EZCORP: It's Easy to Own This Stock

EZCORP (EZPW) (12.52, $472mm) showed up on a screen a couple of weeks ago and captivated me. How could a company classified as a Financial stock be showing such positive fundamental and technical momentum? Well, after spending some time on it and then discussing it with my clients and then buying it, I can say that this is either one extremely cheap stock poised to double over the next 18 months, or I am missing something. I am hoping that perhaps the Seeking Alpha readers can enlighten me!

EZPW is one of three publicly-traded Texas-based companies that provide cash on a short-term basis to borrowers. Originally focused just on pawn lending (EZPAWN), the company also offers payday loans (EZLOAN). While these businesses perhaps might rub you the wrong way (as they did to me and to a few of my clients), I believe that this is a company that provides a valuable service to an underserved market. For both of their businesses, they are providing people cash at very high rates but in a way that allows them to maintain dignity and control. Late payments and bounced checks can be extremely expensive to the customer, and pawning items or taking a payday loan can help avoid these financial hits and the embarrassment and hassle that accompany them.

I think that both of these businesses are very timely, assuming controls are in place and that management understands their clients as well as they maintain they do. Credit is in high demand now and in increasingly shorter supply. Lending to people on a securitized basis (pawn) or to people who are employed and have decent credit on a short-term basis (payday) are great ways to act as the collector on the toll bridge. Traffic should be going up! Speaking of management, I recognize how important in this case that aspect of the company can be. I have to admit to not really knowing too much about them. I was impressed, though, after reading a 2005 interview with the CEO and realizing that the company has clearly said what it was going to do, done it and done only what one would expect it to do. The management team has varied experience in outside industries – retail, uniform delivery, rent-to-own.

Pawn lending, which has deep roots in Texas, is very interesting. The overall pawn market is highly fragmented, with the top 3 (EZPW is #2) controlling only 10% of the share. EZPAWN operates in over 300 locations and recently entered the Mexican market. The company charges a 20% per month service charge and lends on a loan-to-value of 35-50%. The few people who forfeit their collateral end up supplying the retail operations. I visited one and felt like I was at a flea market with tons of bargains. My son coveted the almost-new X-Box 360. The merchandise is predominantly jewelry, but also musical instruments, electronics, tools, and bicycles. The company has been steadily growing its pawn service fees and its retail sales. It does some acquisitions, but it isn’t opening any new units. One interesting kicker: The company has been increasingly melting down jewelry for its gold value – an inflation hedge! The stores have six full-time employees typically and they have lots of information sources for valuing merchandise that serves as collateral. Their pay has a high incentive component.

Payday lending is the growth engine for the company. The loans, which are almost all very short-term, are issued under highly automated procedures. The potential borrower must apply in person. The applicant must have proof of employment and an open checking account. EZLOAN runs a credit check before issuing the loan. Most of the loans are provided by third parties who pay a service fee of 15-22% to the company upon repayment. The loans are typically $500. The company has been opening stores at the rate of 100 per year and currently operates over 400. The market is more concentrated than pawn lending, with the top ten companies controlling 40%.

Financials

EZPW has an extremely solid balance sheet, with no debt at all. They are internally financed. FCF of $40mm has more than doubled over the past three years. A look at the balance sheet shows over $200mm of tangible equity, with total liabilities of just $40mm. The $245mm of tangible assets looks like this:

For a retailer or a financial, this is a STELLAR balance sheet. It actually rivals technology companies. The company is valued at only 2.4X tangible book value and has no debt (no leverage). It turns over its book several times a quarter, so it can react and adapt to any sort of change in losses experienced. Additionally, the investment in Albemarle & Bond, a UK company similar to EZPW, is significantly understated. At its recent price, this investment would be worth an additional $40mm above the cost at which it is carried.

In the recent quarter, sales grew 22%, though organic growth was somewhat lower. The company has generated sales in excess of 15% for the past 5 years, with significantly higher EPS. In the most recent quarter, EPS grew 26% and are expected to continue at that pace over the next several quarters. Balance sheet growth seems consistent with revenue and earnings growth – no yellow flags.

Insiders own about 11% of the company. It is important to note that all of the voting stock is held by Phillip Cohen (and 7% of all the stock), who is not an officer of the company but was the founder. He pulls out $1.8mm a year in consulting fees as well.

Valuation

EZPW is dirt cheap, almost as attractive as the prices on their merchandise! The stock trades at just 10.4 X forward EPS and 7X trailing EV/EBITDA. This is for a company generating rapidly growing free cash flow that totaled $40mm in the last fiscal year. Based on the reaction that I got from a few clients, it isn’t that surprising that the stock is cheap. Being a Financial and a Consumer Discretionary company is not exactly a door opener in this environment. Further, the company is followed by only 3 analysts. Finally, I have often detected a lack of willingness of investors to buy the stock of companies that they don’t exactly know. It would be much easier to get a handle on a more traditional bank or retailer than a pawn shop operator. My guess is that very few of you reading this have ever even stepped into a pawn shop. I hadn’t until I started to research the company.

Compared to two of its more prominent peers, EZPW is priced at least fairly. Cash America (CSH) may actually be the better investment with a similar valuation and a greater exposure to pawn lending. I favor EZPW, though, due to its better balance sheet and its seemingly lower reliance upon acquisitions. On the other hand, First Cash (FCFS) is a lot cheaper, but it is in the used auto lending business, which is dragging down its performance and not at all where I want to invest.

While I expect that the returns on an investment in this stock will be fantastic without any expansion in the PE, I expect that this stock will ultimately trade at closer to 15X when the recession or slowdown is behind us. Earnings estimates continue to increase (though not for CSH or FCFS) and it seems likely that the company’s 2009 consensus estimate of 1.35 could prove conservative. Looking out just eight months, when the company closes out its FY08 and investors key on that FY09 estimate, the multiple might expand to 12 or so, giving a target of 16. A year later, I would expect the company to get its 15 PE off of earnings that should be no worse than 1.55, producing a price of 23. That would be almost a double in less than 2 years.

Technicals

The stock has been in a consolidation for almost two years now, trading between 10 and 17. I see first resistance at 13.50 and would buy more aggressively if it penetrates that level. The highest volume over the past year has been at 15, which also served as resistance in May and then again in October. On the downside, the stock has significant near-term support at 12. I would be concerned if the stock were to trade below 10.50. Short-interest is fairly high at about 7% of the float and 6 days of trading volume. There are 5%+ owners, including one that has 10% of their money in the stock (Watershed out of San Francisco).

Conclusion

I am fascinated with this company – it sure seems like a potential hidden gem. While the barriers to entry might not seem that great, the company certainly has demonstrated an ability to cater to its clients in a highly profitable manner. The company has made investments in its business processes and technology. In a credit crunch, it is likely that the number of suppliers of capital will be curtailed and that the demand should increase, leaving the company with excess capital in a great position. The company hasn’t experienced any significant credit deterioration despite the fact that its lower-end clientele has been under some financial strain due to rising energy costs for quite some time now. I like the positive correlation to the price of gold (guidance assumes $750 spot) and expect that we could see more scrapping demand. The balance sheet is impeccable and the valuation extremely low. The chart is pretty good too! While the stock is already up an impressive 11% year-to-date (20 points ahead of the market), I believe that it can conservatively increase another 20% or so, possibly much higher over the balance of this year. A move to its all-time high price of 17 would represent an increase of 36%, and the stock would still be well below the valuations it achieved in 2006 before unfounded fears of deterioration first appeared. Low PE, low P/B, low debt, low analyst coverage and high growth – a great combo for potentially high returns.

Disclosure: Author has a long position in EZPW

Comments

[rsinj]

PAYDAY LOAN is all you need to read.

You can throw around all the technical metrics and valuation analysis you like. However, this business is nothing more than legalized loan sharking.

Anyone consdering EZPW (or competition mentioned) might first want to educate themselves with payday loans, usury laws, and the public backlash against them.



online.wsj.com/article...

www.azcentral.com/ariz...

www.fredericksburg.com...

www.laurinburgexchange...

consumerist.com/tag/us.../

[Alan Brochstein]

Thanks for your comment. I am well aware of concerns about both the general ethical questions about payday lending, the potential for abuses and the risk of regulation.

It saddens me that people actually need these services, but they do. I guess it saddens me that people need prostitutes (legal in few places), gambling, and cigarettes. Those things will potentially disease, bankrupt or kill you! The alternatives for getting cash quickly include stealing it, borrowing from family members or friends, taking a cash advance on a credit card and potentially entering a debt spiral or getting raped by the bank if you overdraft your account. So, I guess I am in the "necessary evil" camp. Those who would outlaw it better be willing to lend to their family members or be the victims of crime!

As far as EZPW, they appear to me to act very ethically. I looked into their disclosure practices. Further, there have been no legal issues disclosed in their SEC filings. I think that there are likely operators in the industry who give the industry a bad name potentially, but ultimately that should benefit companies like EZPW who are industry leaders.

If you read all of the articles to which you linked, I think that it is clear that many people benefit from payday loans - review the one from the Arizona Republic. At the end of the day, I would prefer to see "loan sharking" of this nature to "unlegalized"... loan sharking and its alternatives.

For investors concerned about payday lending, the threat of regulation is very real. I believe that Georgia is the one state that curtailed it. The real risk is that the APRs get capped. I think that it is kind of silly to annualize out the two-week fee. If that were the case, the FDIC should outlaw or greatly reduce overdraft or NSF fees. These loans aren't intended to be rolled over every week! EZPW makes more money from EZPAWN and its investment in A&B than from EZLOAN. More growth, though, comes from EZLOAN. If that growth were curtailed, I believe that it would be bad but not detrimental. There wouldn't be massive write-downs and some of the business might shift to pawn. In a worst-case scenario, I believe that the stock would lose no more than 1/4 of its value, as the pawn business is very undervalued, especially if it absorbed some of the business lost on the payday side.

[DrHunt]

I have owned EZPW several times over the years. The discount to peers has to do with the bizarre ownership structure- you are essentially buying class B shares, with no voting rights. All of the voting rights, ie, control of the company is vested in one person (Sterling Brinkley), who previously ran Friedman's jeweler into the ground...

[Alan Brochstein]

I mentioned the voting shares in the original article - the company is controlled, though, by Phillip Cohen (through MS Pawn).

[Nate C]

I am not a fan of payday lenders. Sure it sounds great--legalized usury must mean big profits, right? Not necessarily. I have been following other payday lenders like AEA (Advance Cash America). The fundamentals surrounding the business are not as rosy as you might think. The reason they have to charge such egregious interest is because of high default rates on the loans. Look at EZPW and AEA's profit margins--only around 10%. Not great when compared to other industries. Another problem with these companies is the intense competition between them for the same customers--they have no economic moat, they can only compete on the rates of interest they charge.

Another problem with these companies is that a recession will likely cause a spike in the loan default rate. EZPW is a little more shielded from this through their pawn shop business. Overall I would pass on these stocks. Also watch out for increasing legal problems surrounding the industry—AEA was forced out of Virginia and Pennsylvania by the state legislatures which passed laws that capped the amount of interest these companies can charge.