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Larry Meyers, PDL Capital (75 clicks)
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Shares of EZCorp (EZPW) have been under pressure lately, falling from around $17.50 to as low as $15.64 in recent trading. The stock was already substantially undervalued, but what caused it to fall even more, and what's the right move here?
It's instructive to examine the company's macro picture in order to understand recent developments. A substantial amount of EZ's revenue was driven by payday lending and pawn loans. During the financial crisis, unemployment soared. Since a payday advance borrower must have a job, that demographic transitioned into the pawn product. This coincided with record gold prices. The result was that EZ's pawn revenues and profits soared both domestically and in their other big market of Mexico.

Gold prices have since fallen precipitously, a lot of customer inventory had been sold off, and the job market picked up again. Faced with difficult YOY comparisons, revenues dropped off. EZ's Mexican pawn business was very gold-dependent, so those stores particularly suffered. As organic pawn growth returned to the mean of 3-4% long-term growth, and as payday lending has been a saturated market for some time, the company has been transitioning into new products. Revenues and earning assets continue to rise, so the company's core assets continue to generate cash flow the company needs to expand. Take a look at the Q3 numbers and you'll see the core business is just fine. Total revenues were $235 million, an increase of 5. Earning assets were $416 million, an increase of 21%. Pawn loan balances were $137 million, up 2% YOY. General merchandise loan balances were up 11% in total and 9% on a same store basis. Revenues from pawn service charges increased 5% in total and 2% on a same store basis. Merchandise sales increased 9% in total and 5% on a same store basis.

Now let's move on to relatively newer products. Balances on new single payment, multiple payment and auto title loan products were up 48%, driven by auto title loans.

EZCorp made a terrific purchase of an online loan platform, GOCash last year. Online payday lending has exploded in the past few years and is now responsible for 22% of all online lending. GOCash saw a 63% increase in loan book in the quarter, and yet the platform only lends in five of the thirty-three states where it is permitted to lend. GOCash and a very long way to go as it continues to penetrate the market. Ironically, this takes us to the first of two major reasons why EZCorp has sold off recently. Misperception about regulatory moves that actually will help EZ are to blame.

The federal government does not want consumers to have free choice in the short-term lending market, so it has made an ill-advised attack on ACH processors and banks that are involved with online lending. There are four online models: tribal, offshore, choice-of-law models, and state-licensed. Anyone involved with the first three is under assault. However, companies that are licensed in each state that they operate are not, and GOCash is state-licensed platform. This means that as lenders using the other platforms shut down, consumers will move to the state-licensed products, which should boost GoCash's market share. It was already a very profitable business and will be more so, especially as the company also moves this platform overseas.

The company's strategic ownership positions in other companies are also a growth driver. The company owns 60% of Crediamigo, a direct-to-employee loan model facilitated via payroll companies. It gives EZ access to more than 3 million employees, across some 200 companies, with a potential reach of over 1,000 companies throughout Latin America. It owns a large part of Cash Converters, an international buy/sell company with over 700 international locations. It owns Cash Genie, a UK-based online lending company, as well as 30% of Albermarle & Bond, a UK-based pawn lender.

It's the Albermarle & Bond ownership that has also hit EZ's stock. A&B also got hit with the big decline in gold prices, with badly affected its business. Its stock is down 75% from its high, and EZ did not want to inject 35 million British Pounds into the company to shore up its balance sheet. Concerns over the company's debt covenants hurt the stock price as a new CEO has joined the team. Yet, A&B's contribution represents a mere 3% contribution to EZ's assets and net income. The market took EZ's stock down more than 10% based on this and the non-story of GO Cash being impacted.
Meanwhile, the company generated $94 million in free cash flow over the TTM. This means the company is generating tons of cash to plow back into the business. Now, look at the balance sheet. Take all the assets of $1.34 billion. Back out the tax assets, goodwill, prepaid expenses, intangible assets, 80% of delinquent loans, 20% of current loans and receivables, and net assets come to $600 million. Liabilities taken in total comes to about $358 million. So the company's book value translates to about $5.50 per share, and trades at only $15.70, or about 2.9x tangible book. The most similar competitors, First Cash Financial Services (FCFS) has a tangible book value of $300 million, and trades at almost 11x tangible book value.

On a P/E basis, EZCorp is estimated to earn $2.00 per share this year, giving it a P/E of just under 8. Even if one buys into long-term growth estimates of 10% annualized - which I think it well below the 15% EZ will likely grow at given all its new opportunities, the stock should be trading at $20. That alone is 27% above today's closing price. If you buy into the 15% argument, the stock is 50% undervalued.

In the universe of these stocks, you also have Cash America (CSH), which trades at a P/E of 10.5 on long-term growth of about 13.5%. The stock is thus arguably undervalued on a PEG basis. First Cash trades at 20x earnings on 20% earnings growth, so it's arguably fairly valued. DFC Global (DLLR) trades at 10x earnings on 17% long term growth, although that may be a bit optimistic. Closely-related businesses that focus almost exclusively on installment lending include World Acceptance Corporation (WRLD), fairly valued at 10.5x estimates on 11% long term growth, and Regional Management Corporation (RM) trading at 13x estimates on about the same growth rate. Of course, if you want to just play it safe with a basket of financials, and avoid growth stocks, that's why the Financial Select Sector SPDR (XLF) is there for the taking.

Nevertheless, EZCorp remains the best near-term play for at least a trade, and long term remains the most undervalued of the sector. This is a great opportunity to jump into the alternative finance space at an incredibly cheap price. With stagnant wages and stealth inflation eating into people's paychecks, there will be ongoing necessity for short-term credit. EZ's free cash flow will permit continual investment in these and other new initiatives. Don't wait.

Source: EZCorp: 27% Trading Upside, 100% Long-Term Upside