Zigup: an investment tale of two halves.
Overview
Zigup, recently rebranded from Redde Northgate, is the result of a merger between the two aforementioned companies. It operates as two segments: claims and services (trading as Redde) and vehicle rental (trading as Northgate). Within each of these segments the group offers a number of value-added services and enables clients to benefit from synergies between the two businesses.
I see this investment thesis as a tale of two halves. Northgate has historically been seen as a value trap, consistently underperforming whilst operating in an industry that has always competed almost exclusively on price. Redde, on the other hand, operates in a much lower margin industry but its share price performance prior to the merger was strong.
I believe that the vehicle rental business, Northgate, has improved post-merger, benefitting from better management and a trend towards greater levels of usership. Contrastingly, however, I think that the claims and services division has certain long-term structural headwinds, the effects of this we may already be beginning to see.
For this reason, I think the investment opportunity lies in the vehicle rental division, with the claims and services segment likely to materially decline in profitability over the medium to long-term. For the sake of those whose opinions may differ, I have decided to publish the thesis, and counter-thesis, for the two different business segments anyway.
Although this is not a business I would be interested in owning at any point, I have decided to complete the valuation anyway. This is partly because I had already completed the model, and I thought it would be nice to get some use out of it, but also as it may be helpful for others considering the investment. Taking into account my performance expectations for the two businesses, I believe Zigup is trading at, or just above, my estimate of intrinsic value. For those with a more positive outlook of the claims and services business, it may present an opportunity for significant potential upside.
For the sake of clarity, I have decided to refer to each of the segments by their original trading names, Northgate and Redde.
Northgate (Vehicle Rental)
Northgate is the UK’s largest B2B LCV rental provider. In addition to vehicle rental, the group offers a number of complimentary services which it has acquired over the years including fleet services, maintenance and telematics. Its customers include large blue-chip companies, public sector clients and smaller businesses.
Northgate also has significant operations in Spain. Whilst the Spanish business represents a large percentage of group revenues, I believe there is less value from a differentiated viewpoint in this segment. The main reason for this is that the business has performed consistently in recent years, with less exposure to the supply challenges faced by the UK segment (supply of left-hand drive vehicles rebounded much more strongly post COVID).
For this reason, I have chosen to focus on the group’s UK&I vehicle rental business, with the potential inflection in average vehicles on hire (VOH), and other factors, providing a greater opportunity.
Thesis summary
Growing usership - There is a growing trend towards businesses leasing their vehicles, rather than buying them outright. This has many advantages including no up-front investment required, certain tax advantages, and giving businesses flexibility over their fleet size. Available data does show that an increasing percentage of the vans on UK roads are either rented or leased.
Normalising supply – The supply of LCV’s has been significantly impacted by the semiconductor shortage post COVID. This has created pent-up demand within the leasing market, with many fleet operators delaying upgrades to their fleet until supply normalises. Northgate reports that visibility over future vehicle supply is now improving, allowing them to invest in their fleet. This is expected to generate significant free cash flow in FY26/27 when CAPEX is brought down.
Electrification of fleets – Whilst current penetration rates of electric vehicles within commercial fleets are low, improving technology and charging infrastructure is likely to generate significant growth in the coming years. Leasing is an ideal way for companies to increase their exposure to this new technology, with leasing companies taking on the risks of volatile disposal prices and rapid obsolescence of technologies. Northgate has positioned itself to benefit from this trend, with investment in charging infrastructure and extensive support for customers looking to make the transition.
Used vehicle prices – Used vehicle prices have been supported by the rising prices for new vans, creating significantly higher disposal profits for Northgate. Whilst the normalisation of supply is likely to push down used vehicle prices in the medium term, I believe we will continue to see support for prices in the short term and continued elevated disposal profits as a result.
Growing trend towards businesses leasing their vehicles
Northgate believes that there is a growing trend towards companies choosing to rent or lease their vehicles rather than buy them outright (Northgate uses the terms leasing and rental to describe its Northgate operations, so I will use them interchangeably here). Leasing offers several advantages, particularly for large fleet operators.
