Latitude Group Holdings Limited (LFS) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to Latitude Group Holdings Limited 1H '22 Results Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Matthew Wilson, GM, Investor Relations. Please go ahead.

I would like to begin by acknowledging the Wurundjeri people, who are the traditional owners of the land from which I am hosting this meeting today and pay my respect to their elders past, present. [Operator Instructions] I will now pass over to Ahmed Fahour to begin the presentation. Thank you.

Well, good morning, everybody, and thank you so much for dialing in. I'm pleased to announce that you would have already have read, I'm sure, that Latitude has made a cash net profit after tax of $93 million and that we have maintained our dividend for the third half in a row at $0.0785 per share, and this dividend is 100% fully franked. This is a terrific result in a very challenging market environment, both domestically and around the world. I'm going to focus on Slide 13, which is available to you in the presentation deck, and highlight a few key essential factors that have driven this successful outcome. And then Paul Varro, our CFO, will take you through the details behind the numbers and behind the business' performance. The #1 success that we've achieved in our cash profit has come through focusing on our customers and focusing on both the merchant and the consumer and providing the services around installment, sales finance, our card propositions and our personal loans and auto loans products. These 4 products produce 100% of the profit of Latitude. We once again maintained our volume of $3.7 billion for the half. And on top of that, we have one of the strongest consumer finance balance sheets in the Australian marketplace. Our tangible equity ratio at 9.2%, our surplus equity, is well in excess of our target range of 6% to 7%. What that gives you as indication of is how strong our capital position is. And potentially, we are carrying a lot of surplus capital, but we believe this is prudent for the environment that we are looking at today. We have prudent provisioning, 1.6x NCO and that is an increase on where we were before COVID set it. We have very conservative funding and lots of headroom, which positions us for growth in the coming period that we see emerging in 2023 and 2024. Our cash is strong as well, and we maintain our high margin, which gives us an opportunity to continue to invest in the customer experience, and we have strong capital discipline. I'm pleased to report to all of you that the simple transformation is on track and on budget. We are delivering the new Symple platform that we acquired late last year. And now we have this available for all of our customers in Australia for our personal loan and auto products as they apply. This new variable rate offering, which is delivering all the results that we expected, and we're very much looking forward for the rest of the year and its delivering in terms of the volume and the opportunities that we see ahead of us. I'm also pleased to say that I mentioned earlier this year that one of the things that we would expect to see as a recovery post-COVID in the near term is travel. And what this result shows you is that we're not disappointed. The travel segment is booming, and we are real beneficiaries of that. We have the famous 28-degree card it is growing double digit, 23% half-on-half and 29% year-on-year. And what's fantastic is a big part of that growth in the last 6 months was actually domestically driven, and we see signs now of the international component really taking off and continuing beyond June 30. And last but not least, in this result, you would see that we are a very disciplined player when it comes to mergers, acquisitions and our corporate portfolio. We see lots of opportunities. We did not obviously fulfill on the Humm opportunity. And I think it's been well documented, the discipline that we take we're prepared to pay a price which can produce an outcome. If we can't get it at that price, we will move on. That is the bottom line. On the other hand, internally within our organization, we also have disciplines about where we're focused, where our capital will be and the kinds of returns that we expect to deliver. On that basis, we were -- we announced already that we will be divesting our insurance business. It is not a big part of this company, and it's one which would be in much better hands with a specialty insurance company who can take it to its full potential and allow us to redeploy the capital that was in that business into our core businesses, which are successful and profitable. In summary, there is no question that Latitude Financial is the most profitable and successful consumer finance company in Australia and New Zealand. As a matter of fact, there aren't many people who make a profit, let alone the kinds of cash flows, profits. But what I'm particularly pleased about is in the challenging environment of the last few years. We didn't cut any corners. We invested in the company. We positioned it for growth and we have one of the strongest balance sheets, which Paul Varro will take you through in a few minutes. But 2022, like 2021 and 2020, is still very much a COVID infected environment and economy. One of the tell-tale signs of this unusual past few years has been the amount of excess cash that has been pumped into the economy. One of the negatives that's emerged from that is clearly inflation. Inflation is a manifestation of the excess cash that's available relative to the supply constraints that we've seen during COVID. What it's meant for Latitude is that this excess cash has meant a bigger debt repayment into the portfolio than was the case pre-2019. And you can see on Slide 13 an illustration. It shows you that our business has tended to, in the last couple of years, have 10% higher debt repayment on those receivables than pre-COVID. And I already said at the AGM, this one-off situation that's emerged during COVID, a very unusual time period, has led to a significant reduction in our receivables which also means a reduction in our revenue. This is COVID induced. This is not a fundamental part of the economy, and it is one-off in its nature, and it we knew dissipate in the coming year. It's taken -- it will take a little bit of time to work its way through the economy, but there are signs already in the month of August. Just now, you can see how inflation is being tackled, how interest rates are moving and what it means for excess cash sitting in the economy. It will start to decrease. And what that will mean is the growth that we experience will be able to stay on our balance sheet and give us the upside in the coming years that we -- that was taken away from us in the past 2 years. So what that's allowed us to do is because COVID is a temporary phenomenon that will work its way through, what that allows us to do is to look through that and focus on 2023 and 2024 to determine what the Board determined was our dividend for this half, to look for where our cash is and where our future lies, and we're very excited by it. The only other comment I would make about the challenges of 2022, in particular, in the second quarter for us, which is April to June, has to do with the funding market and interest rates. Now we all know around on this call, on this webinar, that interest