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Tempting punts on a troubled business

The latest profit warning from Provident Financial looks like an almighty mess, but its retail bonds may have fallen further than is justified.

The latest profit warning from Provident Financial looks like an almighty mess, with a corporate restructuring in its core business of door-step lending tripping the business into disaster. The firm's shares fell more than 65% in a day, while its listed retail bonds have also been badly hit. PF17, which matures on 4 October 2017, is trading at around £95 against a maturity value of £100. The obviously more risky PF21, which matures in 2021 and pays a coupon of 6%, is trading at around £70.

We shouldn't be surprised by this development. Many retail investors will have seen the carnage in the share price and decided to get out, mindful of the old adages about "no smoke without fire" and "profit warnings come in threes" (this is the second in three months). However, a look at the business suggests this may be an overreaction.

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I am no expert on this firm, but its current market cap is at around £660m versus group net assets of £731m (although that assets figure was before the profits warning, so there is a risk of write-downs). Other threats include the possibility of a run on the successful Vanquis Bank bit of the business but this seems to be solidly profitable, with profit before tax of £100m at the interims. The profits warning did come with news that a supplementary product sold by the bank was being suspended. Moneybarn, which provides vehicle loans, also seems to be trading solidly.

So common sense suggests that although the equity shareholders could be wiped out, bond holders might be safe. There's still a lot of capital to eat through before they would have to suffer losses. My guess is that the banking covenants will very soon be triggered and there will be some searching discussions with the lenders, but it seems to me, at this initial stage, that the retail bonds may have fallen further than is justified.

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The most obvious opportunity is PF17, given that it matures in just two months' time. The firm might fail to repay it, but if that was to happen, I assume we'd be looking at an immediate corporate bankruptcy. So investors might get a nice 5% bounce very quickly.

Obviously, with the longer dated PF21 issue, there's a lot more work that would need to be done in terms of research into the balance sheet. This is now clearly a speculative junk bond and the current price looks about right for that, but I think there may be some upside if the new management fixes the firm's broken internal systems. If the bonds pay out in full until 2021, which is clearly a big risk, then at the time of writing we're looking at a running yield of around 8.5% and yield to maturity of about 16.5%.

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