Firstly, it is a tax efficient way of owning a vehicle. Businesses can claim back VAT on leased vehicles and the monthly payments are tax deductible. Leasing also prevents businesses from having to make large fixed-cost investments, thereby improving cash flow and capital efficiency. Monthly costs are also fixed, with supporting services such as maintenance and road tax often included. This provides businesses with a clear picture of their expenditure, allowing them to budget more effectively.
Leasing also allows companies to pass on the economic risk of owning a vehicle. Changes in depreciation and residual value can significantly impact a company’s profitability, especially during inflationary periods where current depreciation may be insufficient to cover the vehicle’s replacement costs. Leasing companies, with greater knowledge and access to data, are better equipped to cope with these challenges.
Flexibility is another key advantage of leasing a vehicle rather than owning one. Fleet operators in particular benefit from the ability to alter their fleet sizes depending on demand. Short-term rentals and model swaps allow businesses to flex their fleet size to meet seasonal demand, with the scale of rental companies making them better able to absorb and spread excess capacity. Northgate reports that they are seeing a large number of fleet operators now opting for a mixture of owned and rented vehicles, allowing them to rapidly scale up their fleets and meet the demand of new contracts.
The BVRLA, which represents over 1000 companies in the vehicle rental and leasing space, publishes quarterly data on its member’s fleets. Whilst the below graph shows an overall downward trend in the number of business vehicles in the BVRLA leasing fleet, it is not an accurate representation of Northgate’s own market.
The below graph shows a breakdown of the number of cars and LCVs. From this we can see that the number of cars has declined overall in the past 7 years, whereas the number of vans has increased. The recent uptick in the number of business cars in the fleet is caused by the growing popularity of salary sacrifice schemes, offset by the declining popularity of business contract hire (BCH) for cars (think company cars).
Northgate operates primarily in the LCV leasing industry, which saw consistent growth until the end of 2023. This has been driven by a number of factors, but in particular the growing demand and expansion of home delivery fleets. To get a sense of whether LCV leasing has become an attractive option for businesses looking to gain access to vehicles, we need to look at the LCV fleet numbers compared to the total number of vans on UK roads.
Looking at the above graph, we can see that the total number of licenced vans on UK roads has also increased. Taking the comparable period between 2017 and 2023, the CAGR was 2.3% compared to 3.8% growth in the BVRLA LCV fleet. This indicates that a growing percentage of UK businesses are choosing to lease their vehicles rather than buy them outright (with the exception of 2024 which we will look at in more detail below). I expect this trend to continue, driven in particular by the flexibility and simplicity that long-term rental options provide, and the value this provides for businesses.
Improving LCV supply meeting pent up demand
Within the business leasing market, data from the BVRLA Broker’s Report highlights some interesting dynamics. The number of new business contracts between 2018 and 2020 was similar for cars and vans, with cars making up 51% of total new contracts in 2019 and LCVs 49%. By 2023 however, the percentage of new business contracts for cars was 71%, compared to 29% for LCVs.
If we look at the absolute number of new business contracts for cars and LCVs, we see that whilst the number of new car contracts has increased, the number for vans has decreased significantly post covid.
This is consistent with the supply chain challenges in the market, particularly the shortage of semiconductors which are an essential component of modern vehicles. Looking at van production numbers in Europe, which are responsible for between 70-80% of the vans on UK roads, we see a significant drop in 2020. Commercial vehicles in particular are susceptible to supply chain challenges, with OEMs choosing to focus on higher margin passenger vehicles during these periods.
The knock-on effect of this has been significant price increases for new vans. Popular models such as Ford’s Transit have increased by 30%, with most models from other manufacturers showing similar price increases. These significant price rises have pushed lease costs up by as much as 30-40% and are the primary reason behind the slowdown in new contracts.
Looking again at the total BVRLA LCV fleet numbers, however, we see that this has grown in 6 of the past 7 years. Given the reduced number of new LCV business contracts discussed above, this would indicate that the average age of van fleets has increased. This is supported by data from Epyx which reports that the average vehicle age in 2023 was 3.58 years, compared to 3.39 in 2022, 3.25 in 2021, 3.16 in 2020 and 3.03 in 2019. Northgate itself has reported a higher average fleet age during this period, with the FY24 average age at 34 months, down from a peak of 36.7 months.
