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Latitude IPO: no need to buy now, says Morningstar

Lex Hall  |  04 Oct 2019Text size  Decrease  Increase  |  
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Morningstar has urged investors against subscribing to the float of Latitude Financial Group, saying the business is highly leveraged, exposed to lower credit quality and the competitive threat of rival buy now, pay later players such as Afterpay.

Latitude is one Australia’s largest consumer-financing businesses, providing personal loans, credit cards, and no-interest financing products, including a buy now, pay later (BNPL) platform called LatitudePay.

Led by former Australia Post chief Ahmed Fahour, the company provides finance for customers looking to buy big-ticket household items, such as white goods, electronics and furniture.

It has about 2.6 million customers, 1900 merchant partners across Australia and New Zealand, and derives about 60 per cent of its business from big retailers such as JB HiFi (ASX: JBH), Harvey Norman (ASX: HVN) and The Good Guys.

The business model centres on borrowing money cheaply in wholesale debt markets, then lending to consumers at a much higher rate. The business was acquired from General Electric in 2015 and has come to market via private equity owners KKR, Varde Partners and Deutsche Bank.

The offer price is between $2 and $2.25 and the offer closes on 14 October.

High uncertainty, no moat

In a report on the initial public offering, Morningstar analyst Nathan Zaia says the offer risks being overvalued and has set a fair value estimate of $2 a share, which makes it a 3-star stock, with no moat – or sustainable competitive advantage.

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“We don’t like that shareholders must commit without knowing the price and with the top end of the range 12.5 per cent above our valuation, we recommend investors don’t subscribe,” Zaia says.

Zaia has assigned a very high fair value uncertainty rating to Latitude, saying that despite an attractive dividend yield of 4.5 to 5 per cent, the long-term risk of recession and potential for capital losses should be considered.

Latitude currently has a zero-franking balance which means the timing of tax payments could result in dividends not being fully franked until fiscal 2021.

He also notes the business is highly leveraged, exposed to lower credit quality consumer finance and faces increasing competition from BNPL rival, Afterpay Touch Group (ASX: APT), whose share price has almost tripled this year.

“A key business risk stems from the credit quality of Latitude’s major assets, specifically personal loans, payments, instalment, credit card and BNPL receivables,” Zaia says.

“These type of receivables are generally lower quality than mortgages. With the exception of Latitude’s motor loans, which make up only about 5 per cent of receivables, the firm’s assets are not secured.

“This means Latitude is sensitive to macroeconomic drivers, in particular the unemployment rate, the GDP rate and retail spending rates.”

“Consumer demand could also see Latitude’s key merchants embrace BNPL with Afterpay boasting nearly 3 million users and more than 30,000 merchants transacting on its platform in Australia and New Zealand.”

Another risk is more regulatory scrutiny following the banking royal commission, which cracked down on financial services firms.

“Regulatory reform is likely to affect the profitability of Latitude’s insurance business,” Zaia says, “which accounts for 5 per cent of the group operating income. While small, it’s highly profitable.”

Valuing Latitude

Zaia’s base case fair-value estimate of $2 a share equates to a forward price/earnings ratio of 12.7, which is lower than the average of the major banks, and similar to rival consumer finance company FlexiGroup (ASX: FXL).

“We forecast $279 million cash net profit after tax in 2019, in line with management's $278.1 million guidance, and target compound annual NPAT growth of 8.3 per cent over the next five years.

“We credit Latitude paying out around 65 per cent of cash NPAT as dividends - the midpoint of the firm's stated 55−75 per cent range. Our fair value estimate implies a dividend yield of 5.1 per cent.”

Read the full pre-IPO report on Latitude Financial Group here.

is senior editor for Morningstar Australia

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