This service culture has enabled H&T to establish market leadership in the UK, with strong customer loyalty in the localities it serves. The company estimates that 90% of pawnbroking revenue comes from repeat customers. The business has attractive defensive qualities as an investment, given the liquid nature of the collateral, and conservative lending policies. Indeed, H&T delivered earnings growth right through the financial crisis. GROWTH OPPORTUNITIES UK pawnbroking is essentially a mature industry; however, H&T has delivered strong earnings growth over the last five years. Recent growth has been driven by the personal loans and other non-pawnbroking services. In addition, the company has achieved growth in the retail segment, supported by the rollout of a new retail website. The H&T online offering follows a clicks-to-bricks model, allowing customers to order online, with transactions completed in store. The online platform will support all of H&T s business areas going forward. FINANCIAL METRICS AND VALUATION H&T Group has delivered an earnings per share (EPS) compound annual growth rate (CAGR) of 17.9% over the last five years (to 2018e) and a dividend (DPS) CAGR of 20.3%. In the last financial year, the company delivered a pre-tax return on equity (RoE) of 13.1% (pre-tax profit / net asset value) and has demonstrated the ability to keep reinvesting to grow the loan book and the business while maintaining a dividend pay-out (DPS/EPS) of more than 30 % every year for the last five years. MAJOR SHAREHOLDERS 1) Artemis Investment Mgt: 12.8% 2) Fidelity International: 9.8% 3) Close Brothers Asset Mgt: 8.9% Shares in Issue 37.7mln Avg Volume Daily 29,713 Primary index EPIC Next Key Announcement Sector AIM LON:HAT Interim results 2018, expected August 2018 Consumer Finance SHARE PRICE CHART For a company with strong defensive attributes and good growth prospects, we argue that the current P/E valuation of only 10.9x (2018e) represents an interesting potential entry point. Important: All disclaimer information can be found on the last page of this document. Please note that this publication has been commissioned by the company to which this publication relates and therefore it cannot be considered independent. Company Information Address : Times House, Throwley Way, Sutton SM1 4AF Website: www. handt.co.uk Analyst Details Ed Stacey ed.stacey@capitalnetwork.com +44 (0)

2 INVESTMENT CASE H&T has been a strong investment over the last five years. The following chart shows the performance of H&T compared with the FTSE All-share: H&T has outperformed by 49.9% over the period. This reflects strong financial performance from H&T, with earnings per share (EPS) achieving a compound annual growth rate (CAGR) of 17.9% (over five years to 2018e) and a CAGR of 20.3% for the dividend (DPS). In this report we consider some of the fundamental drivers of H&T s performance: A market leading position in UK pawnbroking provides a stable bedrock to group profitability and a strong high street presence to promote other services. Ongoing growth opportunities in each of the company s business areas, including potential growth from the recently developed online platform. Strong financial discipline, with conservative lending and accounting policies, low balance sheet gearing, and a healthy dividend pay-out ratio. In this report we will be giving special focus to the three large business units Pawnbroking, Personal Loans, and Retail which are also the businesses that contributed the most to growth in the group s gross profits in The following chart shows the bridge from 2016 profits to

3 H & T GROUP PLC BUSINESS OVERVIEW H&T operates a network of high-street stores across the UK offering personal finance services, with a leading position in pawnbroking. The following charts show H&T s different business lines by gross profit contribution and segmental assets. The retail and pawnbroking scrap businesses can be seen as direct adjuncts to the pawnbroking business, providing routes for the disposal of goods acquired through the pawnbroking activity. The other business lines are services that are in demand from the high street customer base, with the reassurance of H&T as a trusted local brand. High street presence H&T has existed in some form since the late 1800s, and today operates 182 stores across the country. The map to the right shows the geographic spread. The company places great emphasis on customer service, and has built a reputation as a reliable financial partner to the communities in which it operates, through the face-to-face approach. Online channel clicks to bricks In more recent years H&T has developed an online channel-to-market to complement its high street presence. The company is adopting a click-tobricks approach, meaning that customers will be able to apply online for any product H&T offers, and complete their transaction in store (or viceversa). So far, the online approach has had its biggest impact on the retail segment, with potential for increased penetration across the other business areas. 3

