Orchard Funding (LSE:ORCH), whose shares I bought last week at 48p, is a small player in an industry dominated by two giants. Nevertheless, it has been profitable in each of the last eleven years. Indeed, it has grown profit steadily (except for the Covid years), so there must be some degree of protection from the big boys bullying the firm out of its markets.

Bexhill
Ravi Takhar, CEO and 53.66% shareholder, took control of a small company in 2002. A subsidiary, Bexhill, was created that year to target clients of insurance brokers by lending to them for up to 10 months. Monthly repayments meant that the money returned to Bexhill pretty quickly.
By 2014 Bexhill had about 100 broker clients who helped arrange loans for policyholders so that they could pay their insurance policy premiums upfront. Annual advances were about £30m (at any one time only £10m - £15m was outstanding) which generated revenue (interest) of £1.8m. Profit after tax was £0.87m.
Orchard Funding Limited
The second strand to the company’s lending was conducted through Orchard Funding Limited. From a standing start in 2010, by 2014 this subsidiary was lending money to clients of 400 accountancy practises. In early 2015 its loan book stood at £8m having lent about £16m over the previous 12 months.  Annual revenues (interest) were £1.17m and profit after tax £0.15m.   It had 2,236 borrower agreements, with an average loan value of about £4,000.
Floating on the stock exchange
On joining AIM in 2015, in which it raised £10m gross, or £8.7m after financial advisers had taken their cut, the directors were able to proudly state that the business model was so good that there had been “no arrears or losses on the lending book of the Group over the last seven years” (Admission document). We’ll look at the reasons behind this impressive statement by a lender later.
There were then only 11 members of staff so operating costs were low. Even today there are only 20.
A good net interest margin, low operating costs and low/no default meant that the business was cash generative, leading directors to declare a high ambition for dividends: “As the Group is cash generative it is the Directors intention to implement a progressive dividend strategy” (Admission document).
Technology
Staff numbers could be kept low because it had been improving its processing platform for loan proposals, with feedback from daily use. By 2015 it was used on 100 insurance brokers’ and 400 accountancy firms’ computers, processing each year transactions for over 3,000 borrowers.
Delivered via the internet it incorporates all the systems, procedures and documentation required by an insurance broker or an accountancy firm to introduce its clients to the Group and conduct a finance business. It also manages all the agreements, calculates funding requirements and performs all day-to-day accounting and administrative tasks of the Group.
“As well as supporting our own business, Lend XP is now used by all of our finance company clients. Lend XP enables us to integrate effectively and efficiently with 3rd party IT systems and has continued to increase our operational efficiency and our ability to conduct business with introducers, for whom IT integration is a pre-condition to doing business. IT development clearly has a cost and we therefore continue to invest in this fundamental part of our business…In house IT enables us to efficiently launch products into new markets without significant infra-structure costs. This year our IT has enabled us to lend into the Hire Purchase market quickly and on a cost-effective basis. (2021 Report)
LendXP automatically generates paperwork for end user customers, manages direct debits to collect money and tracks all client transactions. Partners (brokers, accountants, etc.) are not charged to use LendXP.
Orchard recently made a couple of small equity investments into an “Open Banking” platform company called Open B Gateway Limited, a supplier of a computer-based system which allows instant analysis of potential borrowers’ bank statements – these statements are now available for financial firms to analyse (given client permission is granted). Being able to immediately judge past financial behaviour of client borrowers allows better underwriting decisions. Orchard Funding owns 30% of Open B Gateway.
Growth
On flotation the directors said their aim was to double the size of the lending from its annual £46m. They were going to do this by (a) increasing the number of insurance broker and professional firm clients, (b) increasing the volume of business from existing brokers and accountancy firms.
Some of the extra £8.7m raised in the float was useful for handing out to brokers and accountancy firms as commission when they persuaded a client to take credit. Money was also useful for reducing Orchard’s financial risk.
Managers have been successful in growing volumes of loans to £80m in 2022, but the number of insurance broker partners remains around 100 and the number of accounting firm partners is still around 400.
Size of market
While the general insurance market is about £50bn per year only about one-third (FCA) of policyholders choose to buy on credit.
The potential of the accountancy fee fi
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In the last newsletter I drew attention to Orchard Funding’s (LSE:ORCH) net current asset value, NCAV, per share, at 77p, being appreciably more than its share price of 48p. This was a good starting point for increasing my holding for my net current value portfolio. Other factors, mostly on the qualitative side, also came into play - to be discussed in future newsletters.


