Aiful Corpration to Benefit From Japanese Consumer Lending Consolidation

I bought Aiful Corp. ADRs Tuesday (AIFLY.PK) which closed the day at $6.60. The ordinary shares trade in Japan under symbol 8515. One ADR=1/4 ordinary share. I bought the ADRs because they trade in line with the ordinary shares and there's enough liquidity to not get whipsawed placing a decent-sized order, an important consideration in buying any over-the-counter security.

Aiful is one of Japan’s four major consumer lenders and ranks as the largest by assets. The market cap is approximately 469 billion yen (almost $4 billion) and there are 142 million shares outstanding (most owned by foreigners). The stock trades at roughly 1.85 times stated book value and yields 1.82%.

Unlike when I first bought my other Japanese consumer lender, Takefuji (TAKAF.PK), these are no longer plays on stated book value discounts. I’ve recently added to my (currently underwater) Takefuji stake and established a new position in Aiful because now these stocks are a play on a changing industry. And their financial strength is such that they can adapt to the new environment and benefit from the coming consolidation.

I believe that’s true for the other two major players as well -- Acom and Promise -- but I bought Aiful. Why? Primarily because Aiful leads the Japanese consumer lending industry in diversifying away from the traditional consumer finance and into credit cards, home equity loans and small business loans. So it’s well-positioned for successfully adjusting in a sector that’s restructuring, cutting costs and tightening lending standards.

I mentioned industry consolidation. In the next few years the number of moneylenders in Japan is expected to shrink from 10,000 to about 3,000. Many of these outfits are financially weak, and many will have to sell out or even go out of business. Aiful should be among those cherry picking assets from its smaller rivals.

Aiful’s stock price, like those of all Japanese consumer lenders, collapsed last year. The factors involved government imposed interest rate caps, government scrutiny of collection practices and a Japanese Supreme Court ruling that opened the door to interest rate refund claims. Aiful and others set aside substantial provisions for repaying claims, leading to losses for the year ended March 2007. Aiful and the others are forecasting a return to profits in 2008, and I expect the stock price to recover.

What could go wrong with this pick? Primarily that Aiful could need to keep setting aside more and more provisions to pay claims. So much so that the balance sheet gets trashed and the company’s existence is threatened. I do not think that will happen -- but reports out of Tokyo last week were that excess interest claims are still rising. So there are no guarantees.

Finally, I should point something out. Most of my stock picks have performed nicely.

But my other Japanese consumer lender, Takefuji, certainly hasn’t. Regular readers will recall that I originally thought Takefuji would be “dead money” until it worked out. It was trading for $62.50 then, and is currently stuck in the $30s. I hope Aiful does better, yet Japanese consumer lenders could always prove to be the Little Big Horn of my brokerage statement.

AIFLY 1-yr chart

Comments

[Lance]

The stock is probably not going to turn you into a "jumper", but I'd like it a lot more at about 2500 yen, maybe 2200.

Your numbers are old, however. The 1.82 yield you quoted is based on the last dividend of 60 yen per year. But Aiful is only projecting 40 yen this year, so the yield is only about 1.22 percent, which means you really aren't getting much more return for assuming more risk than companies with fewer headaches may give you.

This is bottom-picking for sure, and of course everyone wants to buy bottoms. But these companies have not only taken huge financial hits (about five years of earnings to the red last year in the case of Aiful, and this was what they were earning when they basically had a license to print money), they have become pretty much social lepers.

You are saying Aiful will survive, and I tend to agree with you. But the road back to prosperity is likely to be a long one, and these consumer lenders are notorious for stock volatility. I want to see complete capitulation before I step into this mess, and I haven't seen that yet. Moreover, I'm not sure there are any consumer finance cherries out there to be picked by the survivors.

Aiful says they'll earn about 270 yen per share this year. On July 24 they'll give us the April-June numbers. I wouldn't be at all surprised if they lower the forecast, and the shares take another drubbing. Somewhere there is a bottom of course. But I'm want to buy from someone who bought this 7 or 8 month "bottoming pattern", and then gets exhausted by a 25 percent drawdown from here. Otherwise, I can wait for good news and buy on the way up.

The Takefuji play here is much more reasonable I think; at least you are getting some serious yield for your risk. If you are in for a long ride and can stand drawdown, you're probably only out opportunity cost.

[Lance]

That didn't take long.

Aiful traded at 2,500 today, August 15.

[Lance]

Not to beat a dead horse here, but do you follow up on any of these train wrecks?

This tout is now about 50 percent of your entry price (as of yesterday). I didn't buy it, which is probably obvious from my previous comments. Moreover, given the industry meltdown, I didn't enter around 2200 either. There simply is no way to manage a trade with reasonable risk when these companies are just pancaking.

But you put it out there, and you should follow up on your trades.

Lance

[Lance]

I am NOT going to let this go away. Not because you were wrong, but because you refuse to say anything about it.

Either you respond to your mistakes, or you don't deserve to be a featured poster ... anywhere.

What say you? Silence when your picks go down the toilet?

How professional.

Are you going to wait for 2012 and then claim victory? Your position is FAR underwater; much more than prudent money management would allow.

What say you, wimp?

Lance

[Lance]

So ... you make a tout ... you get your behind handed to you on a silver platter ... people ask for clarification about your tout ... and you are too weak to even reply.

You don't belong here. Got that? Anybody can recommend anything. People with guts stand behind their recommendations, or at least offer explanations.

You ran away and hid. Pitty the bastards that listened to you.

Lance

[Lance]

Let the record show that this moron never responded to any comment posted here, and more importantly, his "average-down buy" (yeah, even "pro" posters can be stupid) is now down about, oh gee, another 50 percent from his average-down entry price.

Buy more here? ^_-

God, I want to get notified so I can take the other side of some of these trades.