4 PAWNBROKING The pawnbroking business offers loans of up to six months duration, secured against items of tangible value - typically gold, jewellery and watches (together these make up 99% of the pledge book). The typical loan-to-value is 70%, leaving H&T headroom to recover their capital if a customer does not repay their loan. H&T is the market leader in the UK pawnbroking industry. The following chart shows market shares as measured by the total value of the company s pledge book. A core element of H&T s value proposition is customer service. The company retains a highly trained and motivated workforce, to ensure that the right lending is made available to the right customers and to ensure that the customer is well informed and well treated at each step of the process. These characteristics are important because a pawnbroking business thrives on customer loyalty. Contrary to some perceptions of pawnbroking as an emergency source of finance, actually a high proportion of users are habitual customers H&T estimates that 90% of business comes from repeat customers. The demographics of the customer base are broadly spread across age groups, albeit with an underweight exposure to millennials (students don t have gold watches to pawn). The following chart shows the demographic age profile of H&T s pawnbroking customer base. Pawnbroking financial characteristics An important key performance indicator (KPI) for the pawnbroking business is the redemption rate the percentage of loans that result in the customer making their repayment and reclaiming their goods. This is particularly important in sustaining repeat business as customers who do not redeem their pledge are unlikely to become regulars. The following chart shows H&T s redemption rate in recent years. 4

5 Redemption rates have held steady in recent years, and have been above 75% every year for the last 10 years. We next consider the service charge realised by H&T in recent years this is a key profit metric in pawnbroking. The following graph shows the pawn service charge and the yield, defined as pawn service charge asa percentage of the average pledge book. We argue that a smooth progression on this metric is indicative of: 1. Prudent lending: A pawnbroker lending aggressively relative to the value of goods would suffer volatility in their profits. 2. Prudent accounting: Pawn service charge is recognised using accrual accounting. A pawnbroker over-accruing in one period could suffer volatility in subsequent periods. We note that H&T s pawn service charge income rose even during the financial crisis, another indicator of the defensive nature of this business. In terms of growth going forwards, we don t expect aggressive expansion of the high street estate of stores, as this is essentially a mature sector; however, there is potential for growth via consolidation in the sector, should smaller independent stores become available at attractive valuations. Also, there is the potential for like-for-like revenue growth from the current stores, particularly via the digital platform. The clicks-to-bricks model allows H&T to expand its reach to new customers while retaining the in-store expertise to make final assessments of the goods before completing transactions. 5

6 PERSONAL LOANS The personal loans business provides unsecured credit, based on detailed affordability checks on the individual customers. We estimate that 90% of loans are provided in-store, with the remainder coming from the growing online business and a small stream of business from third-party referrals. It is important to distinguish the H&T personal loans business from the payday loans segment. The UK government applied new rate caps on highcost short-term (HCST) credit in 2015, and H&T s business was barely affected at all because the company had always stayed away from the very short-term high-interest rate segment. The following chart shows how H&T is positioned compared to some UK stock market listed consumer lending specialists. These are not strictly a peer group as the businesses are not entirely comparable to H&T s loans business, but the comparison gives an indication of where H&T sits in the market landscape. The chart shows loan book split into <50% annual percentage return (APR) loans (near-prime), loans with APRs of between 50% and 100% (intermediate risk), and loans of more than 100% APR (high-cost short-term). The following chart shows how H&T is positioned compared to some UK stock market listed consumer lending specialists. These are not strictly a peer group as the businesses are not entirely comparable to H&T s loans business, but the comparison gives an indication of where H&T sits in the market landscape. The chart shows loan book split into <50% annual percentage return (APR) loans (near-prime), loans with APRs of between 50% and 100% (intermediate risk), and loans of more than 100% APR (high-cost short-term). We don t suggest these metrics as a measure of quality or overall riskiness. The businesses simply operate in different segments: Morses Clubs provides home credit (doorstep lending); Non Standard Financial Group home credit, branch-based lending (similar to H&T), and guarantor loans; Provident offers payday loans, vehicle finance and sub-prime credit card lending, and S&U is in vehicle finance. There are many other players that are not UK stock market-listed, such as Wonga or Sunny in payday loans, or Amigo in guarantor loans. During the past two years, H&T has entered the near-prime (<50% APR) segment and expanded further into the intermediate segment. This reflects the company s strategy to provide its customers with a pathway to rebuild a credit history, starting with the HCST product and progressing with H&T towards near-prime. The following chart shows how the H&T personal loan book evolved from 2016 to