This indicates that whilst demand for LCV’s remains strong, businesses have delayed upgrading to new vehicles. Fleets, however, can only extend their current BCH contracts for so long before the higher maintenance costs and lower disposal values push current lease costs above that of new ones. We are beginning to see the effects of this in Q4 2024, which saw the number of LCVs in the BVRLA fleet decline by almost 11%.
So, are businesses simply using less vans? There are reports that some fleet operators have made attempts to rationalise their fleets, reducing excess capacity where they can, but overall demand is unlikely to be significantly lower.
Some businesses are turning to used vehicles, with both volume and price increases in the used LCV market at the end of 2024 supporting this theory. Used vehicles are not suitable for all businesses, however, with some preferring access to newer and more reliable models. This trend is also limited by supply constraints in the market. As more businesses look to buy used, prices are likely to increase significantly. Given they are already significantly above pre-pandemic prices, there is not much further headroom. The lower level of registrations, particularly in 2022 and 2023, also means that the amount of 3-year-old stock entering the market is likely to be significantly lower than normal, further pushing up prices.
Data on the number of new vehicles registered at the end of 2024 shows that registrations were up from the previous year, but still below the pandemic. This indicates that some companies are also looking to buy their new vehicles outright, rather than leasing them. There are several reasons why leasing has become less attractive than buying. Firstly, the current economic uncertainty is making businesses reluctant to enter into long-term finance agreements. High interest rates have also pushed lease costs up, with some businesses choosing to delay new contracts until these have come down. Volatile used vehicle prices and high inflation have also impacted leasing companies’ ability to set accurate residual values and led to higher monthly lease costs as a result.
Perhaps most importantly, however, OEMs have been focusing on higher margin retail sales at the expense of volume fleet orders. Evidence of this can be seen in Q4 2021 numbers which show that retail vehicle registrations were down only 1.3%, whereas fleet registrations were down 41.3%. Supply is finally beginning to improve, with vehicle production in Europe up 22% in the previous year. According to Northgate, this is beginning to trickle through to fleet operators, with the number of new business LCV contracts also up in 2024 according to the BVRLA.
Looking at Northgate in particular, we can see that the supply chain challenges have had a significant impact on their UK&I vehicle rental business. Average VOH at the start of FY25 was 3k lower than the previous year. Northgate has reported that there was strong demand throughout this period, with the declining VOH caused by supply-side shortages. The below graph shows that this trend is improving, consistent with the improved supply dynamics within the industry. Northgate have reported growing demand, with new business enquiries and contract wins at their highest level since 2019.
Looking at the graph on average vehicles on hire, we can see that Northgate is adding vehicles to its fleet at a faster rate than the industry. One explanation for this could be the sector mix of its customers. Northgate has large exposure to infrastructure and the public sector, both of which are industries that are set to benefit from higher levels of government investment. Northgate has received several large volume orders from customers in these industries, which are expected to be delivered throughout 2025. Northgate’s growing VOH can also be attributed to taking market share, as reflected in the number of new contract wins.
Source: Zigup H124 Results Presentation
I think the current market dynamic create a perfect environment for Northgate in the next 2-5 years. Too many businesses buying used vehicles will create a significant supply and demand imbalance, particularly given the lower supply of new vehicles in recent years. Those looking to buy new vehicles outright miss out on the benefits of long-term rental discussed above, particularly the advantage of flexibility during periods of economic uncertainty. Leasing will therefore become an increasingly attractive option for companies, especially as greater supply and lower interest rates drive down lease costs.
For Northgate, the easing of vehicle supply constraints and strong demand from customers is allowing them to invest heavily in their fleet. The rental fleet was 47,900 at the end of H125, compared with 46,600 at the end of FY24. The group intends to bring CAPEX down in FY26, with the fleet investment expected to generate steady state cash flow of around £200m in FY27.
Electrification of fleets
Fleet operators have been slow to transition to Battery Electric Vans (BEVs), with concerns about performance, particularly range and charging time, limiting uptake. Significant investment from manufacturers in recent years is helping to bridge the gap, with more than half of all new models available now being electric. Rapid advancements in range, battery size and payload capacity are also helping to drive demand, with running costs also significantly below their ICE counterparts.