rates have really taken off. And there is some to go for the rest of this year. We anticipated and was strongly of the view that this was going to happen. And we had started to position our business in the way we priced our products, and we immediately started to do those repricings in April, right through June. Now clearly, your cost of funds goes up much faster than your ability to fully reprice on the front book and it takes some time for the rate increase to offset -- the cost of funds increased to be offset by pricing changes that we make. So that won't fully address and adjust until 2023. And therefore, we play catch-up in the rest of '22, but eventually, you get there. And Paul Varro will walk you through some of that. So we've begun it. We know it's going to come through. We will be able to deal with it fully in 2023 and 2024, but there is a mismatch that does occur right now in this result, but more importantly, into the second half. So with that in background, let me just very quickly touch upon just a few slides, and then I'll hand over to Paul Varro in that part. If you go to Slide 14 in the deck that you have, just some quick data points to support some of the comments I've been making. Volume, I've already spoken about and some of the exciting opportunities that we're already seeing in the lending business. Our PL business continues to grow market share in Australia and New Zealand and has continued this trend over the last 4 years. As of June 30, we sit with 13.5% market share in personal loans in Australia. If you go back to when I started in this job, we were sitting at below 8% market share. We continued to grow and we've documented this in previous reports of ours. But you will see that this is one of the trends or one of the reasons why we had bought Symple was to continue to grow in this exciting area of personal loans and also I might add in the auto space. Another really strong feature of this company I talked about is the strength of our balance sheet and the strength of the customers that we've been doing business with. Back in 2019, the lower -- the higher risk grades, what we call CR4s and CR3s, which are higher risk customers, we price for all of those risks that customer base was 36% of our portfolio. Today, in 2022, that's down to 29%. The inverse is the highest quality customer base, what we call CR1s and 2s, we have increased that portfolio to be over 70% of all the flows of what we have. So with that in mind, what that means is those customers because we risk price, they would get a lower price than those that are higher risk customers because of the way we do pricing. And so therefore, you might see that our RAI margin, risk-adjusted income, has been -- has come down a touch. But that's because we have a higher quality customer base and we price those at a different level in there. We have an opportunity with lower prices that these customers get to also have the benefit of lower provisioning and lower bad debt charges, which is why you've got to look at this thing holistically. One of the hallmarks of our management team is to also invest in productivity and to invest in the digitization of the organization. And when you digitize the organization, you have less expenses and less costs inside the company. Today, we -- you can see that in this result, our absolute costs are down 9% on the second half of 2021. This has continued the trend that you've seen in this company for several years, which is excellent cost discipline while running the company well and running the company strongly. Today, we have just over 1,000 FTEs. In 2018, we were closer to 2,000 FTEs. So you can see we don't need as many people. But what we do is we're investing in the technological and digital capabilities of this organization to be able to work with the customer in the way they want to be worked with. And last but not least, our charge-offs. We have continued to demonstrate very strong disciplines there with a low charge-off, which reflects the quality of the customer base that we have. One indicator that Paul will go through in the deck is 90 days past due. This is a very temporary indicator to tell you what's going on with customers who might miss payments as opposed to charge-offs. And I'm pleased to say to you that we sit at 80 basis points. That is even down further on where we were in 2021, which is down on 2020, which is down on 2019. And it is a remarkable result. We would be one of the very few consumer finance companies in the world that would report 80 basis points on non mortgage consumer finance companies. As a matter of fact, that number is so strong. It is even better than 2 of the 4 major banks in Australia, who have a higher 90 days past due for their non mortgage consumer portfolio. We're very proud of the strength of the balance sheet, the quality of the customer that we work with and the partners and the merchants that we have. In closing off, I just wanted to touch briefly on Slide 16, which highlights all of the successes of what we've achieved with the Symple transaction and the new technology we've implemented in this company. We're not fully there yet, but we have really made big inroads. And the front end of our business is now originating on both the fixed and the variable rate product. I'm really pleased and proud of this team and this organization for all of those successes. And in the coming 6 to 9 months, we will complete the back book migration, and we will be the beneficiaries of years to come of this platform that we now have. On Slide 17, I'm also pleased to announce and report to you all that our international business in both Singapore and Malaysia is up and running, and we are working with customers. We've got 30,000 of those in Singapore. Literally, in the last 6 months, we've built up a terrific merchant base. And we are working very closely with our Australian major partner in Harvey Norman in both Singapore and in Malaysia. We have 2 more announcements to make in the coming period. We have signed contracts with 2 large retailers who have over 200 stores in Malaysia, and we're looking forward to rolling out Latitude's capabilities in those 2 Southeast Asian markets. And to close, which is where I started with, the dividend that you see there of $0.0785 on the first half of 2022, which is 100% franked, will be paid on the 26th of October and the company goes ex dividend on the 23rd of September. We've given a little bit of extra time. I just want to make a note, this is slightly different to previous ones. Just a little bit of extra time of when the stock goes ex dividend to give all of our shareholders time because we have a dividend reinvestment plan. And we want to just give our shareholders some time to fill in the form, if you wish to reinvest the dividend amount that you get into buying shares in the company. Obviously, it is transaction, cost free to do so. And the dividend -- and the franking credit still comes to you even if you elect to do the DRP. It goes without saying that the share price on the 17th of August, this dividend represents an annualized dividend yield of 10% which is extremely attractive. And I hope is a good reward to our shareholders for investing in our company. I'm going to stop at this point. We'll take questions later, but Paul will now dive into a couple of the really important financial results. So over to you, Paul.

