Distribution Finance Capital Holdings plc (LON:DFCH) is the topic of conversation when Progressive Equity Research’s Research Analyst Mike Trippitt caught up with DirectorsTalk for an exclusive interview.
Q1: Mike, first off, can you just remind us of the DF Capital business model?
A1: It’s probably useful to have some brief history. Distribution Finance Capital Holdings, to give it its full name, was founded in 2016, started lending in March 2017 and its principle subsidiary, DF Capital Limited, is a specialist lender in distribution finance, servicing the smaller medium enterprise market, the SME market. The business was admitted to the AIM market in 2019, it trades under the ticket DFCH and, as we speak today, has about an £86 million market cap.
It got its banking license in 2020, allowing it to raise retail deposits and it very quickly started to replace all of its wholesale funding with retail deposits so you now have a specialist lender that is fully retail deposit funded.
The model itself, I think the interesting point here is you have a very experienced management team under the leadership of CEO, Carl D’Ammassa. They’ve taken a fresh look at the market and determined what it needs rather than trying to necessarily shoehorn legacy systems to fit the market. I think what with that combined with what appears to me to be simple but effective and very easy to use IT that is available to the dealers and manufacturers.
So, the primary business is inventory and supply chain finance, effectively providing working capital finance to a variety of markets and I would expect the company will start to develop into new markets probably toward the end of next year and into 2023. The products we’re talking about are motor homes, caravans, lodges, holiday homes, marine transport, industrial, and agricultural and what the company does is effectively intermediate between the manufacturer and the dealer with a fast efficient credit approval process and payment process.
So, one very simple example, what the company refers to as floor plan finance, the dealer orders units from the manufacturer, the manufacturer assesses the status of the dealer, the manufacturer then supplies the units and invoices to DFCH and they then pay the manufacturer and invoices the dealer. The dealer then pays DFCH when the units are sold or at the end of the statutory loan period.
So that is the model, simple and effective and given the growth that we’ve seen in the book over the last year, clearly, it’s a successful model.
Q2: How has the company performed during the COVID pandemic?
A2: Well, the pandemic, clearly the world, all markets have been impacted, supply chain delays have been substantial and the company has not completely ducked that issue, but I think it’s managed the situation very well.
I think you’ve got to think about two things because effectively the business is in start-up during this period so the recent financial performance reflects, first of all, investment in the business, the company needs to get the loan book to a critical mass where the business becomes profitable. The loan book’s going to double this year, that’s already been confirmed in the recent trading update and we forecast a further doubling in the loan book next year. The company will get to a profitable monthly run rate in the first quarter of 2022.
Secondly, the recent financial performance does demonstrate the impact of the pandemic. Loan book reduced in 2020, but is being rebuilt substantially this year, as dealers started to restock. There was an update just a week ago, the loan book was at £243 million at the end of November, that’s double where it was at the end of 2020 so that’s a great performance, but there are some critical orders expected at the tail end of 2021 that will slip into ‘22.
So, they’re guiding to a slightly lower loan book at the end of this year and that has some impact on 2022 finances but I would say overall, it’s been a strong performance during challenging times.
Q3: Why did Arrowgrass sell its shares?
A3: That’s a good question and it’s completely separate and Progressive actually put out a note on this this morning to clarify the situation.
Arrowgrass was a key investor in DFCH from the very beginning and, in fact, was the company’s majority shareholder at the time of the AIM market admission. It reduced its shareholding to below 50% and there was a one year lock in applied, which is set out in the AIM admission document that it wouldn’t sell any of it shares.
The end of last year, October 2020 thereabouts, Arrowgrass informed the company that its investment management of DFCH will continue until the end of 2021 so here we are and hence the sell down.
So, a very large sell down at a substantial discount to the market price is obviously always going to disturb the share price but what it’s done is it’s really freed up the register and removes, I think, one of the perceived overhangs from the Arrowgrass stake. We estimate now top four shareholders own about 30% of the shares compared with almost 70% prior to the sell down.
So, I think if you put all this together, you’ve got a specialist lender, retail deposit funded, under the leadership of a very experienced and capable management team. We’ve had revisions to 2022 earnings and a restructured share register so it’s quite a good sort of line in the sand for investors or new investors to take a look at the business and consider the investment case.
There was a £40 million capital placing in February this year so the company is now properly pre-capitalised to grow and roughly double the loan book from where it is. Shares trade at about 1 times book and it’s going to turn profitable in Q1 next year.
On our numbers, we’ve got the business profitable for the full year and then we’re looking at 12% ROE in 2023 on a loan book of about £500 million so I think it is an interesting time to just look again at the investment case for DF Capital.
