Earlypay (EPY) – 1H23 Results & RevRoof exposure

EPY has come out of trading halt and released 1H23 results and an update on RevRoof exposure. There was a significant amount of information to digest alongside the outlook for the remainder of FY23.

From a credit perspective, the RevRoof loss is a short-term negative, but we take some comfort from the action steps the business is taking to improve long-term corporate governance and risk management. The proof will be in the pudding per se, as the business will now need to show signs to its stakeholders that it has appropriately dealt with this issue. Execution of this strategy is critical for EPY to recover margin and solidify earnings growth.

Outside of the RevRoof issue, the company is in a decent shape (albeit we are at a low point in the cycle), but it is unfortunate that there will be little recovery (if any) from Painted Steel Technologies (PST). The business will need to grow its funds in use (FIU) and recover lost margin, predominantly through a simpler and more efficient funding structure. For example, EPY is unable to pass on increased interest rates for two of their six facilities to preserve their net interest margin (NIM). Optimising their funding structure will be a key task over 2023/2024.

For trade finance warehouse holders, the news that EPY will rationalise its existing warehouses into a single facility (or max of two facilities) will be viewed positively by investors as will the reduction in the single borrower exposure limit to A$10m (essentially reducing overall concentration risk). Going forward, as with the nature of securitised transactions, it’s likely that the RevRoof exposure would be substituted out of the SPV and replaced with new customer exposure. For EPY holdco investors, we note the balance sheet is still strong with net tangible assets (NTA) of A$45m and cash on hand of A$68m. However, holdco investors would be looking for a turnaround in earnings/NIM metrics over the year ahead and execution/compliance of their operational changes.

1H23 results were significantly impacted by the loss provision for RevRoof (A$9.6m). In particular,

• Average FIU across all products up 40% on pcp to A$343m. However, net revenue declined by 3% as higher interest expense was not able to be offset
• Expected credit loss (ECL) provision was up significantly on pcp to A$14.1m (A$9.6m – RevRoof provision, A$3.1m specific provision, and A$1.4m general provision). Note ECL provision in pcp was only A$0.7m.
• Resulted in a profit before tax (PBT) loss of A$7.5m and a net profit after tax (NPAT) loss of A$5.4m (including tax benefit)
• NTA held up at A$45.4m or 15.6cps
• Interim dividend suspended

RevRoof entered VA on 7 December 2022 and was EPY’s largest client, with an outstanding exposure of c.A$30m across IF, trade finance, and equipment finance. As a major secured creditor, EPY appointed Grant Thornton as Receiver and Manager (R&M) over the assets of RevRoof to help with recovery. A sale of the assets and business of RevRoof has now been completed to Design Group, which is conditional on the assignment of two property leases to Design Group from the current landlords of RevRoof. The assets included PPE, stock, IP and transferring employees. Accounts receivable remains under the ownership of EPY and the company is responsible for collection of those receivables.

Note, the sale of the assets and business of RevRoof, does not include the assets of Painted Steel Technologies (PST). While the R&M continues to work to recover amounts owed by PST to creditors, including to EPY, the receivers have taken steps to shut down PST.

Following the sale of RevRoof and revised recovery expectations, EPY has booked a specific provision of A$9.6m in 1H23. Around A$2m of receiver related costs will also need to be booked in 2H23.

Action Steps

• Changes have been made to EPY’s Corporate Risk Governance Framework, underwriting processes and decision making, operational policies and procedures
• The retirement of less sophisticated legacy platforms
• Reduced single borrower exposure limit to A$10m, which aligns with EPY’s next largest client exposure.

Source: EPY Investor Presentation

Once the income, expenses and ECL provisions relating to RevRoof are stripped out, the underlying results are shown below:

Source: EPY Investor Presentation

FY23 will be a period of transition as the business learns from and moves past RevRoof. Earlypay believes this is the bottom of the earnings cycle and expects 2H23 Proforma NPAT to be materially higher than 1H23 driven by continued organic growth in FIU and lower general ECL provisions (compared to Proforma 1H23).

In FY24, Earlypay expects growth to continue building on 2H23 momentum, through:

• Organic growth – to continue with a focused, marketing led distribution for Invoice Finance
• Improvements in NIM to be driven by:
  • Warehouse funding enhancements and the retirement of expensive debt will drive significant cost savings; and
  • Building a more diversified client base, with no outsized exposures, will bring a shift to a lower average client size, that typically have higher margins.
• Continued focus on cost control as earnings bounce back.