Thanks, Ahmed. If you move to Page 22. What we thought we'd do is just lay out some of the key metrics of the half. I won't go through them in a lot of detail, I'll do that in the subsequent pages. All key points to make on this page. Firstly, on the left-hand side, solid cash NPAT result of $93 million, above consensus of $90 million. Continued strong RAI, underpinned by an excellent net charge-off results and also strong discipline in our OpEx with flat OpEx year-on-year and down half-on-half, as Ahmed alluded to. The third point is around our strong balance sheet, again, with TER increasing to 9.2% coupled with stable returns, so ROE strong at 12%. And our return on average gross receivables steady at 3% as well. I'll talk about that a little bit later. And then finally, on this page, consistent EPS and EPS results as well. If we turn over to Page 23, I'll take you through some of the key operational drivers of the result. And Ahmed already spoken to some of these, so I'll just quickly skip through them. But on Page 23, top left, 2% volume growth, up 2% year-on-year, led by Money at plus 9%. Bottom left-hand side there, just a little bit more detail on the repayment rate. And as you'll see, consistent with 2021 elevated payments. So for the half, a payment rate of 100%. Compare that to the first half of '19 at 89% and you can see that real difference in the payment rate relative to our normalized 2019 levels. What those higher repayments do is make it harder for us to grow receivables. And as you can see there on the right-hand side, receivables down 2.8% year-on-year or about $180 million, but flat half-on-half and really steady as we go into 2023. If we turn to Page 24, I'll just take you through some of the key P&L drivers of the result. So top left-hand side of Page 24 is our operating income down $39 million year-on-year. $11 million of that is due to our lower receivables, which I just talked about. The other $28 million is on yield, down 87 basis points. Really, there's 3 main reasons behind that 87 basis points. The first one, as Ahmed alluded to, is the much better risk mix that we've been originating over the past few years. That comes at a lower interest income. But also some strategic pricing changes we made on Go and Gem late in the first half of '21, persisted for 4.5 months in 2022. What we did do is reprice those products as we saw cash rates go up. The benefit of that repricing, along with the new business pricing that we did in PL and autos will help us out in the second half and into 2023 as well. Not surprisingly high funding costs up 29 basis points and then The [ Good Guy ] of 30 basis points, which is due to 28-degrees increasing its volume and its interchange and lower loyalty cost as part of the value proposition changes we made on the GO product where we decreased APRs last year. If we turn to Page 25, this is really the proof point of what Ahmed was saying. The portfolio remains in extremely good shape. As you can see there on the top left-hand side, CR1s and 2s now at 71% of our originations. This is really driving quality assets that are well seasoned given how long we've been acquiring those. Bottom left-hand side is your delinquency. So 30 days past June, 90 days past June, you can see there is sustained very strong performance and better year-on-year. Low delinquencies manifest in the top right-hand chart as lower charge-offs. So charge-offs for the half at 2.37%, down 17 basis points versus the prior year, but up seasonally. And then with those lower delinquencies, with sustained good performance over what is now a 2-year period, we are appropriately provisioned at a provision rate of 3.74%. That coverage of 1.6x our annual charge-off rate is still higher than our long-term averages. And when we look at the unemployment forecast, clearly, we feel very good about the portfolio going forward. If we move to Page 26, those high-quality assets and decreased charge-offs with the lower 17 bps really underpin our risk-adjusted income. You can see there on the bottom left-hand side, the combination of our risk-based pricing driving the increased quality at lower charge-off levels gives us what we believe to be an appropriate RAI yield for the quality of the book at 9.5%. This is an appropriate return as it reflects the quality, the seasoning and the risk of the book going forward. And obviously, as I said before, we have our pricing actions that we've already implemented to help us in the second half of '22. But also we have capacity to reprice more should we need to. A change of pace now if we move on to Page 27, just on costs. Our productivity programs and our cost discipline have delivered flat OpEx year-on-year and down on the half. This has really allowed us to absorb our listing costs year-on-year, our international expansion, as well as additional operating expense investment into the business as well. So good strong results for OpEx. I want to leave you with really 2 last pages. The first page is all about our P&L resilience. The combination of our ability to price for risk, disciplined underwriting, a high-quality well-seasoned book and our OpEx discipline really manifests and delivers significant excess spread with a 3% AGR. That excess spread really generates positive cash either for investment in the business or to return to shareholders. But it also provides a significant buffer in uncertain times. And you can see there 3%, it's a significant multiple of our annual charge-off number bearing in mind, this is also a post-tax ratio. And then lastly, on Page 29, our funding and balance sheet strength. Yet another strong half for the Latitude, strong diversified funding program. We've got $2 billion of limits, a very well-balanced maturity profile that really allows us to access the market opportunistically. With that maturity profile, we don't have to access the market in the next 12 months should we not choose to. And then finally, as I said from the outset, the strong capital base at 9.2% of TER, allowing us to weather difficult periods, but also giving us a great position from which to grow. I'll now hand it back to Ahmed to make any closing comments.

