Finding Value in the Payday Loan Sector

I wanted to take a look at the undervalued payday loan sector and see if crunching numbers might reveal something behind the overall state of the sector. So I put the companies side by side and ran some basic calculations. The companies in the sector are First Cash Financial Services (FCFS), EZCorp (EZPW), Cash America (CSH), QC Holdings (QCCO), Dollar Financial (DLLR) and the venerable Advance America (AEA).

On the surface, it appears that all the stocks except First Cash appear cheap on a current P/E ratio basis, but all are cheap on a 5-yr. PEG ratio basis.

I also like to check each company’s price-to-book ratio, because this is one of those sectors where book value is very close to liquidation value and can reveal some outrageous bargains. Such a thing occurred a few months ago when Advance America was trading at 86 cents per share.

In this case, Cash America appears to be priced for disaster. While the company does have significant exposure in Ohio, where it did close down some 50 stores in response to more restrictive legislation, any further attacks appear to be unlikely.

The grandstanding political hack by the name of Rep. Matt Lundy introduced a bill designed to kill lenders late in the session. Not only did it fail to ever even get heard, the original backers of last year’s legislation have all but admitted it was political theatre, and Lundy’s bill would harm other lenders besides payday lenders.

Cash America is well-diversified across both payday lending and pawn shop operations. It just closed a deal for $100 million in bonds, is on track to earn $3.05 per share this year, up 13%. It generated operating cash flow last year of $253 million. While its Return on Equity is not as high as its peers, it is nevertheless a solid operation. I like it at these prices.

I also like EZCorp at these distressed levels of $10.25 per share. I love profit warnings. Very often, the market sells a stock off more than it deserves, leaving shares to be picked up at a significant discount to fair value. Such a thing happened to EZCorp (EZPW) recently, and the stock is ultra-cheap even on the most conservative of valuation methods.

The company is now forecasting $1.42 in earnings for this fiscal year, which is a 17% expansion on earnings from the previous year, which gives it a price-to-earnings ratio of a little over 7, giving it a PEG ratio of .28. We know that the economy is squeezing payday lenders a bit because one must have a job to get a loan, and one must have disposable income to buy a pawned item.

Eventually, however, the economy will improve and in the meantime, people will discover the great deals they can get buying diamonds at reduced prices at a pawn shop. In addition, EZ is having great success in Mexico despite the economy. They have plenty of cash on hand, and have barely touched their $160 million credit facility. Many of their stores are newer than those of their peers, so they have more room to grow. They see higher net margins than their peers, and the lowest EV-to-EBITDA ratio among its multi-product competitors. I think this is a solid play here and far below its fair value.

Mind you, I like the other players in the sector for the long term. The monoline operators will need to innovate to add to their product mix, but they’ve shown how resourceful they are, especially when confronted by regulatory challenges. Speaking of those….

Regulatory Update

The stocks may be under pressure because the market does not understand how Obama’s new proposed consumer finance regulatory agency will affect the sector. Well, I have good news. Sec. 122(g) specifically states,

g) NO AUTHORITY TO IMPOSE USURY LIMIT.—Nothing in this title shall be construed as conferring authority on the Agency to establish a usury limit applicable to an extension of credit offered or made by a covered person to a consumer, unless explicitly authorized by law.

So while anything can happen in politics, it appears that should this agency actually be allowed to exist over the objections of the massive banking lobby (no sure thing), then payday lenders won’t be facing any onerous regulation. And since they abide already by strict federal and state statutes and regulations, there’s no concern.

Legislative Update

Not much to report here. I am still waiting to see the markup on Rep. Gutierrez’s payday loan bill. Again, this bill won’t have much impact if it passes in its present form, but everyone including myself is opposed to it, even consumer activists (because they want a ban on payday loans). Gutierrez said he wouldn’t accept any more donations from the payday loan industry to avoid the appearance of impropriety, but that doesn’t signal antagonism towards the industry. If it did, the $15 per hundred cap in non-regulated states would be replaced by that nutty 36% APR cap the wacko activists are pushing for.

Overall, there’s value in the sector.

Full Disclosure: Long EZPW

Comments

[Albert Meyer:]

Thanks for the update.

Jul 08 09:07 AM

[DanielMiller:]

EZPW looks the most fundamentally sound to me. Their growth rates blow away the industry averages. Price ratios are irresistable and profit margins are very healthy. Strong insider ownership and soild management efficiency are also pluses. Only drawback is that they do not pay a dividend. I first bought shares at $11.50. Looking to buy more under $10.

Jul 08 09:23 PM

[Violent Cap...:]

umm a 36% cap, or a $15 per 100, would be significantly lower than the 240% apr's these guys are offering now.

working capital is also jumping up across the board (receivables, inventory, and PPE), and as that steadily increase the greater the likelihood that they will have to writedown their assets as time passes.

but i do agree EZPW is prob one of the better companies in this space.

Jul 20 04:16 PM

[Violent Cap...:]

umm a 36% cap, or a $15 per 100, would be significantly lower than the 240% apr's these guys are offering now... so there is room for the fact that the apr's will be constrained, not to mention their higher returns on capital - potentially can lead to a dangerous situation if investors make a bull market out of this.

working capital is also jumping up across the board (receivables, inventory, and PPE), and as that steadily increase the greater the likelihood that they will have to writedown their assets as time passes.

but i do agree EZPW is prob one of the better companies in this space.

Jul 20 04:23 PM

[MicrocapMan:]

Any thoughts on Cash Store Financial (TSX: CSF)? I think they are just as cheap and Canada already has regulations in place. These guys are knocking the cover off the ball and have been very proactive in improving shareholder value: just initiated a dividend and this is on the heels of taking out a slug of stock (3m shares) in repurchases. They also announced another 1m share buyback. Got 450 stores and lookingto add 50-70 more stores a year.

Jul 28 08:21 AM

[Larry Meyers:]

Yes, I just became aware of them. I have not yet dug into the financials but plan to in the near future.

Jul 29 06:51 PM

[Aldo09:]

Payday loans get a bad rap, at least from people that don't grasp a larger picture. Payday loans are simply short term small amount loans between paydays a person can apply for, and a financing charge applies – usually $15 to $30 per $100 loaned. Since so many lenders have gone online, you can get online payday loans, or internet loans, no fax payday loans, whatever you want to call them, by filling out online loan applications, and lenders can deposit funds into your checking account within a few hours. Online lender networks exist as well, such as the website Personal Money Store, who can connect you with a payday loans lender that will work best for you.

Aug 12 04:05 AM

[MaxwellD:]

Payday loans are a supply that was created as a reaction to a demand. That's Econ 101 – supply meets demand, whereas large entrenched credit cards that are given massive government favoritism and protection – that's economic fascism. Still, payday loans are a way to get small amounts of money that you pay back quickly for a fee. There's no credit check, and many lenders make this money management tool available with direct deposit, and can get you the funds you need within hours. You have to take care and be responsible, as with any other financial action – and pay it back. If you need quick cash, and want to make it easy on yourself, you can get payday loans.
You can read more on payday loans by visiting this link:
personalmoneystore.com.../

Sep 10 12:53 AM