Cube Midcap Report (28 Nov 2019) – Cash machine #PAY #VMUK

Cube Midcap Report (28 Nov 2019) – Cash machine #PAY #VMUK

Good morning!

Today’s report will primarily cover the results at Paypoint (PAY) and Virgin Money (VMUK).

Finished at 2.20pm.

PayPoint (PAY)

  • Share price: 992p (+1%)
  • Market cap: £678 million

H1 Results

This is a retail payments company which I’ve had some awareness of for a long time. It popped up on my screening tools many years ago, thanks to its huge Return on Capital and Return on Equity metrics.

Through 50,000 stores in the UK and Romania, it processes over £10 billion of payments annually.

It’s important to note that the company publishes both “revenue” and “net revenue”, where “net revenue” is defined as:

“…revenue less commission paid to retailers and the cost of mobile top-ups and SIM cards where PayPoint is principal. This reflects the benefit attributable to PayPoint’s performance eliminating pass-through costs which creates comparability where PayPoint is agent or principal and is an important measure of the overall success of our strategy. “

PayPoint’s revenue has decreased, but net revenue has increased. Here’s a complete explanation of what happened (note 4 of today’s report):

As you can hopefully see from the highlights above, Paypoint has benefited from reduced commissions to retailers and a reduced cost of mobile top-ups and SIM cards, in those sales where it is deemed to be the principal instead of merely an agent.

If you scroll back to 2015, you might recall that PayPoint had a bitter dispute with newsagents over their commissions (see here and here and here).

That dispute has blown over for now, but it’s clear that Paypoint’s margins remain very healthy indeed.

The company reports an operating margin of 42.1%, down 370bps compared to lastyear. It says that there was a one-off VAT benefit last year (worth £1.7 million), which boosted the operating margin. Excluding the effect of that VAT benefit, the operating margin is approximately flat.

Excluding that VAT benefit, H1 underlying PBT is up by £0.9 million (4%).

Operational Progress

The company’s new terminal, PayPoint one, is spreading faster than expected. Here’s its introductory video:

This new terminal is now at more than half of all sites in the UK, and is responsible for driving PayPoint’s service fees higher by 32%, compared to last year.

The UK (rather than Romania) is reponsible for the lion’s share of PayPoint’s net revenue. Here’s the breakdown of where the sales are coming from:

  • Service fees £6.3 million
  • Card payments £4.2 million
  • ATM £6 million
  • Parcels/other £3.4 million (partnerships with eBay, DHL, FedEx and Amazon).
  • Bill payments £22 million
  • Top-ups/eMoney £8.1 million (mobiles, pre-paid debit cards, lottery tickets).

Net revenue from bill payments, traditionally the largest segment, increased by almost 4%. Unfortunately, net revenue from bill payments is set to decline by a significant amount (£1.4 million in the first three months alone), since negotiations with British Gas failed. I wonder is there any chance that the two companies might realise they miss each other, after a few months apart?

Top-up/eMoney declined, as direct debits continue to take market share from pre-paid mobile.

The over-arching worry with PayPoint, at least from my perspective, has been exactly this: that many or all of its activities could gradually be replaced by online banking. Its typical customer prefers to pay for things in person or using cash, rather than using their bank account.

As the population becomes increasingly “banked” and activities go online, the worry has been that the demand to pay bills at your local newsagent will decline.

Despite these fears, PayPoint’s revenues and profits have been more or less stable.

It turns out that Paypoint has been able to prove itself immensely useful to retailers, and the products and services it offers have been a little “stickier” than expected.

Growth areas have been discovered which weren’t easily predicted, e.g. PayPoint increasing its retailer fees for card payments. There is also a big opportunity in parcels: while revenue hasn’t come through yet, parcel volumes are rising, customer reviews are excellent, and major new partners have been signed up (mentioned above). PayPoint wants to be “the definitive parcel point solution”.

Romania remains a very healthy market for the company, as net revenues in that region increased by 6.2%.

Cash generation is always excellent: £27.1 million in the period (versus PBT of £24 million). The company does report a very large “trade and other receivables” line, but most of this is “items in the course of collection”, i.e. funds temporarily held by retailers. The company has a net cash position even if you exclude funds held on behalf of customers and security deposits by retailers.

The dividend yield is mighty: 42p is coming in interim dividends (including an interim special dividend). The forecast yield is 8%.

My view

As you might have guessed, I have a favourable view of this company. It appears to enjoy network effects from the fact that its symbol is recognised and trusted nationwide, making retailers want to be part of its network. Growing service fees from its new terminal suggest that its technology provides substantial value to these businesses. And despite constant worries about growth, revenue is stable and profits are slowly increasing.

So I wouldn’t mind owning some shares in this business (and I’ve owned shares in it previously, as part of a fund). It’s a good example of a quality midcap which deserves more attention from investors.

Virgin Money

  • Share price: 170.6p (+19%)
  • Market cap: £2,450 million

Final Results

The market clearly loves these results.

This is despite a reported loss of £194 million. On an “underlying” basis, VMUK think it made a profit for the year of £539 million.

PPI provisions are the main issue here:

We, like the rest of the industry, were surprised by the scale of the PPI information requests and complaints during August. We have moved swiftly to address the issue and are leveraging innovative technology solutions to enable us to deal with genuine customer complaints as quickly, and as cost effectively, as we can. It is nonetheless frustrating to incur a further £385m in provisions in Q4 as we look to close out this legacy issue.

The scale of PPI provisions and acquisition costs incurred during the year led to a statutory loss of £194m for FY2019. However, as outlined at our CMD, we have a clear path to statutory profitability and a statutory return on tangible equity of >12% by FY2022.

Return on Tangible Equity (RoTE) of >12% on a statutory basis would be a fantastic result, and would be worthy of a premium market cap, in my view.

The balance sheet shows equity at September 2019 of £5 billion, of which tangible equity is £4.5 billion. Balance sheet fair value is of course a tricky question, as it is for any bank. The VMUK balance sheet includes, for example, £400 million of defined benefit pension assets, and £300 million of tax assets.

But if we allow £4.5 billion to represent a simple estimate of tangible equity, then VMUK is currently trading at a price to tangible book value of only 0.54x.

If it succeeds in producing a statutory (i.e. non-adjusted) return on this tangible equity of >12% within the next three years, then it looks seriously undervalued.

Guidance for FY 2020 is “in line with medium-term strategic and financial targets“.

Strategy involves putting itself forward as a different kind of bank, with “digital” current accounts, “concept stores” and a “digital disruption hub” in Newcastle. Customers will gain access to rewards across the entire Virgin empire. And the old Scottish Clydesdale Bank name is being retired, as the entire organisation rebrands under Virgin Money.

Would Richard Branson ever have imagined that his little record shop brand would grow to take on the financial industry? I suppose that banks are relatively straightforward in comparison to space flight!

VMUK’s CET1 ratio (a measure of financial safety) sits at 13.3%, which would generally be considered safe (HSBC is arguably too safe at a CET1 ratio of more than 14%).

Side ventures include a joint venture with Salary Finance (workplace lending) and an energy switching partnership with Gocompare (I have a long position in GOCO).

Core financial products are making steady progress and at least maintaining market share, e.g. business lending +4.5%, personal lending +16.1% (driven by credit card lending and other growth areas) and mortgage lending +1.7%.

My view

If this does what it says it’s going to do, it looks seriously undervalued to me. I’d like to study it in more detail, to understand why the market is so wary of it.

The share price was as low at 105p a few months ago, versus 200p+ over the summer. Clearly, the stock market isn’t quite sure what to make of it, either!

That will do for today. I’ll be back again tomorrow with another Midcap Report.





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