Thank you very much, Paul. Look, the only thing that I just wanted to add to what Paul was saying was that we have spent a lot of time in the last 5 months, also thinking about how do we enhance a number of these customer experiences and also setting up the business for what we consider to be a changing regulatory environment that has emerged over the past few months. And we are really proud of how we positioned the business to be able to anticipate some of those things that are going on. And one good example of that is when we set up the very small buy now pay later business that we have, which many of you know, is less than 1% of our business. When we set that up, we did not run that business without a credit check. Most people thought that it got around all the regulatory environment, which at that time, it did. But right now, the reality is that the things that we thought was appropriate, which is if this is credit, if a customer is going to take money, we have a responsibility to at least check that it's the right thing for them to do for even what is a small amount of money. And so we took it upon ourselves to do that. And yes, we didn't add as many customers and do as much business as other people did, but we did the right thing. And now we look back and we realize with the change of environment, we can see we did do the right thing, and we never caused any harm for our customers, and we did the right thing by the community in how we did that. And that's a reflection of the low, bad and doubtful debt charges. Our net charges are among the lowest in the world for a consumer finance company of the -- due to the quality of the business and the great customer base and the prudent approach that we've taken over the last few years. I'm so proud of our company and how we are disciplined about those things. And I just wanted to add that as a closing comment. We're very happy to take your questions. Please follow the instructions of the operator.