First I’ll show how Orchard might have fitted into my Modified cyclically adjusted price earnings ratio portfolio as well as the NCAV.  As you can see in the table below for the last nine years Orchard has produced impressive earnings per share numbers for a share valued by Mr Market at 48p (with 21.35m shares in issue that’s a market capitalisation of £10.2m). The average is 6.5p
Thus the cyclically adjusted price earnings ratio is 48p/6.5p = 7.4, about one-half of that for the UK market.
My, admittedly thin, reasoning for allocating to the NCAV portfolio is merely that I only have nine years of data for earnings rather than the more conventional ten used for a CAPE ratio calculation.  It really doesn’t matter which portfolio it goes into; simply that it is a deep value investment likely to provide a good return. Having the reinforcement of fitting not just one but two strict criterion is comforting.
It’s also comforting to see such a high proportion of earnings flowing to shareholders in the form of dividends. The business is cash generative, growing steadily (until Covid-19) at a rate which doesn’t absorb a high proportion of the money it makes.
The directors, including the 53.3% holder, prefer to reward shareholders regularly – his dividends amount to more than a third of a million each year – rather than splurge on rapid expansion and speculative ventures............

I’ve more than tripled my holding in Orchard Funding (LSE:ORCH) at 48p because its net current asset value is 77p and it is financially and operationally stable with a loyal customer base and low-risk business model, as well as having a highly experienced and capable managerial team. It also produces a reliable 3p dividend each year supplying an attractive 6.25% dividend yield.
Given the quality of the customer offering and the potential to tap adjacent markets it is likely that the dividend will grow nicely from here.
Since 2014 annual earnings per share have averaged 6.5p putting the shares on a cyclically adjusted price earnings ratio of 7.4, almost half the market average.
Even in the year ending 31st July 2020, one affected by Covid, earnings per share came out at 5.96p. In the worst year, the one ending 31st July 2021, they were still a creditable 3.91p.  Now they have bounced back, all the way to 7.11p.
The resilience displayed in the Covid slump was the second time the business model was tested by events beyond the firm’s control having sailed through the Global Financial Crisis in good shape.
The business
The company in its modern form was built by former investment banker Ravi Takhar following his acquisition of 100% of the equity in 2002. He now owns 53.66% after the sale of £10m of new shares to other investors when it joined the AIM market in 2015.
The business model is simple: around the country are thousands of insurance brokers whose clients often do not want to pay say a £2,000 annual insurance premium all in one go at the start of the policy.
Orchard Funding, through its Bexhill subsidiary, offers brokers and their clients a deal.  It will pay the premium and, in return the client will make say 10 monthly payments to Bexhill.  The amount paid each month is slightly more than one-tenth of the premium to allow for an effective interest charge.
Typically, Orchard will fund one half of its outstanding loans to customers with its own money and one half will come from an annually arranged loan facility from NatWest or Toyota. It also raised £3.9m this year from a Retail Bond issue this year, paying 6.25%.
Even paying an average of 3.57% on the funding it borrows (which includes bank fees etc.) Orchard can make a good profit because it charges APRs much higher than that.
The insurance broker is happy because the ultimate customer is p....

I’ll consider Orchard Funding’s (LSE:ORCH) financial stability by firstly looking at its vulnerability to financial distress and secondly it propensity to generate cash year by year.
Piotroski analysis
In 2000 Joseph Piotroski published research looking into the question of whether you could take a bunch of value shares and then separate out the strong from the weak using accounting ratios and measures.
The nine factors, taken as a whole, indicate where a company is along the spectrum, ranging from showing great improvements to its financial position at one end to exhibiting increasing financial distress at the other.
I'll conduct Piotroski analysis on both year on year changes and secondly on changes between the latest half year and that of the previous corresponding HI.
Profitability factors
If the firm is profitable and produces positive cash flow it has a capacity to generate funds internally.  A positive earnings trend suggests an improvement in the firm’s ability to generate positive future cash flows.

