Orchard is a finance group specialising in insurance premium and professional fee funding in the UK. The listed group was formed in 2015 but it’s trading activities date back to 2002. The group has 2 subsidiaries, one being ‘Bexhill’, an insurance premium funding business which services over 100 brokers across the UK, and the other being ‘Orchard’, established in 2010 providing fee funding to accounting and law firms amongst others. CEO Rabinder (Ravi) Singh Takhar has been with the business since Bexhill started trading in 2002 and owns more than half of the listed company.
Whilst this video is a few years old now (early 2020), it provides an excellent overview of the business and its future, most of which remains the same despite the introduction of caravan hire purchase lending. Over the years since this video, the group has grown its average loan book from ~£30m in 2020 to ~£46m in half year 2023. This has led to an increased profit, but with the cost of funding increasing significantly, profit has not risen as fast as this loan book as the group has not passed on increases in their funding costs, despite the 12-month tenure of most of their loans allowing for consistent revision of their pricing. This skew to the customer in my view, has allowed them to grow their loan book to where it is today. Nevertheless, I have done my research and find the business to be very conservative in general, with diligent and thoughtful involvement into niche areas of lending.
More specifically, the business model involves providing credit in respect of insurance premiums and professional services fees which allows the customers of these firms to extend their repayment up to one year. More recently, they have extended to providing longer term hire purchase loans (up to seven years) and gap insurance (up to three years). They refer to this business model as a ‘hold and collect’ model in which financial assets are held to maturity to collect principal and interest, it is a very traditional business model which is widely used. Sales volume is highly dependent on the ability to secure new partners, and to increase business with existing partners, whereas pricing relies on a mix of the cost of funding, the competitive market, and the perceived risk that the borrower is unable to pay. Longer term loans utilise open banking to view banking activity and more accurately assess risk. Orchard’s board looks to target more than a 10% net interest margin in any given year. The group’s non-interest-bearing costs rank in order from Employment costs, bank fees, advertising, and compliance costs.
Speaking to the risks, the group as explained specialises in insurance premium funding, which in the UK is dominated in a duopoly, with Orchard Funding a distant 3rd player. These top players are Close Premium Finance and Premium Credit, which according to various online resources, control over 90% of the market. In the article linked, Bexhill describes competition in the market, with an interesting barrier to entry being broker commissions paid in advance for exclusive use along with multi-billion dollar spend on integrating themselves into the broker network to make the choice seamless. Bexhill goes on to propose the potential for price fixing with so few competitors. For some context, in 2022 Premium Credit generating a 54.7% pre-tax operating margin, whereas Orchard Funding generated a 33% operating margin. Pressure from the regulator (also here) could bring this disparity more in line, and assist Orchard in gaining more market share, along with a better margin. In my view, the odds are reasonable that Orchard could benefit from a future alleviation in competition, but there is also substantial risk of being dominated by incumbents. In the shorter term, funding costs are likely to put pressure on the group’s margin, but with the short-term nature of their loans, should see a relatively quick response in their lending rates.
To combat their uncertain funding position, the business floated the idea of applying for a banking license several years ago but put it on hold going into the pandemic. Recent discussions with management reveal that the banking license would require a cost base of £2-5m per year, which at their current size is not prudent. In saying this, Ravi has written a book titled “How to Build a Bank…” to be released in November this year. It is fresh in his mind, and I think given this that a banking license remains likely in the future as a result. In the meantime, the group has acquired (at NIL cost) a bond finance business and subsequently issued a fixed 6.25% fixed-coupon (bi-annually) bond with a June 2nd, 2027 maturity date. These bonds have traded at and around their par value since listing with very limited movement around par and perceived as low risk as a result. The listed stock trades at a deep discount to book and pays a larger dividend than the coupon on the bond. With the group looking to further grow its loan book and £49.3m on lent to customers on 31 January 2023, there is a noticeable lack of funding capacity (~£52.3m capacity at 31 January 2023) to further expand it this current stage. It appears likely that the group will consider a further bond issuance soon.
When asked about the growth ambitions of the business, it appears that they intend to delve deeper into the leisure industry, specifically static caravans. It is seen that these loans provide long term, safe profits for the group as caravan park operators cover payments to Orchard if they are not paid by residents. The group is working to build relationships with park operators locally and nationally and that the industry is a multi-billion sector which Ravi believes they can safely double the group’s balance sheet with these loans.
The idea was brought to my attention from one of the unitholders later last year, and I have recently checked back in on its progress. Upon checking I had noticed that the business had fallen over 25% since then and was now trading at ~0.45x book value, despite its average ROE since listing of 9.2%. With a 45% average payout ratio, this means that the group is trading at ~5x earnings as well. Given the fluidity of their loan book, non-discretionary nature, conservative practices and founder, Orchard Funding is an excellent investment case for the trust to have some exposure to. The group should pay us a dividend yield of ~10%, whilst having the ability to compound its book value 5% p.a. This is in line with our hurdle rate at a 15% return, but I think shortfalls to this can be justified given the companies substantial discount to a liquid book value, which sets us up for a more robust margin of safety. Furthermore, with the group at multi-year lows in its interest margin, there is reason to believe that a fundamental improvement in returns on equity is likely as well should rates stabilise. In terms of our hurdle rate, I am expecting a consistent ~10% dividend along with >5% EPS growth (>15% CAGR), and the prospect of the business re-rating to a P/B closer to 1.0x in the next 3-5 years (15-24% CAGR).