[Operator Instructions] Your first question comes from Josh Freiman from Macquarie.

Just to check, you can hear me?

Yes.

Perfect. Just a couple of questions for me. I know in prior results, you guys have sort of been looking for elevated repayment rates to normalize. And it looks, I guess, pretty cyclical looking at the chart in the pack. But I guess at what point are you guys expecting this to normalize now that macro events have changed?

Thank you very much for that question. Yes, we've been waiting for this economy to -- for this -- for the excess cash in the economy to work its way through. We had hoped at the end of the Delta wave at the end of last year. And I remember, it was only in November last year that we had anticipated that the excess cash being doled out in the economy would start to dissipate. Unfortunately, 2 things have happened in the first half of this year, which is Omicron hit and state governments continued to support the consumers and Australians in the economy. And then secondly, when the extra $750 was supposed to end as of 30th of June, the federal government announced that it would extend until September. One of the things that we've attached in the deck that we gave out today in Slide 35. And what it shows is a correlation between our repayment rate and the excess household liquidity. And you can see it's a perfect correlation. That alone has been driving this excess amount. Now what is really clear in this document is that it is fast approaching, very, very fast approaching that the excess liquidity is going to be worked its way through by your own modeling, the higher interest rates and the repayments required to meet the higher mortgage rates that are out there. And quite frankly, the higher cost of living has meant excess cash in the economy is being soaked up. Now I get some back of the envelope calculations myself. And if you book some assumptions about what's fixed rate, what's variable rate, et cetera, et cetera, it looks like about $2 billion a month is being taken out with each of the rate rises that's announced by the government. Now you have your own models that will do that. Matt Wilson and I have been intellectually debating this number. But I think you'll find it somewhere in the order of $2 billion plus per month. That is going to really, really start to kick in. So the average Australian will pay an extra $8,000 per annum to support higher debt repayments associated with the mortgage repayment. Now eventually, probably by the end of this year, that is going to start to bite and that excess liquidity is going to disappear, and there should be some normalization into 2023.

Ahmed, I won't ask you to send the analysis to me, maybe I'll give it a stab on my own first.

I would like you to do that, and then I'd like you me and Matt Wilson to have a little debate with each other on it.

That sounds good. Just a second question for me. And it's just with respect to the capital position. You guys have noted a target capital range of between 6% to 7%, and you guys currently have a position of 9.2%. But you've also delayed the dividend and initiated a DRP. Is it possible for you to reconcile these outcomes for me?

Yes. It's -- well, there are 2 different points out there. One is a capital position and one is when we're paying the dividends and things like that. What we tried to do is -- well, our capital is sitting there obviously way above our range. And what that means is that we have an opportunity to grow our receivables without having to use up or draw upon capital from the market or from anybody else. So it's a really important point that we -- when we grow, we tip capital into our trust structures, into our warehouses as our equity to support our funding arrangements. So we're sitting there very comfortable with the capital position. In terms of the dividend, we paid the dividend in October. But what we try to do is to pay the payments and the cash flow management. We delayed the -- we introduced this DRP program, and we're trying to match when the trust structures, how they fall between growth and when you put capital into it and when you take -- sorry, when you put cash into when you take cash out of it. So one of the things that we did -- this is getting into an inane amount of detail, but just to give you just a little bit of insight. When we were implementing the new simple platform, just as an example that we have, rather than write the receivables -- all the receivables that we have rather than write them into and put them in on a monthly basis into the trust structures immediately, we actually took them on to the corporate balance sheet. We did that for a little while, just to be prudent to make sure everything works and all the systems work. And so we did that. And then we're now going to put them back into the trust structure. So we just have a slight timing issue in the way all of that flows work. But by and large, you should not interpret that anything other than just literally a timing issue around the corporate capital versus the trust capital that we have in place. We feel we're in a really good position, and we're really looking forward to because we've got actually excess capital, and I really don't want to be sitting there with 9%. Now partly, it's how does the economy shape up. But actually, what I'm really excited about is that we can grow, and we don't need to go back to the market for capital, whereas I think you'll find others I'm not in that comfortable position that we're in.

