While everyone is painfully aware of the credit crunch, especially with respect to the housing market, investors are perhaps less familiar with another spigot run dry: automobile lending. Leasing has died, the auto manufacturers have shut down or curtailed lending and most third-party providers of capital to the market have retrenched.
Automobiles are big ticket items that are generally bought on credit. Borrowers are strapped, and lenders are in retreat. It's no wonder that the outlook for the auto industry is so bleak even after such a disastrous year. Investors who, like me, believe that the recovery will be slow are well served to think through how these dynamics will play out. I believe that there are four areas that could benefit: Auto-parts stores, salvage/recyclers, lenders and pawn shops.
I was negative on my favorite automobile parts store, O'Reilly (ORLY), last year. I covered my short in January, but I am now considering buying this member of my watchlist. One of my observations at the time was saturation, which could become less of a problem given consolidation. In fact, ORLY played the role of consolidator by purchasing CSK Auto (CAO).
While ORLY took on some debt as part of that deal, it still has one of the better balance sheets in the industry along with above-average margins. In any event, whether its ORLY or one of its peers, including Advance Auto Parts (AAP), Autozone (AZO) or Pep Boys (PBY), the overall industry should benefit from a slowdown in new car purchases due to the lack of available financing.
Why? As people keep their cars longer, they will need to maintain them. While these stores cater to the do-it-yourself repair person (not me!), they also act as just-in-time inventory hubs for repair shops. An aging fleet of vehicles implies more repairs.
The salvage/recycling industry is an interesting angle. As the economy remains challenging and credit availability for new purchases is constrained, the "repair versus replace" argument swings in favor of repair.
To that extent, components from totaled vehicles become even more valuable than typically. Copart (CPRT) is a pure-play on the resale of used vehicles via auction. The company has a very high return on capital, no debt and a PE multiple of just 15X. LKQ (LKQX) recycles components for resale. While it trades at a lower PE, it does have some debt on the balance sheet.
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If you want to see the LKQK chart, click here.
Like almost any stock since then, it is down a lot, though less than one might suspect ("just" 26%, with the S&P 500 down 31%). I pointed out in that article that "ACF is potentially dead meat, as it historically has relied upon the capital markets to finance its lending (securitization). I believe, though, that they will survive."
That the stock has held up better than the broad market despite its very high risk could suggest what I believe to be the case: Despite the risks, the company is in a great position. Access to capital and the losses on the existing portfolio have to be weighed against the opportunities to lend at fantastic margins in a favorable competitive environment.
Again, this one isn't for the timid. The stock trades at a substantial discount to book value, not surprisingly. I view the company as having massive scale and infrastructure that should appeal to anyone who wants to earn high returns in the future in the business and is willing to absorb near-term losses on the existing portfolio.
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The final area is perhaps too far "out of the box" for many, but I firmly believe that the dynamic I am describing could positively impact pawn shops. EZCORP (EZPW) is one of my largest positions, and I own it for reasons that extend well beyond this argument. I prefer it to CashAmerica (CSH) due to its better balance sheet and a few other reasons, but both should benefit.
For those who do purchase a new or used car, the days of "no money down" are gone. I believe that the higher down payments required could lead to people pawning items at the margin. A car is a necessity for many, not something they can do without. Unlike a home, a car can actually help its owner to make money, whether directly (sales, for example) or indirectly (commuting where public transportation isn't a viable alternative).
To the extent that someone needs a car and can't buy one with the type of easy credit to which we have become accustomed, I believe that they will need to turn to alternative sources of credit/cash. I realize that most readers of this article don't fall into this category, but I estimate that many of lower means certainly do.
I first wrote about EZPW in February, and, remarkably, the stock has gone up. I think that it has a lot more to go. Minimal debt, huge return on capital, a focused and methodical expansion and a stunningly low valuation for an "unFinancial" (no leverage) all suggest to me a possible gain of 80% or more over the next year.
We are probably going to face tight credit in automobile lending for quite some time. In the following table (below), I have included a few metrics for all of the companies mentioned. I am sure I left off some other potential beneficiaries and would appreciate anyone sharing their ideas with me.
This phenomenon, unfortunately, extends well beyond housing and automobiles. We should expect credit card standards to tighten immensely, and we are already seeing a massive constriction in lending for education.
While it is easy to focus on the impact on consumer spending, a more interesting exercise is to think about what changes might occur in the way people go about paying for big ticket items. I believe that the absence of credit will lead to material pressure on all goods that can be converted to cash as long as credit remains constrained. I mentioned gold as a short last week, and I have never seen such a furor created by one of my articles. We know that people are selling their stocks en masse, but what's next? Art, antiques, coins and stamps all stand out to me. Pawn lending appears to be an obvious beneficiary, but I am sure that there are others. I am not yet comfortable enough to even suggest a publicly traded company that has been performing quite well that could benefit from the need for cash, but I will say that it is in the "life settlements" business (formerly known as viatical settlements industry). Yes, the business for selling one's life insurance pay-off at a discount today is booming.
Disclosure: Long EZPW and ACF