There have also been issues with electric vans being classified as HGVs due to the weight of their battery, requiring a different category of licence to drive them. This is set to change, with standard Cat B licence holders able to drive zero emission vehicles up to 4.25 tonnes. The government has also extended the ‘Plug-in Van Grant’ for another year, which allows businesses to claim back on the purchase of their BEVs. This has been somewhat offset, however, by the decision to impose vehicle excise duty on electric vehicles for the first time.
Demand in 2024 was relatively flat, and whilst BEV volumes rose by 3.3% to 22,155 units according to the SMMT, they remained at 6.3% share of the overall market. This is not surprising given the current stagnation in the industry. Electric vehicles also still lag behind their ICE counterparts in performance, especially for those vehicles that are required to cover significant distances. Looking slightly further out, I believe the electrification of fleets will begin to accelerate. This will be driven by improvements in technology, as discussed above, but also better charging infrastructure and the introduction of the ZEV mandate.
Long-term, the electrification of fleets is therefore likely to act as a tailwind for the vehicle leasing industry. Leasing of EVs allows companies to electrify their fleets without the need for significant capital investment. It also allows businesses to avoid some of the pitfalls of owning an EV, namely the uncertainty over long-term battery performance and the subsequently volatile used EV prices.
Northgate itself has invested significantly in this area, offering EV open days for customers, a new online EV suitability testing platform, and charging and fleet consultancy services. Northgate also has its own charging infrastructure business, ChargedEV, understanding the importance of this in future uptake of electric vehicles.
The introduction of the Zero Emissions Vehicle (ZEV) Mandate in 2024 means manufacturers will be heavily incentivised to sell electric vehicles. 70% of new vans sold must be zero emissions by 2030, rising to 100% by 2035. Despite a recent relaxation of some of these policies to support carmakers, the basic outline remains the same. Failure to comply with the new quotas will mean hefty fines for manufacturers.
Those customers with the capacity to take significant EV volume from OEMs, like leasing companies, are likely to receive concessions for helping manufacturers to achieve their targets. This in turn will allow leasing companies to offer better prices, improving affordability and helping to drive further uptake.
For these reasons I think that Northgate stands to benefit from the electrification of fleets. It has positioned itself to be at the forefront of the transition through its investment in technology and infrastructure, and through education of its customers. Its scale also means that it will be a benefactor of the ZEV mandate, allowing it to offer more competitive prices to customers as a result.
Normalising used vehicle prices
The lack of new LCV supply during COVID meant that prices for used vans surged by 54% during 2020. This created a natural hedge within the business where growth in rental revenues was constrained by lack of new vehicle supply, but disposal profits were significantly higher. Between FY21 and 22, disposal profits increased by 453%, driven by an average increase in PPU of 504%. Because these price increases weren’t built into contracts, all additional revenue flows straight to the bottom line.
More recently, Northgate’s H1 25 results were impacted by a significant decline in disposal profits during the first half of 2024. A large number of BCH LCV contracts expiring led to an influx of used vans into the used market. This, combined with the fact that the average van entering the market is 10 months older and carrying 9222 more miles than its 2019 equivalent, lead to a collapse in prices at the start of 2024. Northgate also reported lower used vehicle sales volumes which combined saw a drop in UK&I disposal profits of 25%.
The share price reaction to the drop in disposal profits is understandable but should not come as a surprise. Looking at the below chart, we can see that disposal profits were highest in FY22 where average used vehicle prices shot up, but the residual values built into contracts did not reflect this. We are now seeing lower disposal profits in FY24, partly caused by a drop in prices, partly by a change in mix of vehicles sold, with Redde de-fleeting through the UK&I division. Most importantly, however, new contracts have now been priced to reflect these higher residual values.
Consensus, including forecasts from McKinsey, was for used vehicle prices to return to near pre-pandemic levels during 2025. Whilst I do think this will eventually be the case, I expect that it will take slightly longer for the trend to materialise. The most recent data for Q1 2025 is reporting volume growth of 21% and average sold prices up £554 for used LCVs. This is being driven by the elevated prices for new vans and businesses’ desire to steer clear of long-term finance agreements. The impact of lower levels of LCV registrations in 2022 is likely to further bolster used LCV prices in the short term, with limited amount of 3-year-old stock entering the market.
