This below-the-radar SME lender is undervalued

There are not many companies that have raised profit guidance three times this year and are rated on a miserly forward price/earnings (PE) ratio of seven and on a 24 per cent discount to tangible net asset value (TNAV), but that’s the case with Time Finance (TIME:28.5p), an alternative provider of finance to the high-street and challenger banks.

The Bath-based group provides three main finance products – Invoice Finance, Asset Finance and Loan Finance – which small and medium-sized enterprises (SMEs) require for day-to-day working capital requirements and to grow their businesses over the longer term. It lends to more than 10,000 SME customers from its own balance sheet or through brokering-on business that does not meet its lending parameters, mainly due to the size of a transaction, pricing or credit quality.

As Time Finance is not a retail deposit taker, wholesale funding facilities are utilised at competitive rates to fund lending to SMEs operating at the smaller end of the market. That way, an acceptable net interest margin is made on lending activities, and with a ‘margin of safety’, too, hence why the group has delivered a profit in every year of the past decade even through the Covid-19 pandemic. Time Finance has £50mn headroom on its lending facilities, so remains well funded to continue cherry-picking business in the SME sector, too.

Lending book growing and arrears improving

Business has been booming, as highlighted by the headline-grabbing near-quadrupling of pre-tax profits to £4.2mn in the 12 months to 31 May 2023. Moreover, with own-book originations strong – rising 14 per cent to £73.4mn and accounting for 96 per cent of all new business – and management scaling secured lending activities and increasing the average transaction size, expect another year of robust growth.

Moreover, by almost doubling the average deal size to £40,000 since 2021, management is driving down delinquency debt levels and generating efficiencies by dealing with a lower number of enquiries from more established and credit-worthy businesses. Provisions now account for below 3 per cent of the net lending portfolio, a reduction in line with the one percentage point reduction in net arrears to 6 per cent of the lending book and a reflection of faster lending growth coming from the group’s ‘hard’ asset and invoice finance businesses. Combined, they account for 70 per cent of the lending book.

Furthermore, the operational gearing of the business is such that profit growth outpaces revenue growth by some margin in a positive revenue cycle, hence why house broker Cavendish is forecasting 19 per cent growth in current-year statutory pre-tax profits to £5mn on 9 per cent higher revenue of £30mn. On this basis, the shares are rated on a forward PE ratio of seven.

Creating shareholder value

It’s not only the group’s own lending book and profits that are increasing. So, too, is the size of its balance sheet, and with it the inherent value being created in the business.

This is best illustrated by the group’s rising TNAV, which increased from £30.2mn to a record high of £34.2mn (37p) at the 31 May 2023 financial year-end. Cavendish forecasts that TNAV could rise to £37.9mn (41p) by 31 May 2024 based on its growth in pre-tax profit. The brokerage’s TNAV estimate is 44 per cent above the current share price, highlighting the value opportunity on offer. Or put it another way, Time Finance would have to write off more than 4 per cent of its lending portfolio to wipe out the share price discount to TNAV. That’s simply not going to happen given that the business is focused on secured lending.

Admittedly, a consequence of recycling all profits back into the business is that shareholders forego a dividend. However, the growth in TNAV highlights the economic value that is being added to their interests in the enterprise, and it’s compounding. That’s because Time Finance made a post-tax return on average tangible equity of 10.6 per cent in the 2022-23 financial year, so retained profits are generating an identical return by recycling them back into the business.

I highlighted the compelling value on offer when the shares were trading at 26.5p last month (‘Alpha Research: Business is booming for this underrated lender to SME’s’, 18 August 2023) and I maintain my 40p fair valuation. Buy.

■ Simon Thompson’s latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com at £16.95 each plus P&P of £3.75, or £25 plus P&P of £5.75 for both books.