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Why I’d shun Provident Financial for this attractive alternative stock

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UK-based home collected credit (HCC) lender Morses Club  (LSE: MCL) scores better than non-standard lender Provident Financial  (LSE: PFG) against just about every quality and value indicator. The difference in the two firms’ market capitalisations is vast, with Provident Financial’s £1.71bn dwarfing Morses Club’s £181m, but I’d rather go with the smaller firm.

Refinanced for the future

This month, Provident Financial concluded its 17-for-24 Rights Issue aimed at raising around £300m net. Some of the money will be used to meet the costs arising from the now-settled investigation by the Financial Conduct Authority (FCA) into the firm’s Vanquis Bank and its Repayment Option Plan (ROP). The rest of the money will make sure Provident has a high enough financial buffer after increased regulatory capital requirements kick in, “primarily due to an increase of approximately £100m in respect of conduct and operational risk assessments.”

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Despite the refinancing, I’m avoiding the firm because the bottom fell out of its business model recently. There’s more to successful investing than plunging into the stock of firms that have just demonstrated their ability to fail.

No sign of trading weakness blights today’s full-year report from Morses Club, however. Revenue increased more than 17% compared to the previous year and adjusted earnings per share moved 8% higher. The directors expressed their confidence in the outlook by pushing up the final dividend for the year by 11.6%.

The firm provides what it describes as vital” short-term funding for 10m people in Britain who can’t access mainstream sources of finance. Loans typically cover customers’ shortfalls in income and their “unexpected” household expenses. The firm said it offers transparent fixed interest rate products and does not charge its customers any fees or penalties for late payments, “ensuring they never pay more than their original agreement.”

Growth prospects

The business is growing. Customer numbers came in 6% higher than a year ago and the net loan book grew by 19%. Doorstep lending doesn’t look like it’s going out of fashion any time soon, despite the problems over at Provident Financial. Morses’ chief executive Paul Smith said that the company’s “advanced digital platform” improved the customer experience and “streamlined the lending process.” Benefits included the reduction of the operating cost ratio and enhancement of the firm’s regulatory compliance. Mr Smith reckons technology also enabled it to access a new customer base in the wider non-standard credit market and to expand its product offering to provide customers with “the flexibility they desire.”

Looking ahead, the company plans to pursue more organic expansion by integrating new agents into the business.” City analysts following the firm expect earnings to grow 20% for the trading year to February 2019 and 18% the year after that, suggesting they remain unconcerned about recent calls from the media and consumer groups for tighter regulation in the HCC sector. However, with the share price close to 142p, there could be some negative speculation around with regard to the issue. The forward price-to-earnings ratio for the year to February 2020 runs close to nine and the forward dividend yield is around 6.5%, which looks like an undemanding valuation given the growth anticipated.

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Kevin Godbold has no position in any of the shares mentioned.The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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