Seeking Alpha
Long only, value, contrarian, long-term horizon
Profile| Send Message|
( followers)  

My original analysis about EZCorp Inc. (NASDAQ:EZPW) was posted in Spanish for an investment blog in Spain. After receiving questions from many readers I've decided to expand my original thesis and complement the information in order to paint a more complete picture about the company. I decided to translate most of my original article into English in order to include it as part of this more extensive article I'm posting today for the American market through Seeking Alpha. All figures are expressed in USD.

EZCorp operates pawnshops and short term loan offices in the US, Canada, Mexico and the UK. The company's main focus is to provide immediate cash solutions to clients, which are for the most part, under-banked. Such cash solutions are granted through pledged loans (including cars as collateral), paycheck credit (with automatic payroll deduction) and non-guaranteed loans with one or more pre-programmed payments.

Furthermore, EZCorp is a passive shareholder in two companies from the sector. 1) 33% stake in Cash Converters International Limited, company that trades in the Australian stock Exchange under the symbol CCV and which has an approximate current market value of $600 million and 2) 30% stake in Albemarle & Bond Holdings, PLC, company that trades in the London stock Exchange under the symbol ABM and which has an approximate current market value of $170 million.

EZCorp currently operates 1,369 stores and are distributed as follows:

  • 489 Pawn shops in USA.
  • 486 Financial service stores in USA.
  • 254 Pawn shops in Mexico.
  • 45 Paycheck loan service locations in Mexico.
  • 35 Second-hand buy/sell stores in Canada.
  • 33 Financial service stores in Canada.
  • 20 Second-hand buy/sell stores in Mexico.
  • 7 Second-hand buy/sell stores in USA.

EZCorp is the second largest pawn shop and instant cash solution business in the US market and also one of the largest in Mexico. For those who are not familiar with the industry:

Brief Industry Description

A pledge loan has an approximate duration between 40 and 120 days and the average loan is made for $135 in the US market and $60 in the Mexican market. In most cases loans are backed against gold jewelry and to a lesser extent, against cars, household appliances and merchandise in general. The average monthly interest is 20% (240% annualized) and risk is very low because collateral is always of greater value than the amount granted on loan.

In the case of non-guaranteed loans, risk is higher, although this type of loans are traditionally carried out with clients who have a record with the company and under certain credit qualification criteria used by the company. Here, default risks is higher, as collateral is lower, if any, therefore it is a less profitable business but necessary in order to penetrate into a market niche of those who do not wish to leave anything as pledge. Interest that is collected is similar and duration of the loan is traditionally of 30 days, although it sometimes runs longer. The average loan in the US is $560.

For paycheck credits, mainly in the Mexican filial company, Crediamigo, a weekly, bi-weekly or monthly discount is given depending on the way collection is carried out in the company that employs the worker in question and that is how the loan is paid automatically with no need of collection management. Most contracts are signed with government companies, as permanence of Mexican workers tends to be longer in government-run companies as opposed to private companies, although there are also non-performing accounts, as companies do not share responsibility with the pawn shop and once the worker is separated from his/her position, any automatic charges are suspended.

There are small entry barriers which have made the industry undergo a brief consolidation in recent years. The main entry barrier is having enough points of sale in order to sell off the jewelry and other merchandise that is kept by the company from unpaid pledge loans, in such a way that the company does not face short-term liquidity problems. This is why most of the large pawn shops also have an additional business consisting of second-hand buy/sell transactions.

Company Summary and Main Competitors

Two main operating segments:

  1. Pawn shops and buy/sell used product stores.
  2. Financial service locations and loans against paychecks and online.

Three Reporting Segments:

  1. United States and Canada (Main segment).
  2. Latin America (business in Mexico, pawn shops, Crediamigo and TUYO - Second-hand buy/sell business).
  3. Other international businesses (United Kingdom and income from market share in CCV:AU and ABM:LN).

Main Competitors:

  1. Cash America International Inc. (NYSE:CSH).
  2. First Cash Financial Services Inc. (NASDAQ:FCFS).
  3. Advance America Inc. (NYSE:AEA).

Summary of the Company's Balance Sheet

Operating Assets (Net)

$1,196,972,000.00

Total Liabilities (Net Debt)

$284,863,000.00

Net Worth (Book value)

$912,109,000.00

Outstanding Shares

51,133,000.00

Book Value per Share

$17.84

Summary of the Income Statement

Merchandise in General

$335,410,000.00

34%

Jewelry and Gold

$208,319,000.00

21%

Pledged Services

$235,642,000.00

24%

Consumer loans

$207,671,000.00

21%

Other Income

$5,425,000.00

1%

Total Sales

$992,467,000.00

COGS Merchandise in General

($192,014,000.00)

57%

COGS Jewelry and Gold

($134,848,000.00)

65%

Loans Bad Debt

($41,377,000.00)

20%

Total COGS

($368,239,000.00)

