Why I'd buy Provident Financial plc shares after 15% rebound

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Provident Financial PFG

When shares in Provident Financial(LSE: PFG) fell off a cliff earlier this year, I was shocked.

The big crunch came from a profit warning issued on 22 August, but the shares had already been falling prior to that. That fateful day ended with the price down a staggering 82% since May's high point, to just 590p, after having reached a peak of 3,284p.

The company, which offers loans to sub-prime borrowers (that's those with poorer credit ratings), was having trouble with its home credit trading. It had switched from using self-employed agents to full-time employees, but that led to serious staffing issues and problems with collections performance dropping to 57% from 90% a year previously.

The FCA was also investigating a Repayment Option Plan employed by the firm's Vanquis Bank.

The bottom line was an increase in pre-exceptional losses and the scrapping of the dividend, which had yielded 4.7% in 2016.

Coming back

The share price did pick up a little after hitting rock bottom, and we saw a rebound of more than 15% on Friday after Provident released a trading update -- as I write, the shares are changing hands at 925p.

The firm told us that a "home credit business recovery plan has been developed under new leadership to re-establish relationships with customers, stabilise the operation of the business and improve collections performance", but August's estimate of a pre-exceptional loss of between £80m and £120m for the company's Consumer Credit Division is likely to be about right.

That's still a big hit, but many investors will be relieved that the figure has not risen -- in similar cases with other firms, early figures have often come in on the conservative side.

While the FCA probe into Vanquis Bank continues, the division "delivered further good growth through the third quarter of the year against credit standards that have recently been tightened." The rise in high-interest lending to poorer customers is raising concerns in regulatory circles, so that's almost certainly going to be a factor for Vanquis Bank, and for Provident Financial as whole, in its long-term future.

Other divisions seem to be doing fine, and with new leadership taking control of home credit, I really do see the current share price as seriously undervaluing the long-term profitability of the company. There are, however, still two key short-term problems.

The company confirmed that there will be no dividend this year, and it's still on the hunt for a new chief executive while executive chairman Manjit Wolstenholme provisionally covers the dual role.

Time to buy?

Post-shock forecasts are suggesting a 65% fall in earnings per share this year, which is pretty drastic. But the share price fall looks to have already accounted for that, leaving us with a forward P/E multiple of 15. That's close to the FTSE 100's long-term average, and many will see it as too high for a company that's in financial trouble.

But Provident's troubles genuinely do seem to be short term to me, and I really don't see any long-term problem. In fact, analysts are already predicting an earnings recovery for 2018 -- at 103p, EPS would still be well below recent years' levels, but it would drop that P/E to only around nine.

The dividend is expected to come back in 2018 at 37p, far below 2016's 135p, but that's still a 4% yield on today's price.

A million by retirement

I reckon stashing some Provident Financial shares in your SIPP should greatly enhance your chances of enjoying solid income for years after you retire, and there are more top shares out there that can do the same.

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Alan Oscroft 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.