For this reason, I think we will see continued support for used vehicle prices in the short-term and continued elevated disposal profits as a result. Looking further out, we will also see the normalisation of used vehicle prices offset by increased volume of sales as the higher VOH trickles down, albeit with lower profit contributions.
Why Northgate wins and will continue to win
Northgate’s ability to take market share in vehicle rental is related to the value of its integrated offering and its scale.
Vehicle rental has historically been a commoditised product. Within BCH this is still the case, but leasing companies are increasingly looking to add complimentary services to increase stickiness and differentiate their offerings. Additional services such as maintenance and fleet management also reduce friction for customers. Fewer employees are required to manage the different vendor relationships as well as less time needed to search for operators in each of the verticals.
The increasing importance of complementary services such as telematics for fleet operators, provides a tailwind for the group. Telematics included in BCH contracts can be fitted by the leasing company pre-delivery, preventing the need for on-site visits by technicians and further reducing downtime. Northgate now has over 14,000 fitted, representing nearly a quarter of its UK fleet and 40% higher than the previous period. There are also natural synergies with other services such as maintenance and fleet management, with the enhanced ability to share data between the different services.
Maintenance is another area where customers benefit significantly from the group’s integrated offering. According to the BVRLA, 66% of new van BCH contracts include maintenance, with Northgate including it as standard on all hire vehicles. Northgate also offers collection and delivery, out of hours servicing, and will provide a replacement vehicle if the customer’s will be off the road for more than 2 hours. All this is essential for fleet operators, who cannot afford to have multiple vehicles sidelined at repair shops.
In addition to repair, Northgate customers also benefit from access to Redde’s services in other areas. One of the first new offerings the group developed was channelling Northgate accidents through FMG, which was offered to customers in 2020 and has seen strong uptake since. Other examples include the launch of a flexible car rental proposition utilising the Auxilis credit hire fleet and Northgate fleet customers using Redde’s vehicle recovery services.
Fleet customers also have access to a wide range of different vehicles through Northgate. These include refrigerated vehicles, through their acquisition of FridgeXpress, and specialist traffic vehicles, through their acquisition of Blakedale. These specialised vehicles are a significant differentiator for the group, whose varied customer base requires access to a diverse range of vehicles.
The ability for customers to wrap up multiple supplier agreements into a single contract significantly reduces the administrative burden for the customer. The entire range of services can be accessed through a single account manager, improving the simplicity of the offering and bringing down costs. The value of this integrated offering to customers is reflected in the expansion of the group’s rental margin post-merger.
Finally, the group’s scale gives it several cost advantages. Firstly, it has greater pricing power with OEMs. I mentioned this in the context of electric vehicles previously, but it is also relevant within volume orders of ICE vehicles. The combined fleet size has also allowed the group to increase vehicle utilisation, reducing the number of idle vehicles in the fleet. Lastly, the use of co-locations between the segments has allowed them to cut duplicate costs whilst improving quality of service for each of the businesses. All of these factors provide significant cost advantages for Northgate which can then be passed onto the customer.
Claims and Services (Redde)
This segment of the business offers the full range of services required in the event of a road traffic accident. This includes credit hire (which I will explain in more detail below), direct hire, claims and incident management, vehicle recovery, repair services and legal services. Essentially this allows insurance providers to outsource the entire range of processes that are required in the event of an accident.
As mentioned, through my research in this area, I thought this segment of the group raised more questions than it answered. Given I usually prefer to invest in companies operating in growing industries, the prospect of what I saw as a long-term decline in the credit hire business did not make for an attractive opportunity. It is worth mentioning, however, that Redde has won and continues to win large new contracts. It is therefore possible that revenues in this segment remain elevated, and investors are able to benefit from the growth in the vehicle rental business.
Counter-thesis Summary
Declining credit hire business – I believe that the future of the credit hire industry is under threat. Improvements in safety critical components such as brakes, the increasing prevalence of automatic braking technology, and the expansion of low-speed zones in cities are all driving down the number of road traffic accidents. Available data supports this, showing a long-term decoupling of the trend between collision numbers from total vehicle miles travelled.