37%

Gross Margin

$624,228,000.00

63%

Operations

($303,486,000.00)

49%

Management

($94,035,000.00)

15%

Depreciation

($23,289,000.00)

4%

Amortization

($1,979,000.00)

Others

$1,000.00

Operating Profit (EBIT)

$201,440,000.00

20%

Interest Income

$1,550,000.00

Other Extraordinary Income

$11,741,000.00

Income Before Taxes

$214,731,000.00

22%

Taxes

($71,023,000.00)

33%

Net Income

$143,708,000.00

14%

Outstanding Shares

51,133,000

Net per Share

$2.81

Profit Analysis, Last 7 Years

Net

Per Share

Book Value
Per Share

ROCE

Retained Earnings

(Accumulated)

Return on

Retained

Earnings

2006

$0.69

$4.03

21.11%

$1.78

41.96%

2007

$0.88

$4.99

21.76%

$2.65

36.51%

2008

$1.21

$6.30

24.23%

$3.86

33.83%

2009

$1.42

$8.65

22.60%

$5.29

44.32%

2010

$1.96

$10.48

22.70%

$7.25

25.25%

2011

$2.43

$13.19

23.15%

$9.68

28.01%

2012

$2.81

$16.33

21.31%

$12.49

25.14%

Margin of Safety and Investment Risks

There are some red flags to worry about and that is the reason why I have not gone overboard with the size of investment in this position. The following are the three main risks I consider could potentially work against any investment in the company:

  1. There are two types of shares and the shareholder carrying voting privileges -Phillip E. Cohen- gets paid a huge salary for his hedge-fund style consultancy services and could, at any moment, make decisions against common shareholders. Even tough this hasn't happened yet, it is still an evident risk.
  1. Most of the company's equity increase is in intangibles like Goodwill and there is a clear risk of future balance adjustments due to Impairments, which would destroy part of the company's value and the supposed profit obtained on Retained Earnings. Such Goodwill has resulted from buying companies during recent years; which by the way questions the company's ability to grow organically and of course puts in question the quality of Net Income and its sustainability over the long run.
  1. The company does not pay dividends and although the Return on Retained Earnings is spectacular, past events do not guarantee the future and such situation may change at any given time; in addition to the fact that the company could carry out a series of bad investments which may destroy most of its value.

After saying all that, my conclusion is that EZPW's intrinsic value ranges between $42 and $47 per share. From its current price of $19.15 there is Margin of Safety bigger than 50%; that is, there is the possibility of buying a dollar for less than 50 cents; therefore, to me it seems like a highly attractive opportunity and that's why I consider the risk/reward ratio is attractive and have decided to take a small position which I am willing to considerably increase if I am able to lower my average cost.

I've reached this conclusion by taking into account: 1) a discount rate of 7%, 2) Net Income per share for 2013 of $2.43, 3) a Book value per share by the end of 2013 of $20.43, 4) a Return on Retained Earnings of 25.14%, 5) a Return on Common Equity of 19%, and 6) no dividends.

Why these variables? 1) The 10 year Treasury bill yields 1.8% and the historical equity risk premium is around 4.2%, which will equate 6%. I've decided 7% arbitrarily because I don't like to go below this threshold. 2) I decided to consider an average for 2010-2012 instead of taking 2012's net income at face value in order to be more conservative, 3) after reviewing the last 10 years of financials I think the company will have a book value by the end of 2013 close to the one I'm considering, 4) The average Return on Retained Earnings for the last 7 years is 33.57% but I'm taking into account last year's return since it has been the lowest of that period, 5) the average ROCE for the last 7 years is 22.5% but I'm taking into account only 85% of that in order to be conservative, and 6) I'd rather have the company multiply my retained money tax-free by a factor of 25.14% every year than paying taxes on dividends and having to look where to get an equivalent return.

Also, I always like to compare the current stock price to the lowest level reached during the financial crisis, similar to what Graham used to do when comparing to depression numbers. That comparison gives me a mixed feeling and something to ponder. The lowest level reached during the crisis was $9.58 per share, at a moment where book value was approximately at $7.6 per share, so even though it was a level more than 50% lower than the current level, it was still a level that equated to 1.26 times book, which will translate to $22.47 for current book. So that's why I have mixed feelings about downside potential in case of a future crisis similar or worse than the previous, but I think downside is quite well protected.

And finally I will also like to state that I don't see a near term catalyst that could make the stock reach its potential, which is also something to ponder when investing and for those investing only where catalysts are present, this is clearly not a place to be. I stand by Graham's statement "In the short term, the market is a voting machine, but in the long term, is a weighing machine". I'll wait until that happens, if ever.

Disclaimer: This article represents only the opinions of the author and in no way should be considered investment advice and should not be relied on for making an investment decision. The content of this article is intended solely for the entertainment of the reader.

Source: EZCorp, Inc.: Like All Value Investing, Hidden In Plain Sight