Okay. I guess just a follow-up. I'm a little bit confused because this isn't the DRP sort of just a bit of a drip feed of you guys going back to the market asking for capital?

Well, DRP, there's no discount. There's no nothing there. It's just to give -- what we're really worried about with the -- in terms of some of the feedback that we get is our stock is illiquid. And a lot of our investors have said, liquidity is the single biggest issue. There isn't enough shares that if I want to buy stock. And there are some of our shareholders, which is on the record who do wish to actually buy more shares, and they're finding it really difficult to do that. So what we've done is we made it available to everybody so that we don't play any differentiator again because I don't want the shareholders, those that are excited about buying our stock, to take away any more liquidity that we already have. Does that make sense to you? And I'm happy after this phone, call for Matt and -- us to give you more information about that. I don't anticipate it's going to be a big number, by the way.

Yes. No, the liquidity point makes sense.

Okay. Fantastic. No problems.

Your next question comes from Simon Fitzgerald from Jefferies.

Just the first one here. Obviously, net charge-offs historically low. You've mentioned also fact that your -- quality of your customer is improving in the last 2 halves. And then also, obviously, the 90-day past due, very good performance there as well. I'm just interested to know whether you're looking at sort of fine-tuning the approval process potentially to sort of stimulate a bit more volume given those trends? Or do you expect those 90 days to sort of track back towards historical levels?

Yes. Look, that's a great question. And you're absolutely right. What's the use of having a pristine balance sheet, if you don't actually do something with it? And so it's back to that point. We're sitting there with excess capital. We're sitting at 9% . What a great balance sheet we've got, a beautiful customer profile, and we want to grow. And actually, bad debt charges being so low, gives you huge headroom for us to grow into. And so with the new Symple platform that we've put in place, what we've done is we've been doing some refining of our risk grades, and we've gone from 9 risk grades to 27. Paul? I think 27 risk grades. And we've really got our 27 different points of where we can calculate the return on equity that we would make per customer and get the pricing positions correct. There is actually an emerging opportunity right now, particularly around CR3s, not so much of 4s, but CR3s where there is huge potential for us because it's very attractively priced in terms of how we do it to take advantage and to be out there in the marketplace when others we know, other nonbank lenders, are really, really struggling due to their funding, their cost, their liquidity and their capital position. We're in a position to provide services on the new Symple platform at the right pricing to position that. This is definitely, I can assure you a huge opportunity subject to the economy holding up, which we think it will in 2023, and we will be beneficiaries of that. Paul, did you want to just add a comment about that?

Just to chip in as well. Simon, it's a great question. And just to let you know, we're constantly refining those underwriting settings. So at the moment, we're running champion challenges on the limit assignments for our personal loans. The gates has always been open. We've always had those risk appetites available at CR2 and CR3, one way to drive some more of those assets onto the bookings via our limit strategy. So we'll hold a cohort that we call a champion out and compare it with a challenger cohort, whereby we'll issue higher limits to that. We'll then see how those perform vintage over time. And then if that performs better on a risk-adjusted basis, we'll implement that into the main scorecard. So we're constantly doing that every few months to make sure that we're refining our settings, to make sure we optimize it on a risk-adjusted basis.

Okay. That's helpful. And one other question. You mentioned, obviously, the price increases that came through. I think you mentioned that you started those in April. I'd be interested to know just in terms of the volume impacts that may have came through and just price elasticity of just those recent months where the price changes came through, please?