Provident Financial Group

Charlie Huggins (CFA) - Fund Manager

30 June 2017

We had some disappointing news from one of our holdings last week. Provident Financial Group (PFG) issued a profit warning after the market closed on Tuesday 20 June, causing the shares to fall by 17.5% on the Wednesday. Regrettably, this was one of our bigger positions, so it cost the fund 0.78% on the day. We decided to set up a conference call with management to get a better understanding of what went wrong.

What went wrong?

The profit warning relates purely to PFG’s Home Collected Credit division where the group is undertaking a large transformation. The changes have led to greater than anticipated business disruption, meaning profits from this division are expected to come in significantly below expectations.

Earlier this year the group said it would be moving its Home Collected Credit business from a self-employed agent model to a fully employed model (i.e. employing full time, salaried staff to replace part time, self-employed agents). Total headcount will reduce from c. 4,700 to c. 2,900, with around 2,500 full time Customer Experience Managers to handle home visits and collections.

There are always risks when a company changes its business model, and in this case it looks like the changes have been poorly handled. During this transitional period, the group were unable to keep a hold of and appropriately incentivise its existing self-employed agents. This has resulted in a much higher than anticipated loss of staff, and those who did choose to stay have not been provided with sufficient motivation to take up the slack. This means collections and new loans are running below expectations.

What is Home Collected Credit?

PFG’s Home Collected Credit business provides loans to low income households. The customer will borrow a fixed amount for a short period, typically a week or two, and the repayment amount is set at the outset, with collections made at the customer’s home. This business model has been established for over a hundred years, and has historically relied on self-employed agents to lend and collect money on the lender’s behalf.

How does this impact our view?

Although we are disappointed with how this transition has been handled, we recognise that PFG has a very strong long term track record, and has done a tremendous job of diversifying its business model. Whilst the Home Collected Credit business once dominated, last year it accounted for just a third of profits. Nowadays, Vanquis, their credit card business, is much more important to PFG’s fortunes and this division has continued to perform well in recent months, as have other parts of the group.

We believe the problems in Home Collected Credit will prove temporary, and that the business will emerge stronger with time. In the long run, the move to a fully employed workforce should lead to significant cost savings, while giving PFG much more control over the lending process. This should result in better customer service, and an improved collections and sales performance. Over time, we think these changes will give PFG a significant advantage over the competition.

We aren’t expecting the dividend to grow much this year, but we think it is likely to be maintained. On this basis, the shares offer a historical yield of 5.5%, which we view as attractive. Although, remember, income is variable and not a reliable indicator of future returns.

For these reasons, we have decided to maintain our position, although we haven’t added to it further. There is still a risk of near term business disruption, and it will be a few months until we know whether the new model is working. In the meantime we will continue to monitor the company, and the actions of its competitors, very closely.

Lessons

If there is a lesson here it is that companies undergoing large changes to their business models can often run into problems. Investors have a tendency of focusing on the likely benefits of change, without adequately assessing the risks which may materialise in the short term; and in this instance we have to hold our hands up and say we overlooked the significance of some of these risks. It is a valuable lesson, and one we don’t intend on facing again.

Summary

Whether we have good or bad news to report, our aim is to be as upfront as possible with our investors. When things go wrong, we want you to know why.

Provident Financial have not handled their restructuring well and the lesson has proved painful – there is no getting away from that. However, we remain confident in the group’s long term investment prospects, given the continued success of Vanquis, their largest business and look forward to reporting more positive progress in future blogs.

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