This international financial services company operates a network of 1,269 stores - 511 in Canada alone -- and generates over $320M in annual sales. Dollar Financial specializes in serving under-banked customers. Dollar is making a name for itself as a low-end disruptor, to borrow from Clayton Christensen's seminal 1997 book, The Innovator's Dilemma. Low-end disruptors seize markets that incumbents choose not to pursue. Because working class individuals need to cash checks, get loans, and wire money just like anybody else, DLLR is capitalizing on customers behemoth firms like Bank of America (BAC) and Citigroup (C) deem too unworthy to target.
Low-end disruption occurs when the rate at which products improve exceeds the rate at which customers can adopt the new performance. Therefore, at some point the performance of the product overshoots the needs of certain customer segments. At this point, a disruptive technology may enter the market and provide a product which has lower performance than the incumbent but which exceeds the requirements of certain segments, thereby capturing a market. And because the disruptor is focused on serving the least profitable customer -- satiated by a good enough product -- competition is scarce. The target customer is practical and in pursuit of pure functionality -- he or she will not pay up, initially, for enhanced services. However, once the disruptor has "locked" a customer segment, it seeks to improve its profit margin through innovation and up-selling. If the incumbent never returns to the market it initially ignored, the disruptor literally has a gold mine all unto itself.
This is the sort of environment in which Dollar Financial operates. With time, the market will recognize this fact and juice shares.
We think that although Dollar Financial needs improvement on the profitability side of things, the company is briskly expanding and could be a much larger player in the years to come. We look favorably upon strong insider ownership; additionally, we like how the firm just came off a secondary offering, which should simultaneously reduce debt, increase book value, and give the firm a better valuation in the marketplace. We think the stock has gotten a depressed valuation because the firm is highly leveraged (4.4 debt/equity ratio vs. rival Ace Cash's [AACE] .47).
Nevertheless, as Dollar Financial diversifies it businesses -- and refinances its debt to more favorable terms in the second half of '06 -- we think the stock could see more upside. We apply a higher than normal EV/EBIT (enterprise value to operating income) multiple than the Street is using and see shares hitting $25 by the end of the year, representing a 25% move from Thursday's closing price.
DLLR 1-yr chart: