Recent Buy: Pepper Group Ltd (PEP:AU)

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Full disclosure: Long Pepper (insert cleaver sexual innuendo). Do your own research prior to making any investment decision and seek personal and professional investment advice. This post is not a solicitation to buy or sell any stock. 

The following is an brief overview of Pepper Group Ltd, one of my recent acquisitions. You can read the other overview, on Sukin Skincare (BWX Ltd) here.

All $ are AUD unless otherwise noted.

According to Morningstar, Pepper Group (PEP:AU) is a diversified, global financial services business comprising Lending, Advisory and Asset Management (aka Servicing) services across residential and commercial property sectors and provides loans for consumer, auto and equipment finance. The company has been operational since 2000, and listed on the ASX 31st June, 2015. It operates in Australia, NZ, Ireland, UK, Spain, South Korea, China and HK. European readers may better know Pepper Group as ‘Pepper Money’. Pepper has a market cap circa $537 mln.

As of March this year, Pepper Group had around $50.8bln in AUM (assets under management) with Lending accounting for $7.7bln. The Lending arm of the business is the fastest growing due to its small base and recent expansion yet contributes slightly more than 50% of income. The lending arm consists of Residential Mortgages (prime, near prime and non-conforming) and Consumer Lending (Auto, Equipment, Point of Sale Finance, Personal Loans and Credit Cards).

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From Pepper’s 2017 Presentation

Financial Performance. When looking at newly listed companies, it pays to do a bit of digging. I read through any publicly available documents, the IPO Prospectus and recent annual reports and investor presentations. It seemed that in 2014, Pepper produced NPAT of $35.1mln on $234.9mln in revenue, which has grown to NPAT of $61.6mln on revenue of $413.2mln. Management has provided guidance of Adjusted NPAT of ‘at least’ $67.5mln for CY2017. ROE was 13.58% in 2016.

Dividends. In 2016, Pepper had a dividend yield of 3.43%, paying 8.4cps fully franked. It had a low payout ratio of 24%.

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CAGR’s over the past 4 years for AUM and Income. From Pepper’s 2017 Presentation.

Growth. Pepper has gone through a period of acquisitive growth over the past 3-5 years, however the CEO has noted that in Spain, Ireland and the UK, these acquisitions are starting to bear fruit. This should be most noticeable in 2018, as fixed cost of the European operations should be covered by the end of 2017. AUM have grown from $4bln in 2012 to $50bln in 2016. As the company matures, it’s payout ratio may increase and this (alongside a larger market cap) is likely to make it more attractive to retail investors. One might expect some level of continued inorganic growth, which Pepper seems to do reasonably well at. In South Korea for example, Pepper bought a small Mutual Savings bank back in 2013. Fast forward to 2016 and residential mortgages and consumer lending there grew 52% YOY to $1.28bln which produced revenues of $76mln for the Group CY2016. There is also the potential for a decent level of organic growth, as re-branding of acquisitions provides greater share of mind and greater lending restrictions imposed by banks encourage consumers to look toward non-bank sources of funding.

Risks. A significant risk to Pepper is any event, gradual or sudden that causes borrowers to default en mass or reduces consumer appetite for credit (e.g. sustained unemployment, high interest rates or a large downturn in the housing sector). Peppers average Loan to Value Ratio (LVR) is about 70% and its 90 day delinquency rate is at 1.36% Pepper says because they are quite choosey about who the lend to. These provide some buffer to any risk. That said, the majority of their lending goes to ‘near-prime’ customers, first homer owners or investors that don’t qualify for a bank loan. So there are some mitigating factors, but if a perfect storm could be a disaster (or is that opportunity?).

Geographical and political risks exists, as changes in lending criteria, monetary policy etc. could have an impact on the Groups ability to operate profitably. Whilst Pepper isn’t regulated by APRA (like the banks) it is still regulated, as are it’s operations overseas. There are risks regarding access to funding and capital and liquidity requirements. Pepper currently funds its lending via warehouse facilities, term securitisations, corporate debt facilities, whole loan sales and customer deposits. If any of these become difficult to access, or Pepper is required to contribute ‘first loss’ equity capital to more senior noteholders in Pepper warehouse facilities and term securitisations. These would most likely occur in a housing market collapse and widespread default.

Takeover risk is a slight concern (that’s right, Takeover is a risk). The Australian Financial Review published a story indicating that private equity firm KKR & Co might attempt a takeover of Pepper Group to gain access to Australia’s shadow lending market. Whilst some investors love takeover rumours, my heart sank on reading the article – to think Pepper could be bought out for a ‘premium’ to its current share price, at a sale price that is highly likely to be less than the future expected value should the business do reasonably well (e.g. bought out for $4.20 when in 3-5 years it might be worth $8). It would be a short sighted move for the board / shareholders to approve a takeover at anything less than multiples of the current price. The same paper published an earlier story that KKR & Co and Oaktree Capital Management might team up with Pepper to focus on lending to Australian consumers where Pepper would take the lions share of non-conforming mortgages.

Early in May I bought 715 shares of Pepper at $2.89 (yes, I’m a small fry).

This post was on the lengthy side so thanks for sticking with it! It’s a pretty brief overview really just to introduce the company and my initial thoughts on it. I hope to post soon about a the other two positions I hold, as well as a couple companies I’ve examined but couldn’t convince myself on the thesis so have held off.

What investments have you made recently? What do you think of Pepper Group? (spicey long pepper jokes welcome).


4 thoughts on “Recent Buy: Pepper Group Ltd (PEP:AU)

  1. A good well timed buy I would say. I know nothing about share (property is my game) but I do know the APRA changes are making investment loans much harder to get. So the non-ADI lenders will reap the rewards I think.

    1. Hi Cath, thanks for visiting and sharing your comment. I agree more people will seek out alternative sources of funding as banks tighten their lending criteria. Good luck with your property investments 🙂

  2. Very interesting WF30, I didn’t know much about Pepper before. I didn’t know it was so globally diverse. I’m interested, I’ve added it to our watchlist. The one thing with finance stocks is how cyclical they are, I just hope that Pepper aren’t picking up the worst borrowers that the banks don’t want. Very nice & low payout ratio though. One to watch 🙂

    Mr DDU

    1. Seems to me that the majority of the loans go to people who can manage them and the delinquency rate is reasonable. They’re helped by the fact that the banks are black listing certain suburbs etc. it pushes decent wage earners their way. If there is a large credit crunch they’ll suffer as much as the next lender though…

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