Does 9% customer growth make Provident Financial plc a better buy than Lloyds Banking Group plc?

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Lloyds

Sub-prime banking group Provident Financial (LSE: PFG) said today that customer numbers at its main subsidiary, Vanquis Bank, rose by 9% to 1.55m last year. Higher levels of borrowing mean that this growth resulted in a 14% rise in customer lending at Vanquis during 2016.

Provident's share price has risen by 190% over the last five years, during which its dividend has doubled. But the shares have taken a breather over the last year, and have fallen by 21% since peaking in December 2015.

Today's trading statement suggests that the group's business remains on track. So has last year's modest de-rating created a buying opportunity? Or should you opt for a mainstream alternative such as Lloyds Banking Group (LSE: LLOY)?

Strong lending growth

Provident Financial focuses on sub-prime lending through a mixture of doorstep lending, online loans, credit cards and car finance. All divisions of the business reported strong lending growth last year, with receivables rising by 12.3% during the first half of the year.

In a year-end trading statement this morning, the firm said it expects to report 2016 results "in line with market expectations," with "each business meeting its internal forecast".

This implies that this well-run business will report an adjusted pre-tax profit of £333.9m and earnings of 172.3p per share for 2016. That gives a 2016 forecast P/E of 16.5. No comment was made about the dividend, but consensus forecasts show a payout of 130.9p per share, giving a prospective yield of 4.6%.

Lending to customers with poor credit ratings usually carries high interest rates. Provident reported an annualised average margin of 32% for the first half of last year, making it far more profitable than mainstream banks.

Of course, Provident's customers are also more likely to fall into arrears. With disposable incomes expected to come under pressure this year, this could become a bigger problem for Provident.

Notwithstanding this risk, I'd argue that Provident shares are a reasonable investment at current levels, if you're happy with investing in this type of business.

Banking on Lloyds could be smart

Lloyds' £1.9bn deal to acquire MBNA's UK credit card business has put the bank on track to control 26% of the UK credit card market. That's only just behind market leader Barclaycard.

The deal is intended to help rebalance Lloyds' business so it's less dependent on the slowing mortgage market. Another attraction is that credit card debt is generally very profitable. Lloyds expects to achieve a return on investment of 17% during the second full year after the acquisition.

However, while Lloyds expects the acquisition to add 3% to earnings per share during the first full year following the acquisition, that's not until 2018. The outlook for 2017 is weaker, and analysts currently expect earnings per share to fall by 6.6% to 6.7p this year.

As a result, Lloyds' stock looks quite affordable to me at the moment. The shares trade on a 2017 forecast P/E of 9.6, with a prospective yield for this year of 5.5%. At this level, I believe Lloyds could be an attractive income buy.

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Roland Head owns shares of Barclays. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.