The credit crisis has been so bad that even banks won't lend to each other. About the only source of credit that's still available is the one that the media love to unfairly bash: payday loans. These short-term loans have found widespread favor among their users, which is why over 25,000 storefront operations exist in the United States alone.
One of the pioneers in this space is Advance America (AEA). The company went public in 2004 and is the largest player in the space with over 2,800 locations. The company is retrenching after a difficult period. It lost a few battles with the corrupt consumer activists that constantly attack it, but the product is in such demand that payday loans always find a way to prosper. The bad press the product gets, and market's lumping of the company in with traditional financials, has created a buying opportunity in the stock.
And it's a BIG buying opportunity.
The key to understanding Advance America is the enormous amounts of cash its business throws off. Despite the challenges the company has faced this year, pushing net income down almost 35%, it still generated almost $75 million in cash flow from operations through the first six months. This is after its tiny $5 million of interest payments. There was also more than enough profit and cash flow to pay the $17 million in dividends.
To reiterate, this was what it generated in challenging times.
But times are about to improve. Stephens Inc., the investment bank that follows the industry, believes there is still room for another 3,000 – 4,000 stores in the United States. Analysts see Advance America's earnings growing by another 10% in 2009. At Wednesday's closing price of $2.56, and a projected $0.71 in earnings in 2009, that gives it a forward p/e of 3.5. Yes, that's 3.5, for a company with 10% earnings growth. Toss in that juicy dividend of 20%, and the story is compelling.
But there's more. The company is trading at book value. This means the market values the company for what it is currently worth, and is paying no attention to the $150 million annual run rate of free cash flow, the dividend, and that the company has further growth prospects. That's utterly ridiculous.
I believe the company will grow beyond its loan product. It will not just going to sit back and let the market mature. Advance America has always been resourceful and forward-thinking. As the internet payday lending space begins to shake out and the most profitable lenders begin to solidify operations, I expect Advance America to make a strategic acquisition in this space. In addition, I expect it to begin actively examining the auto title lending space, which is a highly fragmented and profitable market. It'll need to add personnel experienced in this arena, but I believe auto titles are the next industry for payday loan companies to go after. Auto titles provide returns similar to those of payday loans, but with real collateral behind the loans in the form of auto titles.
And who better to lead the company into its next chapter than one of its founders? The company has brought back a pioneer of the payday loan product, the legendary Billy Webster, as Chairman, following a family sabbatical. This should also reassure investors who have seen daily sales of company stock by Mr. Webster for the past several weeks. But just to make sure that nothing odd was going on, I phoned Mr. Webster and asked about these sales and what they might foretell about the company.
"I would not take over the Chairmanship if I did not have complete confidence in the company's future," Mr. Webster told me. Indeed, why would anyone go through the obvious damage to reputation by re-taking the reins of a company they thought was going to fail? Who wants that on their resumé? It defies common sense.
So why the sales and why now?
"I never set up a 10b5-1 plan, despite being told early on to set one up. At this point in my life, having a family, and with much of my wealth tied up in company stock, it just made sense to diversify my personal holdings", Mr. Webster explained.
Indeed, since the IPO, Mr. Webster hasn't sold any of the 2.7 million shares of his company. He didn't sell shares despite signs that the market was starting to mature 18 months ago. I believe these to be perfectly acceptable reasons for his recent sales and I am not alarmed.
In the meantime, I see a $7 company trading at a 65% discount, throwing off fabulous cash flow and a delicious (and safe) 20% yield. The company needs no additional credit to further grow its stores, so the present credit crisis will not affect them. In fact, we may see a big upswing in payday loans as the economy slows and other sources of credit remain closed off to average citizens.
Full Disclosure: Long AEA at time of writing.