- With the pick-up in the economy, the profits payday lenders enjoyed in recent years may be over.
- Publicly-traded companies are moving to mitigate losses from their payday loans by boosting their pawn shop businesses.
- Investors should carefully examine payday lenders, taking loan positions to allow them to benefit from shifting of their business models.
A year ago, businesses operating in the payday lending space seemed to hit their strides as worthy investments. Their ability to capitalize on the financially strapped consumer with high-interest loans was a boon for many of these businesses.
However, now the tide is turning against them as regulations and an improved economy have left their loan products less desirable.
Not to be done, many of these companies have shifted their focus back to their main money-making source: the pawn business. While this area of their businesses is the strongest of any of their others, the rate of growth is a concern that investors should keep in mind if they are considering investing (or holding their positions) in these companies.
With a market cap of $1.4 billion, First Cash took a major proactive step to maintain its financial position. Last year, it bought 19 pawn stores in Texas for $70 million. The Texas market, specifically in Houston, is ripe for the picking when it comes to pawn stores. Its proximity to Mexico, another growing market for the pawn shop business, is also a plus for First Cash. It also announced last month the completion of its twelve-store large format pawn acquisition in South Carolina, bringing the grand total of such additions to 112 last year.
Cash America's core business is its pawn business. Its market cap is in line with First Cash's at about $1.2 billion. While First Cash was buying up pawn stores in Texas, Cash America was unloading its payday lending business in the area. It closed 28 lending locations in its Texas markets. Clearly, the loans made at these locations to the so-called under-banked or unbankable were not paying off for Cash America as lucratively as they did during the economic slowdown that was in full swing in 2008.
With a market cap of roughly $663 million, EZCORP is the smallest of the three companies mentioned in this article. Its largest core business is also the pawn shop business, while its consumer loan business is the second largest. Company officials say that its overall loan balance grew in 2013, despite regulatory changes (especially at the state level) that are making it difficult for these loans to be made. Governments began cracking down after finding that consumers were being taken advantage of with these payday loans. Several states passed laws limiting the fees and interest that can be charged, while others like Georgia have flat out banned them. No matter; EZCORP has shifted to making its loans online instead of at its brick-and-mortar stores. By making the loans online, there is a lesser chance in getting caught up in laws and regulations. However, the federal Consumer Finance Protection Bureau has begun exploring these online loans. It's only a matter of time before the agency strikes at limiting these products.
There is also the issue of the competitive retail environment to consider.
The industry was growing in all directions, even creating new businesses. One of them, for example, is Landmark Cash, was formed specifically to match borrowers to payday loan lenders. It boasts being able to increase an applicant's chance of being approved and they can be reviewed by several lenders instead of one.
When it released its fourth quarter and year-end earnings for 2013, Cash America had to admit that its domestic pawn lending business was under pressure. The reason stems from falling gold prices, which is a headwind that all of these pawn shop/payday lenders must contend with.
Cash America was being challenged by lower gross profit due mainly to the significant year-over-year fall of the price of gold. Lower levels of scrap gold volume has only aggravated the situation, and not just for Cash America; the change had affected all pawn shops. The increasingly competitive retail selling environment has also made it hard for the pawn shops to move their merchandise.
Future of pawn
Execs at these companies naturally say that the pawn shop business is growing. I don't doubt that at all. However, my concern centers on how fast this area is growing, and if it will be enough to offset the loss of the windfall of revenues these companies reaped from making those high interest payday loans.
A red flag indicating these payday lenders/pawn shops won't see any positive growth for at least the next few quarters is the guidance released when they reported their latest earnings. Cash America expects its EPS for the first quarter of 2014 will be between $1.15 and $1.25 per share. That compared to $1.40 per share in the prior year.
Without giving specifics, EZCORP's CEO said year-over-year financial comparisons in the second quarter to be challenging:
"Our U.S. pawn and financial services businesses continue to anniversary gold volume declines and regulatory changes respectively."
As far as its online businesses, officials expect they will have quarter-over-quarter improvement, but will not cross into profitability until the third quarter.
First Cash expects earnings for this year to be between $3.00 and $3.15 per diluted share. That's based on its assumption that revenue from core pawn fees and merchandise sales will increase 15% to 18%, primarily driven by contributions from new and acquired stores in both the U.S. and Mexico.
In its last earnings report released in January, it was stated that:
"The projected core revenue growth rates in fiscal 2014 will continue to be partially tempered by expectations for the size and number of pawn loans collateralized with gold jewelry. The earnings guidance also reflects anticipated further revenue declines in 2014 from non-core scrap gold sales and payday lending fees."
Go long or not at all
There is solace to be taken in these businesses recognizing, and moving quickly to address the issue of declining revenues from payday loans. Shifting to the pawn shop business is not without challenges, however, including falling gold prices and competition from traditional retailers. I'd move with caution when it comes to payday lenders unless you are prepared to go long these stocks as they beef up their pawn shop efforts.