Begbies Traynor to gain ground in the face of debt market chaos

With borrowing costs on the fly, we will inevitably see a significant increase in the amount of delinquent debt for sale over the next few months as creditors sell an increasing volume of bonds (below face value) debt buyers.

This is hardly a revelation. We have been aware of a succession of non-performing loan sales across Europe since 2014, when the European Central Bank stepped in to support potentially insolvent banks, particularly those in Italy.

We also know that consumers who are overly dependent on purchases on credit find it difficult as real household incomes decline. As if to prove it, the the wall street journal recently revealed that US consumers with poor credit histories are falling further behind in paying off their subprime credit cards and personal loans. Delinquencies in the United States hit an eight-month high in March, a potential harbinger for Britain’s consumer credit sector – the largest in Europe. It is perhaps significant that Experian (EXPN) is configured to include “buy now, pay later” data in customer credit files. With soaring inflation and the resulting fall in real wages, it is worrying to think that a significant portion of consumer debt in the UK could have been generated by non-discretionary purchases.

Servicing corporate debt also promises to be a tougher business going forward. Government Insolvency Service figures show the number of business insolvencies registered in April was double the 2021 comparison rate and 39% ahead of the pre-pandemic level.

The ability to service existing debt has been challenged by supply chain issues and soaring energy costs. And there are other indirect factors that influence corporate cash flow decisions.

The last Corporate Debt and Cash Flow Report – a survey of FTSE 350 companies compiled by professional services group Herbert Smith Freehills – suggests business capital expenditure and working capital commitments are set to rise through to the end of 2022 and possibly beyond . It also concludes that the rising tide of negative macroeconomic effects, no doubt exacerbated by events in Ukraine, “should not reduce the supply of debt but could impact the terms, pricing and timing of lifting. debt”.

With the rising cost of capital, it is interesting to note that over 70% of survey respondents expect to include sustainability elements in their next financing terms due to the continued adoption of environmental protocols , social and governance. Compliance in this area could increasingly be built into lending criteria for companies engaged in sustainable finance, but it would do little to reduce borrowing costs.

Many state-owned companies have taken the decision to shore up their balance sheets in the face of pandemic-induced trade disruptions. But analysis by the Bank of England indicates, somewhat surprisingly, that Britain’s big companies had lower overall debt in the second quarter of 2021 than before the Covid-19 outbreak.

The analysis notes that businesses can struggle to meet their loan obligations when their interest payments amount to 40% or more of their revenue. At the end of last year, the debt-weighted share of companies with interest coverage ratios below 2.5 stood at 37%, well below its all-time high. The bank says an increase in borrowing costs of “nearly 400 basis points would be needed for this share to reach all-time highs.” However, the review of corporate leverage was undertaken before the recent rate hikes and it does not apply to companies further down the food chain.

We presented the investment case for Begbies Traynor (BEG) in late 2019, when shares in the recovery and financial advisory group changed hands at 88p apiece. They have appreciated 51% in the meantime, but we see further upside potential, not only because corporate insolvencies are expected to rise, but also because analysts are recalibrating forecasts after the release of an update. trading day “comfortably ahead of market expectations”. . Revenue and adjusted earnings are now expected to increase by 30% and 55% respectively, while operating margins are also moving in the right direction.

Management noted that the number of insolvencies – up 50% over the period – has returned to pre-pandemic levels as government support measures have been gradually lifted. Unfortunately, the administrations – which generally generate more costs – have not yet fully recovered. This is the only downside for the corporate recovery and financial advisory division, although deteriorating macroeconomic conditions are certainly fertile ground for insolvency practitioners. Either way, there is currently no surplus of countercyclical options available to investors, so it might be worth applying the rule to Aim stock again.

Tana T. Thorsen