EZCORP: Another Hard Look at This Hybrid Retail / Financial Play

I first wrote about EZCORP (EZPW) (14.28, $704mm market cap) in early 2008 and have followed it closely every since. In fact, it is one of only two names I have held since inception over the past 18 months in my Top 20 Model Portfolio (Catalyst Health (CHSI) is the other). It has been quite the ride, as it ended 2008 up about 35% but was cut almost in half from its Q4 peak at the March lows. This year has seen some sharp moves up and down, but it is still down 6% y-t-d after surging post-earnings on Friday. I expect the stock could move to an all-time high price over the next year, potentially appreciating 60% to 23.

EZPW is primarily a pawnshop operator with a secondary business in payday lending. In the big picture, the company provides credit to those without access (a large and growing population!). The company is classified as a Financial, but it is really a hybrid. Unlike most financial companies, it isn't leveraged (pro forma net debt to cap is <10%). It derives a significant portion of its earnings from the sale of used goods, so it is a retailer as well.

The pawn business remains very attractive. The company did two acquisitions last year and plans to open six de novo stores this year. Payday lending expansion has stopped, with the company pursuing additional products to mitigate regulatory risk, including auto title loans and installment loans.

Mexico has been a source of growth, and the company will open about 50 stores in the coming year. Some of these are typical general merchandise stores, but the majority are 400 s.f. jewelry-only establishments. Another area of expansion is Canada, where the company is rapidly expanding its payday lending presence. Finally, it is important to note that the company has a 30% stake in an UK pawn company and just made a 30% investment in an Australian company. The earnings of these entities are booked beneath the operating income line.

The company just completed its fiscal 2009. Sales grew 30%, but they were boosted by two acquisitions. EPS grew 17% for the year, with half the increase attributable to the acquisitions. This growth was quite impressive considering the negative impact the economy had on pawn sales. To the company's credit, credit-losses on payday lending fell during the year. The company guided above expectations, suggesting that it will earn 1.65-1.69 per share in FY10 (18% growth at the mid-point).

Before I demonstrate how cheap the stock is, allow me to explain the factors that have led it to become undervalued and why that may change. I believe that one of the biggest problems this year was related to their purchase of Value Financial Services. This deal was problematic from the get-go, with an initial announcement in June 2008 followed by an abrupt termination in July.

A new and more expensive deal was announced in September and closed in December. The problem for the stock was that the sellers had a price protection plan with the company. It was poorly crafted, as it required the sellers to actually sell the stock if they wanted to get reimbursed for a decline in price.

On top of this, the company surprised mid-year with weakness in its pawn retail operations, leading them to lower guidance for the year from 1.51 to 1.42. Finally, an overiding issue for the entire year has been concerns over payday lending regulation, though the central commanders in Washington have been too busy with Healthcare reform to go there.

Another drag on the stock has been a lack of understanding about its minority investments in non-U.S. pawn and unsecured lending. If you listen to the last call, many analysts (including me) questioned the most recent investment rather than repurchasing stock. Finally, I don't believe that investors are aware of the large drag the decline in the Mexican peso was. Against this backdrop, I believe that the recent addition of the stock to the S&P 600 index and the realization that the company has several growth drivers to mitigate any payday lending curtailment concerns are catalysts for driving a higher valuation. I also believe that a better appreciation of the diversification and growth opportunities from its minority investments will help too.

As I said, this stock is very cheap. Based on recent guidance, which was slightly above the prevailing consensus at the time, the company trades at about 8.5 times one-year forward numbers. On a trailing basis, its Enterprise Value to EBITDA ratio is just 6X. The stock trades at 2.2X Tangible Book Value. This is for a company with very little net debt (after the Cash Converters deal), 5 year trailing EPS growth of 43%, Great Recession EPS growth over the past year of 17% and expected one-year EPS growth of 18%.

The stock is cheap on all of these metrics compared to its closest peers, First Cash (FCFS) and CashAmerica (CSH) and also has a better balance sheet. A final note on valuation: The company carries its investment in A&B at cost, while its market price exceeds that level by $26mm. Here is the last 5 years on several valuation metrics (click to enlarge):

I have recently raised my target to 23 a year from now. Here is how I get there:

• 12PE
• 2011 EPS of 1.92 (up 15% from 2010)

I think that the chart is excellent too. This year has been a consolidation continuation - three and a half years now. Given the low valuation and the high potential growth, I would expect to see it catapult out of the base (click to enlarge):

I like stocks where I see growth potential and deep value characteristics. I believe that I understand, as elaborated above, why the stock has cheapened.

I like the management team, though I should note that the long-time CFO will be retiring (replacement to be named by year-end). The company isn't widely followed (5 analysts), which suggests some potential for being a hidden gem. Most investors don't really know the company, as their customers aren't likely to be investors! The company fills an important need, has done so ethically as far as I can tell and has done so in a manner that has generated double-digit return on capital for years. Free cash flow this past year ( a year of investment) was $61mm, suggesting a FCF yield of almost 9%.

As I look at the stock technically, I see one point down to support but 9 points up to my target. I don't think 12 PE is a stretch at all - it has traded there in the past and its growth certainly seems to justify it. EZPW seems easy to recommend.

Author's Disclosure: Long in a portfolio I manage and in my Top 20 Model Portfolio