Sometimes I break my own investing rules.
For example in the last post I mentioned how classic value investors avoid financial firms due to the historical instances of weak balance sheets and cavalier use of leverage.
I took a particular swipe at Fairpoint Group (FRP) commenting that:
assets of £10.6 million is listed as ‘unbilled income’ – well if income is unbilled how can it be an asset? How can investors be sure that any income due to the business is legitimate if it has not been properly ‘booked’?
Labouring the point here is what the notes to the accounts stated in terms of this ‘unbilled income’:
Unbilled income in relation to work performed in the legal services segment is recognised based on the status of the case, the likelihood of recovery and the expected recovery rate. Where a case is contingent at the balance sheet date, no revenue is recognised. Where entitlement to income is certain, it is recognised at selling price or estimated selling price based on an analysis of historic recovery rates. Where the entitlement has not yet been quantified, it is valued at cost. Appropriate provisions are made in respect of unbilled income based on the age of the related time cost.
Status of the case… likelihood of recovery… expected recovery rate…
This type of wishy washy accounting to a rational person leads to uncertainty as the the value of a firms’ assets.
Today’s investment into subprime lender and FTSE 100 laggard Provident Financial (LSE: PFG) is based purely on the fact that at today’s share price Provident Financial has:
- Suffered a major collapse in its share price (81% since May this year)
- PE Ratio of 3.32
- Price to book value of 1.01
- Current ratio of 5.24
- Posted positive 3, 5 and 10 year earnings growth
- 13% 5 year average dividend growth rate
- High returns on capital employed and equity
Provident is not without it’s problems as has been highlighted in the mainstream press this week:
Provident Financial £PFG: a relatively unpopular large company https://t.co/hoHfqGzAVR
— David Thomas (@djthomas) August 23, 2017
It also has a lot of debt as you would expect from a subprime lender with debt levels increasing against equity over the years.
Perhaps the most worrying thing to come out of the trading statement yesterday was the reduction in collection rates for it’s loans which has in turn negatively affected guidance
Collections performance is currently running at 57% versus 90% in 2016 and sales at some £9m per week lower than the comparative weeks in 2016. The extent of this underperformance and the elongated period of time required to return the performance of the business to acceptable levels invalidates previous guidance. The pre-exceptional loss of the business is now likely to be in a range of between £80m and £120m.
Another worrying factor is the way the business changed it’s model of using self-employed local collection agents to using customer experience managers which has broken the relationship between company and customers making it much more difficult to collect loans.
The self employed debt collectors formally utilised by Provident were slow to take up full-time employment with the firm since many of them are not happy with the new working practices.
The chief executive has resigned and the interim dividend has been suspended.
Trading at multi-year lows the share price reflects all of these issues and is trading at a discount to past average earnings which allows for a large enough margin of safety to take a position at this level despite the ongoing problems.
I see this investment being part of the Shares and Stock Markets portfolio for years as the board work their way through these issues and return Provident Financial to a stable large cap enterprise that rewards shareholders with decent returns.