7 An important measure of risk for a personal loans business is the impairment ratio the level of write-downs of delinquent loans relative to the overall loan book. H&T s increasing shift into the lower risk segments has meant that the company has been able to sharply increase its overall personal loans business, whilst reducing the impairment ratio. The following chart illustrates these metrics. RETAIL The retail business offers new and second-hand jewellery and watches. Most of these items are sourced from H&T s pawnbroking business items from pledges that are not redeemed by the customer as well as some goods purchased over the counter, and a small amount are from third-party suppliers. The goods are sold in store and via the retail website, which has begun to gain significant traction during the last two years. The following chart shows the revenue growth of the H&T retail business The online channel was an important revenue contributor in 2017, and we believe this will be an increasing feature in 2018 and beyond. The portal offers an enhanced route to market for items such as high-end watches, with the customer having the option to select their product online and then inspect in store before completing their transaction. H&T operates its online retail through the brand est1897.co.uk in reference to H&T s original founding date. The graphic below shows the opening page of the site. Investors who are in the market for a high-end watch should visit the site. 7

8 GOLD PURCHAISING AND PAWNBROKING SCRAP The gold purchasing business acquires gold items from customers primarily through the high street stores. Some of these are refurbished and sold through the retail business, with the remainder sold as scrap. The pawnbroking scrap revenue stream represents the proceeds of unredeemed goods from the pawnbroking business that are not suitable for retail and are therefore sold as scrap. Both of these businesses are sensitive to the gold price. The following charts show the gross profits of the gold purchasing and pawnbroking scrap businesses, and the spot price of gold. We present further details ofh&t s sensitivity to gold prices onp11. OTHER Other service offers through H&T stores include third-party cheque cashing, foreign exchange (FX), and the buyback service acquiring items of some tangible value, typically electronic goods like smart phones, with an agreement to sell them back to the original owner within a set timeframe. Buyback is not unlike pawnbroking in some respects, but typically addresses a younger age demographic. This forms part of H&T s We buy anything proposition. The following chart shows the gross profit contribution from these other businesses. These grew strongly in , driven by the buyback and FX segments. 8

9 H & T GROUP PLC FINANCIAL CHARACTERISTICS We next examine some of the financial characteristics that underpin the H&T investment case: robust profitability, a strong balance sheet, and a consistent dividend pay-out. We also examine the company s sensitivity to the gold price. Continuous profitability The following chart shows H&T s profitability in terms of pre-tax return on equity (RoE), defined as profit before tax (PBT) dividend by net asset value (NAV). We note that the company has always been profitable, even in the financial crisis 2008/2009. Not many personal finance companies can make this claim. The RoE declined in , primarily due to the falling gold price in our view. The company subsequently undertook a strategic derisking, including reduced balance sheet leverage. This results in a lower RoE but also greater consistency going forward in our view. Strong balance sheet H&T now operates with a low level of net debt. The following chart shows gearing Net Debt / Equity compared with the other UK listed personal finance stocks. As with our previous comparison on p4, we don t see these as direct peers, but representatives of the comparable investment universe. There are good reasons why the companies in the preceding chart operate with different levels of gearing. For example, Morses Club applies no leverage, given its high exposure to subprime unsecured lending. Meanwhile, S&U in secured auto credit can afford to apply more leverage. We would argue that, in context, H&T is conservative, with low gearing, high exposure to secured lending (pawnbroking) and lower risk unsecured lending (the personal loans profile, p4). 9

10 Earnings growth, and dividend pay-out H&T has delivered strong earnings growth in recent years while offering a healthy dividend, and we expect this to continue in the coming years. The following chart shows the EPS growth, together with the dividend pay-out ratio DPS / EPS. Our forecast for earnings growth is driven by further growth in retail and personal loans, supported by the continued expansion of online sales, and demand in the market place. Details of our forecasts are on p12. Gold price sensitivity Finally, we consider the sensitivity of H&T to the gold price. The company is exposed to gold because 99% of the pawnbroking pledge book consists of precious metals and jewellery. The following chart illustrates the sensitivity of the share price to gold. Investors may see gold-price sensitivity as a positive or a negative. We would argue that investors should have some gold plays in their portfolio. 1 0

11 OUR FINANCIAL FORECASTS The following tables include our forecasts for H&T s P&L, balance sheet, and cash flow. 1 1

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13 Important Please read this information: This report has been commissioned by H&T Group Plc and prepared and issued by for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however, we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as s solicitation to effect, or attempt to effect, any transaction in a security. This document is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. has a restrictive policy relating to personal dealing. does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of may have a position in any or related securities mentioned in this report. or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a personalised service and, to the extent that it contains any financial advice, is intended only as a class service provided by within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law,, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. 1 3