Change in business mix – Though the group does not provide a breakdown between credit hire and repair revenues, I believe the contribution from repair is growing faster than credit hire. This is driving down the division’s EBIT margin, with the group citing changes in the business mix as the reason behind the contraction.
Shorter credit hire periods – Longer vehicle component lead times in the repair business led to longer credit hire lengths, significantly boosting revenues over the past few years. This trend has begun to normalise, and I believe it will continue to create downward pressure on sales and profits in the division.
An end to ‘extraordinary’ profits – The growing consolidation within the credit hire industry means that insurers and credit hire firms are working more closely than ever before. This, and the desire to protect their unique legal position, has led to a rise in the number of protocol agreements. Whilst this does provide some benefits, it also likely marks the end of the often ‘extraordinary’ profits earned by credit hire companies.
The future of credit hire
Credit hire is a slightly alien concept. In the event of a non-fault road traffic accident, the driver is entitled by UK law to a like-for-like replacement vehicle. The vehicle is provided to the driver ‘on credit’, with the cost then recovered from the at-fault driver’s insurance company. If the at-fault driver’s insurer refuses to pay, the credit hire company will seek payment through legal proceedings.
In some cases, this was a contentious area, with insurance companies complaining that the cost of credit hires was higher than standard industry rental rates. The industry has progressed significantly in this time however, with 70% of claims now managed through protocol agreements. These set out pre-defined rates dependant on certain conditions and allow faster settlement of claims and reduced legal costs.
The main factors that affect performance within credit hires are traffic volumes and the number of reported road traffic accidents (RTAs). Usually this relationship is relatively consistent, with the exception of the most recent half year results (H125), where the trend de-coupled and Redde saw normal traffic volumes but reduced RTAs. The below graph does show, however, that whilst traffic volumes have increased on average over the past decade, the number of collisions has fallen (collisions are not the same as RTAs but will serve as a suitable proxy).
There are a number of possible reasons for the decline in collisions. The first is the general improvement in safety-critical components such as brakes. The next is the introduction of lower speed limits within urban areas, with 20mph zones now common in most cities. Given that almost twice the number of reported collisions take place on urban roads this is likely to have had a significant effect. The introduction of automatic emergency braking (AEB), which has been mandatory for new vehicles in the UK since 2022, is also likely a factor. Given, however, that most vehicles still don’t have this technology its influence is unlikely to be significant yet. The final reason is the creation of clean air schemes reducing traffic volumes in cities. Given urban driving contributes a greater proportion of total collisions, the discouragement of driving in cities is also likely to have influenced RTAs.
I think long-term, the increasingly lower level of road traffic collisions compared to total traffic volumes is a threat to the credit hire business. That said, this trend is likely to be protracted given the time taken for new technologies such as AEB to become standard and the fact that the effect of lower urban speed limits have already been felt.
The other factor that has affected RTAs is the lower percentage of accidents being reported to insurers. The average cost of motor insurance increased by 15% in 2024, partly driven by the increased cost of settling claims for insurers. This is pushing many policy holders to handle claims outside of their insurance, with a quarter of those surveyed reporting settling a minor incident themselves. This behavioural change amongst policyholders, combined with the lower overall number of collisions, is likely to materially affect credit hire revenues in the long-term.
Greater contribution from vehicle repair
Redde acquired Nationwide Repair Services out of administration in September 2020 and now operates 64 sites and employs 1,600 staff. The business has been a strong performer for the group, and whilst its results are not separated from the other claims and services revenue, I believe it is contributing more and more to sales in that division.
A strong performing acquisition is not a problem in and of itself. Of more concern is the way this affects the division’s gross margin and masks what I believe are weaknesses in the credit hire business. If we look at Redde’s margin pre-merger, we see that its EBIT margin was often above 8%. Looking after the acquisition, and excluding FY20 and FY21, we see that Redde’s margin has declined from 6.6% in FY22 to 5.8% in FY24. To make this trend even more concerning, the post-merger number are presented on what the group calls an ‘underlying’ basis. This essentially means it strips out non-operating expenses and certain recurring charges such as amortisation of acquired intangibles. This means that the true accounting post-merger margins are likely to be lower still, and the downward trend starker in reality.
The group does provide some commentary on the downward trend in EBIT margin, citing changes to the business mix. Whilst there is no breakdown provided as to the different businesses’ contributions to claims and services revenue, I would expect repair now makes up >25%. Prior to going into administration, Nationwide Repair Services had revenue of approximately £190mn, so it would not be difficult to make a case for this having increased partially during this time.
Owing to their labour-intensive nature, repair businesses are naturally lower margin. This is a fact of the industry rather than a problem with Redde specifically. The issue here is that the Redde business was a strong performer prior to the acquisition because of the capital light nature of the business driving strong returns on capital. The lack of breakdown provided within Claims and Services means it is impossible to judge the health of the credit hire business and therefore make decisions around its long-term health.
Normalising vehicle part supply dynamics
The same supply chain challenges we looked at within vehicle rental also led to protracted lead times for vehicle parts. This created longer credit hire periods and drove strong top line growth for the claims and services division in FY23. Zigup’s most recent full year results reported a reversing of this trend as supply chains began to normalise.
Lead times for new parts are yet to fully normalise and return to the levels seen pre-Covid. For this reason, I think we can expect to see further reduction in revenue from the reversal of this trend. There is an offsetting factor in that the repair division’s profitability is negatively affected by the longer vehicle repair times but given that the credit hire business is higher margin, I think the net effect of this trend is still negative.
An end to ‘unfair’ practices
There is an interesting dynamic within the credit hire industry where the insurance companies that Redde pursues for compensation are either current or potential clients. The group says this unique dynamic has created scenarios where they have won new business from pursuing claims with an insurer. On the flip side, however, Redde must tread carefully, or risk destroying valuable or potentially valuable relationships. This is accentuated by the growing consolidation within the industry, with fewer large credit hire and insurance companies working more closely than before.
As discussed previously, credit hire occupies a unique position within the UK legal system, but the industry is not without its critics. There have been numerous reports of abusive practices and inflated credit hire costs, with one district judge stating that people would be “shocked” if they heard about some of the practices used by credit hire companies.
Other than the benefit of lower costs, part of the reason for the rise in protocol agreements is likely an attempt to mitigate the risk of legal changes within the credit hire industry. This is understandable given that an estimated 60,000 credit hire charges were issued within the county courts in 2023. With the already significant backlogs in the UK legal system, it would not be hard to see credit hire’s unique position becoming threatened.
Whilst there are benefits to the increasing number of protocol agreements, it also likely marks the end of the ‘extraordinary’ profits that used to exist. Reviews of Redde tell stories of policy holders being provided with significantly more expensive cars than their own to inflate the value of the credit hire claims. These ‘tricks’ of the trade are less possible than before, partly because of the rise in protocol agreements, partly because of the growing consolidation within the industry, but also because credit hire companies may otherwise risk their favourable position within the legal landscape.
Valuation
I have valued Zigup using a DCF model under three different scenarios. These scenarios reflect my assumptions around the health of the rental business, and the slow decline of the credit hire business.
Scenario 1 (Base Case) – Assumes modest single digit revenue growth overall, no higher than 6%. NOPAT margins remain slightly below their current level throughout the forecast period. Invested capital turnover also remains just below its current level, with forecast re-investment starting at over 100% and coming down to around 75%. This is in line with the group’s spending plans with free cash flow starting to come through in FY26 and accelerating as re-investment comes down. Assumed ROIC, both with and without the effects of acquisitions remain below prior year values, but above FY20/21.
Scenario 2 (Bull Case) – Models slightly higher revenue growth than scenario 1, with 5% in the first forecast year and peaking at 7.2%. NOPAT margin in this scenario expands to around 10.6%, above the prior year but below the historical average. Re-investment to support this growth is also higher, starting at 121% and coming down towards 70% at the end of the explicit forecast period. This means invested capital turnover is at 1.1 times, below the prior year value.
Scenario 3 (Bear Case) – The bear case makes some fairly punitive assumptions. Revenue growth is very slightly negative for all segments apart from Spain, which shows very modest single digit growth. NOPAT margin in this scenario declines significantly to a level below anything the company has registered post-merger. Re-investment required to support this has been left very high, which means the company destroys significant value. ROIC also declines to around 3% at the end of the forecast period, well below the company’s cost of capital.
