JGWPT Holdings: The 'Smart Money' Is Investing In This Deeply Undervalued $11 Stock

| About: The J.G. (JGWE)


At just $11, this could be one of the most undervalued stocks in the market today.

This company has a solid business model with minimal credit risks and court-approved structured settlement deals.

Recent merger & acquisition deals imply this stock could be worth $36 per share.

With what is probably a one-time earnings miss out of the way and with the stock showing signs of having bottomed out, downside risks appear low and upside remains significant.

With the stock at rock-bottom levels, short sellers could also help fuel a significant short-covering rally, which adds another potential upside catalyst.

JGWPT Holdings, Inc. (JGW) is a specialty financial services company that focuses on buying structured settlement payments, annuity payments, lottery payments, and providing pre-settlement funding. It provides these services under the J.G. Wentworth and Peachtree Financial Solutions brand names, and it is one of the world's largest buyers of deferred financial payments. Basically, if you have a large lottery winning, an annuity, or a legal settlement, but want a lump-sum payment, this company can provide it. Of course, this can come at a price, and that makes this a fairly high-profit margin business. However, if you just won a multi-million dollar lawsuit or a big lottery payout, or if you have an annuity that needs to be converted into cash due to personal or health reasons, you are probably going to be a lot less concerned about the fees than you might normally be. As this is a niche business in the financial services industry, it also means there is not a lot of competition. Furthermore, it means that many investors don't even realize the investment opportunity that this company offers or just how undervalued this stock is now. This might make it a hidden gem that could surprise to the upside. Let's take a closer look at the company and the stock below.

The chart below shows this stock appears to have formed a very solid base and could now be poised for a significant move higher:

As the chart above shows, this stock was trading for nearly $20 per share in March and declined sharply to around the $10 level after an earnings miss. However, more recently, the stock has been trending higher and it appears ready to reclaim the 50-day moving average, which is $11.41 per share, and continues to rebound. Longer-term, the upside potential appears much more significant, and in May, analysts at Barclays reiterated an overweight rating and set a $17 price target for this stock. That implies upside potential of about 60% from current levels.

An earnings miss that caused the stock to drop was possibly a one-time event due to an interest rate spike in Q1:

For the first quarter of 2014, JGWPT Holdings reported earnings of 34 cents per share, which missed consensus estimates of about 43 cents per share. The miss was primarily attributed to higher interest expenses during the first quarter. As many investors remember, interest rates spiked in the first quarter, but have since declined significantly. This is why earnings should be much stronger in the coming quarters. The company also has been requested to provide information to the U.S. Consumer Financial Protection Bureau to make sure it is in compliance with the Truth in Lending Act, and the Consumer Financial Protection Act of 2010. These appear to be formalities and part of doing business in the financial services industry. I can't find a single financial services company or bank that does not have ongoing compliance checks and inquiries by regulators - it is just a part of doing business. Nonetheless, investors dumped the stock on that news and the earnings miss, and it remains at very undervalued levels. Seeing weakness and downside momentum from the earnings miss, shorts have also piled into this stock, but that might now become a positive, since the stock has clearly bottomed out and it is now too cheap to ignore.

Although shorts piled into the stock, at these undervalued levels and with the downside momentum clearly over, shorts could fuel a major rally:

According to Shortsqueeze.com, about 1.5 million shares are currently short. This represents about 15% of the float, and with an average daily trading volume of about 200,000 shares, the short position is equivalent to about 8 days' worth of trading volume. That is enough to cause a significant short covering rally. This company is profitable, and based on PE ratios and other valuation metrics like recent merger & acquisition deals, the stock is very cheap and therefore possibly ripe for a short covering rally.

"Smart money" is investing in this company, and potential downside risks appear to be lower than many investors realize:

Even though some shorts have a significant position, the shorts are greatly outnumbered by the bulls. Some "smart money" investors are betting big on the potential upside for this stock. For example, Waddell & Reed Financial, Inc. owns nearly 9% of the company. Indaba Capital Management owns just over 8%. Kerrisdale Capital owns about a 5.4% stake in this company and appears to be very bullish on the stock. Kerrisdale points out that this stock could be worth $36 per share, based on one of the last merger & acquisition deals in this sector. In a report on this company, Kerrisdale also points out that every structured settlement must be individually approved by the judge. This is important, because it shows that this business model is recognized and endorsed by various parties, including the legal system. This reduces potential downside risks for investors. When considering an investment in a financial services company, it also makes sense to consider the potential for credit risk. However, as pointed out in the Kerrisdale report, this company takes minimal credit risk and often quickly resells the structured settlements. The report, which came out in 2014, details why the potential business model risks are relatively low, that this company is the leader in this industry, and why the stock price should be re-rated to much higher levels. It states:

"Unlike other consumer-finance firms, JGW takes minimal credit risk and, under a well-established legal framework, obtains official court approval for every transaction it does. Regulatory uncertainty cannot justify its low valuation. But a slew of negative non-fundamental factors has dogged the stock since its November 2013 IPO: weak post-IPO trading, expiring share lock-ups, and, because of the ongoing involvement of its controlling private-equity shareholders, a small float relative to its market cap. As these non-fundamental issues fade away, the stock should re-rate dramatically on the strength of its underlying operations."

This could be one of the most undervalued stocks in the market when you consider the PE ratio and market capitalization:

Analysts expect the company to earn $1.63 per share in 2014, $1.94 per share in 2015, and $2.49 per share in 2016. That means the stock is extremely cheap in terms of the PE ratio, as it is trading at only about 5.5 times forward earnings. If the company earns $2.49 per share in 2016 and you put a PE ratio of 10 on it, you could be looking at a $25 stock in just a couple years. The board appears to see significant value in the stock, and in May 2014, a $15 million share repurchase program was announced. That might not sound like very much, but since this company currently has a market capitalization of just about $142 million, the share repurchase is enough to buy back more than 10% of the shares outstanding. The $142 million market capitalization also makes this company a very affordable takeover target for another financial or private equity company.

In conclusion, this stock appears to have bottomed out, and the downside momentum has clearly faded. With what was probably a one-time earnings miss and overblown compliance concerns, the current share price appears to be giving investors an ideal buying opportunity. Smart money investors like Kerrisdale Capital clearly see significant upside based on M&A deals, and they believe that the market will re-rate this stock much higher based on minimal credit risks and a solid business model. The PE ratio indicates this stock is too cheap, and a share repurchase by the company also implies it is undervalued. Finally, short sellers could become an upside catalyst, especially since the stock has clearly bottomed out.

Here are some key points for JGWPT Holdings:

  • Current share price: $11.03
  • The 52-week range is $9.43 to $19.88
  • Earnings estimates for 2014: $1.63 per share
  • Earnings estimates for 2015: $1.94 per share
  • Earnings estimates for 2016: $2.49 per share
  • Annual dividend: n/a

Data is sourced from Yahoo Finance. No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.

Disclosure: The author is long JGW. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.