1. Positive net income before extraordinary items? Orchard Funding made profits in the year to 31st July 2020 (£1.3m) and in the half year to 31st January 2021 (£0.5m) and so a score of ‘1’ is gained for both the annual analysis and the half-year analysis.
2. Positive cash flow from operations?   Cash generated from operations was £1.6m for the year and £0.64m for the half year.  Orchard thus gains a score of ‘1’ for this factor for both the annual analysis and the semi-annual analysis.
3. Positive change in return on assets employed in the business from the previous year?  Profits were poorer in 2020 than 2019 and in the latest half year and so no Piotroski point here.
4. Cash flow greater than profit? (so profits are not driven primarily by positive accruals, which may be ‘managed’).  Orchard gains its third point here for both the annual and half-year analysis.

Leverage, liquidity, and source of funds
Measuring changes in capital structure (debt:equity ratio) and firm’s ability to meet future debt service obligations.

1. Change in leverage over one year. Has the firm’s long-term debt reduced relative to its total assets?  I’ll include all borrowings. 2020:  £11.1m/£32.2m = 34%;  2019: £16.2m/£33.6m = 48%. One extra Piotroski point for the annual analysis.   Half year:  2021: £10.7m/£35.5m = 30%;  2019: £14.2m/£36.2m =  39%. Another Piotroski point for the half-yearly analysis.
2. Has the firm’s current ratio (current assets divided by current liabilities) improved? Annual: 2020: £29.7m/£14.2m =  2.1;  2019: £34.6m/£19.6m = 1.8. Loans granted to customers are double the amount borrowed from Barclays, etc. And the position improved over those years, so a fifth Piotroski point. Orchard could withstand a lot of customer default before its balance sheet was imperiled. Half year analysis: 2021: £32.2m/£16.7m = 1.9;   2020: £38.7m/£23.4m = 1.7. Fifth Piotroski point
3. Has the firm avoided raising fresh equity capital (e.g. rights issue or placing)? Yes, so it gains sixth Piotroski point.

Operating efficiency

1. Has the gross profit margin improved? Gross profit is a strange concept for a lender. If I take net interest income (interest received less cost of funding) then that rose from 85.5% in 2019 to 86.3% in 2020. For the half years it rose from 86.3% to 87.1%.  Thus it gains the seventh Piotroski point for both the annual and half-year analysis.
2. Has the ratio of turnover to beginning-of-the-year total assets improved? (This indicates greater efficiency in the use of its assets from either having fewer assets for a given level of sales or raised sales). Annual analysis: 2020: £4.6m/£34.9m = 13.2%; 2019: £4.9m/£32.5m = 15.1%. No Piotroski point. Half year: 2021: £1.9m/£29.9m = 6.4%; 2020: £2.4m/£34.6m = 6.9%. No Piotroski point.

An overall Piotroski score of seven is very good, so I conclude there is little indication of increasing financial distress.
What about cash flow?
Orchard has demonstrated excellent cash flow generation ……………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1

Orchard Funding (LSE:ORCH), a company I bought into this week, is a small player in an industry dominated by two giants. Nevertheless, it has been profitable in each of the last ten years. Indeed, it was growing profit steadily until Covid-19, so there must be some degree of protection from the big boys bullying the firm out of its markets.
Bexhill
Ravi Takhar, CEO and 53.3% shareholder, took control of a small company in 2002. A subsidiary, Bexhill, was created that year to target clients of insurance brokers by lending to them for up to 10 months. Monthly repayments meant that the money returned to Bexhill pretty quickly.
By 2014 Bexhill had about 100 broker clients who arranged loans for policyholders so that they could pay their insurance policy premiums upfront (it now has 150 insurance broker partners). Annual advances were about £30m (at any one time only £10m - £15m was outstanding) which generated revenue (interest) of £1.8m. Profit after tax was £0.87m.
Orchard Funding Limited
The second strand to the company’s lending was conducted through Orchard Funding Limited. From a standing start in 2010, by 2014 this subsidiary was lending money to clients of 400 accountancy practices. In early 2015 its loan book stood at £8m having lent about £16m over the previous 12 months.  Annual revenues (interest) were £1.17m and profit after tax £0.15m.   It had 2,236 borrower agreements, with an average loan value of about £4,000.
Floating on the stock exchange
On joining AIM in 2015, in which it raised £10m gross or £8.7m after financial advisers had taken their cut, the directors were able to proudly state that the business model was so good that there had been “no arrears or losses on the lending book of the Group over the last seven years” (Admission document). We’ll look at the reasons behind this impressive statement by a lender later.
There were then only 11 members of staff so operating costs were low. Even today there are only 22.
A good net interest margin, low operating costs and low/no default meant that the business was cash generative leading the directors to declare a high ambition for dividends: “As the Group is cash generative it is the directors intention to implement a progressive dividend strategy” (Admission document).
Technology
Staff numbers could be kept low because it had, for 13 years, been improving its processing platform for loan proposals, with feedback from daily use. By 2015 it was used on 100 insurance brokers’ and 400 accountancy firms’ computers, processing each year transactions for over 3,000 borrowers.
Delivered via the internet it incorporated all the systems, procedures and documentation required by an insurance broker or an accountancy firm to introduce its clients to the Group and conduct a finance business. It also managed all the agreements, calculated funding requirements and performed all day-to-day accounting and administrative tasks of the Group.
Growth
On flotation the directors said their aim was to double the size of lending from its annual £46m. They were going to do this by (a) increasing the number of insurance broker and professional firm clients, (b) increasing the volume of business from existing brokers and accountancy firms.
Some of the extra £8.7m raised in the float was useful for handing out to brokers and accountancy firms as commission when they persuaded a client to take credit. Money was also useful for reducing financial risk, i.e. not having to borrow so much from Barclays; until that point about 75% of the money lent was obtained from Barclays, after the float one half came from Orchard’s own cash resources.
Size of market
While the general insurance market is about £50bn per year only a fraction of policyholders choose to by on credit, about £9bm to £12bn.
The potential of the accountancy fee finance market was given a boost at the time of the float by the banks pulling out of market for small-ticket, short-term, unsecured funding. The addressable market was perhaps £300m.
Low defaults
Orchard has multiple layers of credit protection:

1. Customers feel they must pay. Failure to pay insurance premium finance obligations may leave the borrower uninsured and therefore unable to operate essential day-to-day activities. Likewise, clients of accountancy firms know they must satisfy their accountancy fee obligations in order to file important documents such as tax returns.
2. Early payment.  Orchard receives the first payment from the customer before funding is issued to the insurance broker or accountancy firm, thus eliminating first payment default.
3. Delay in paying commissions. On average Orchard pays commission to brokers and accountants 30-45 days after entering a credit agreement. One and a half instalments from the borrower are already in the bag by then.
4. Direct debit collection. A timely collection and traceable link to the customer.
5. Short duration. The weighted average time to receive the full repayment is under six months.
6. Cancellability. The borrowing facility can be cancelled by Orchard at any time.
7. Insurance carrier rebate. Cancelled insurance policies before the end of the full term usually result in unearned premiums being rebated by the insurer. Thus, if a customer ceases monthly payments the insurance company will receive notification to cancel the policy and pay a rebate. At any time unearned premium rebates will exceed the loan value due to Orchard’s strict repayment structure.
8. Recourse to insurance broker or accountant. They guarantee repayment.
9. Regulation. Industry bodies such as FCA regulate say brokers limiting poor behaviour
10. Government insurance. The Financial Services Compensation Scheme provides pays out in the event of insurance company or broker failure.

Competition
About 90% of ins……………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1

In the last newsletter I drew attention to Orchard Funding’s (LSE:ORCH) net current asset value, NCAV, per share, at 72p, being appreciably more than its share price of 56.8p. This was a good starting point for including it in my net current value portfolio. Other factors, mostly on the qualitative side, also came into play - to be discussed in future newsletters.

First I’ll show how Orchard might have fitted into my Modified cyclically adjusted price earnings ratio portfolio as well as the NCAV portfolio.  As you can see in the table below for the last seven and a half years Orchard has produced impressive earnings per share numbers for a share valued by Mr Market at 56.8p (market capitalisation £12.1m). The average is 6.5p (if I include an annualised EPS for 2021).

Thus the cyclically adjusted price earning ratio is 56.8p/6.5p = 8.7, about one-half of that for the UK market.

My, admittedly thin, reasoning for allocating to the NCAV portfolio is merely that I only have seven and half years of data for earnings rather than the more conventional ten used for a CAPE ratio calculation.  It really doesn’t matter which portfolio it goes into; simply that it is deep value investment likely to provide a good return. Having the reinforcement of fulfilling not just one but two strict criterion is comforting.

It’s also comforting to see such a high proportion of earnings flowing to shareholders in the form of dividends. The business is cash generative, growing steadily (until Covid-19) at a rate which doesn’t absorb a high proportion of the money it makes.

The directors, including the 53.3% holder, prefer to reward shareholders regularly – his dividends amount to more than a third of a million each year – rather than splurge on rapid expansion and speculative ventures………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1