Lex Hall: Hi, I'm Lex Hall and welcome to another Morningstar series of 'Ask the Expert'. Today I'm joined by Nathan Zaia, who's the new banks analyst for us. He takes over from David Ellis, who retired in August. Today, we're going to talk about the upcoming float of Latitude Financial Group, which is a consumer finance company. We're going to talk about how it works and why Nathan is a little less bullish on the valuation.

G'day, Nathan.

Nathan Zaia: Hi, Lex.

Hall: Now the valuation for Latitude is set, they're looking for about $4 billion at a range of $2.22 and $2.25 a share. They tried to IPO last year, but they didn't succeed and they're having another crack at it this year under the stewardship of Ahmed Fahour, who is known to us all for leading Australia Post. It's a consumer finance company. They work with shops like Harvey Norman, JB Hi-Fi allowing people to buy whitegoods, appliances, electronics, things like that. Let's sort of drill down a little bit into what they do. A big chunk of their business is in instalment products. Can you sort of take us through what that meant?

Zaia: Yeah, Lex, so basically with these instalment products, it allows a customer going to the store, agreed to make scheduled repayments and that allows them to take the product there and then and have nothing to pay generally for 3, 6, 12, 24 months. So, Latitude is the largest provider of these instalment products. So, a lot of people might not have heard the name, but if you think of a Harvey Norman ad where its 60 months free flashing in front of your face, Latitude's the company behind that. So, basically, Harvey Norman, they will pay Latitude, a small percentage of the transaction value very similar to our after-pay, it could be 3% to 4% and Latitude then take on all that credit risk.

Hall: Okay. And so the advantage for shops like JB Hi-Fi and Harvey Norman, is that it allows them to move more stock?

Zaia: Yeah, that's a fair assessment, Lex. So, basically, someone that doesn't have the money right then and there, can make a purchase. And it might have been something they were considering buying, but with one of these instalment options, I guess, it pushes out your obligation. So, it makes you either more willing to purchase it or gives you that ability to purchase it.

Hall: And so their competitors in this space would be people like Afterpay?

Zaia: Yeah. So, traditionally it's been more credit cards, and HSBC have a similar card offering. The likes of Afterpay and Zip sort of newcomers and what they have done really well is, take I guess consumers unwillingness to get a credit card and for some reason, millennials seem to think one of those buy now pay later isn't credit. So, they've been really successful in I guess playing on that different perception of what credit is.

And what they've also done really well is, they have made the signup process really easy that made the product terms very simple. So, just equal repayments and they have charged no fee to the customer. So that's really resonated with customers. But I think the other part of their success has been a small credit limit and having to repay frequently has allowed them to make the signup process really simple and not do a credit check. Whereas someone like Latitude, because they are lending bigger amounts and they are going to want to make sure that that customer can repay. And because they are larger amounts, people often want a longer period to repay. So, that's why the business models are slightly different. I mean Flexigroup does have Humm and Zip has an offering which is large transaction size.

Hall: What sort of transaction size are you thinking about there?

Zaia: Say anything above $1,000 really.

Hall: Now, I notice it has a dividend yield of 4.5% to 5%. You say in your IPO report that that's fairly attractive. Is that enough to entice people to subscribe, do you think?

Zaia: Yeah. I think that's one of the elements people need to look at before they invest in any stock. And really we see quite a lot of uncertainty in the earnings. So, it's about how sustainable and consistent that dividend will be. So, I wouldn't necessarily just go in and buy this stock, and there is a lot of things that could go wrong in terms of earnings.

Consumer financing is generally lower quality and high risk than say a mortgage. So, if you think about periods where unemployment might rise, a lot of these people will probably struggle to repay. And historically Latitude's been 3.5% to 4% of their loans have been impaired or go bad as a percentage of their savables. There's also a competition as we were talking about with those buy now pay later. So, while we're not expecting them to have an immediate effect on Latitude's volumes, I mean, these merchant relationships that Latitude has are very important to their business. So that 60% now come from instalment payments, income wise, but there's also a feed effect from instalment payment customers into personal loans, motor loans, and advanced cash withdrawals. So, if you all of a sudden turn off the tap to instalment products, then it has a flown effect throughout the business. So that's another key risk that supports our normal and very high uncertainty rating.

Hall: Okay.

Zaia: Yeah.

Hall: Just finally, we've gone into a historic period now where the cash rate is at 0.75%. Do you think that'll have a bearing on these kind of companies such a low interest rate?

Zaia: I don't think so. I think that's kind of been a tailwind for businesses like this, they're able to go out and borrow money very cheaply. And they're not necessarily passing it on to their customers. So the cheaper their funding got, it's not like the 24%, 25% they charge, when a loan enters interest-bearing has really gone down much at all. So they're actually benefiting from cheap and widely available credit. Whereas a bank, they've got a large portion of their funding from deposits, and part of that they can't really reduce the rate a lot more. It's obviously better to have those deposits. They're secure, cheap source of funding long-term, but it is proving a headwind for the banks right now whereas Latitude, don't have that.

Hall: Okay. All right, Nathan, thank you very much for your insights.

Zaia: Thanks a lot.

Hall: I remind you that you can see Nathan's pre-IPO report on Latitude Financial Group on morningstar.com.au. I'm Lex Hall. Thanks for watching.

Lex Hall: Hi, I'm Lex Hall and welcome to another Morningstar series of 'Ask the Expert'. Today I'm joined by Nathan Zaia, who's the new banks analyst for us. He takes over from David Ellis, who retired in August. Today, we're going to talk about the upcoming float of Latitude Financial Group, which is a consumer finance company. We're going to talk about how it works and why Nathan is a little less bullish on the valuation.

Â