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Dano Siran
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I am a buy-and-hold investor who invests in high-quality temporarily undervalued companies.
  • CACC Fairly Valued At $111 0 comments
    May 28, 2013 3:27 AM | about stocks: CACC

    On May 24th the Credit Acceptance Corporation (NASDAQ:CACC) price per share rose 5% intraday after the financial services firm Stephens initiated coverage of the company with an Overweight rating. The stock closed at $111 for a 9% YTD gain. I wanted to invest in this company since 2010 after I found out how well it weathered the roughest patches of the credit crisis, but its valuation was never low enough to provide me with a comfortable margin of safety. Although the price of $111 increased the P/E ratio to 11.7, it still remains within the levels of past two years (see Chart 1), which is encouraging as it shows that the optimistic rating from Stephens did not immediately result in an overvaluation of the company. In this article I will try to analyze whether $111 is fair given the current state of CACC business.

    (click to enlarge)

    CACC provides financing for the purchase of used cars by people with sub-prime credit. It works with 4,355 dealers (as of the Q1 2013 filing) from the market of some 50,000 dealers (as per D. Busk, the Senior Vice President, during the Q4 2012 earnings conference call). CACC ranks among the nation's top five sub-prime car financing companies but operates in a market that is fragmented and new entrants continue to surface due to easy access to capital and low interest rates. The competition has increased in the last couple of years and CACC responded with the same strategy as during the last period of tightened competition in 2006 and 2007 and that's by increasing the number of dealers that it does business with (as per D. Busk during the Q4 2012 earnings conference call).

    Chart 2 displays the growth rates of $-amounts of new loans in each quarter versus the same period in the previous year (green bar graph). In Q1 2013, the $-amount of new loans declined 7.5% compared with the same period last year. Comparing the current growth rate to the rates from the last period of increased competition we see that there was no such decline between 2006 and 2007. In Q3 2007 the growth rates slowed to1.5%, but a two-digit growth resumed in the following quarter. We do not have such robust growth now; in fact Q1 2012 was the last quarter of two-digit growth. So judging from these growth rates alone, CACC's ability to take on new business has deteriorated more now than during the last period of increased competition in 2006 and 2007.

    (click to enlarge)

    The blue graph in Chart 2 represents the quarterly $-amount of new loans indexed to Q1 2005. It gives a perspective on how much business CACC currently takes on compared with Q1 2005. Even though CACC generated less business in Q1 2013 than during the same period last year, it still had a strong quarter and if the history is any guide than we could assume that CACC will write at least as much new business in the rest of the year as it did during 2011. Of course, it's just as well possible that the declines of 2009 will recur and fetch reduced valuations. Applying 2009 P/E to the current TTM earnings yields a price of $90, but such severe decline is unlikely given the general bullishness in the market.

    CACC discloses the forecast of what % of the purchased loans it expects to collect (blue bar graph in Chart 3). Although the forecasts have come down in last few quarters, they still remain about two percentage points above the forecasts from the crisis years of 2008 and 2009 and above the last period of increased competition in 2006 and 2007. The red bar graph in Chart 3 represents the advances that CACC pays to dealers when it purchases the loan contracts. The 47.2% paid during the last quarter is the highest % since 2006, which shows that due to heightened competition CACC has to commit more capital to purchase new loans.

    (click to enlarge)

    Another way to gauge CACC's the ability to grow business is to look at the new unit volume per dealer (Table 1). Lately, the ratio has been in low teens and increased to 13.1 in the last quarter. History shows us that since 2006 Q1 was always the strongest and somewhat indicative of the rest of the year. Hence the current 13.1, which is the lowest Q1 ratio in past eight years, does not bode well for the forthcoming quarters. Obviously, we cannot read too much into these numbers but the decline is a bit disconcerting. On the other hand the growth in the number of active dealers has been in excess of 20% in the past two years just as in 2007. If CACC is able to continue reaching new dealers at these clips, then the lower unit volume per dealer would be somewhat compensated for.

    (click to enlarge)

    In addition to looking at the new business, it is also important to evaluate the performance of the existing contracts (Table 2). This set of data reveals how much of the existing contracts has been collected already and compares it to the historical collection rates. For example, in Q1 2013 CACC has collected 58.5% of the contracts originated in 2011 whereas in Q1 2010 it collected 61.3% on similarly aged contracts (red cells). However, the contracts purchased in 2012 had a longer average initial term than those from 2008, so the collection will be lower since it is spread out over a longer period of time. For the contracts with equal initial terms, e.g. those purchased in 2007 and 2010, the last reported collection rate is in excess of a comparable rate in 2007 (blue cells). The reader is encouraged to make his own interpretation of the data but to me it appears that there is no deterioration in the performance of the existing contracts.

    (click to enlarge)

    Another way of looking at the strength of the existing contracts is by comparing the quantity of the contracts that is required to support the current securitization versus those from previous years. As part of its business, CACC securitizes the purchased contracts in order to free up capital. If CACC is now depositing a higher $-amount of loans into the securitizations than before then it can be argued that the current loans are of lower quality and vice versa. Table 3 shows six securitizations that CACC effected since 2008. For each balance outstanding, i.e. the capital it raises from investors, CACC is required to deposit loans into the securitizations trusts, i.e. loans pledged as collateral. The ratio of the two shows that the required gearing of the trusts has decreased since 2008, which suggests that the deposited loans are performing as expected.

    (click to enlarge)

    So coming back to the purpose of this analysis, paying $111 per share of CACC, in my opinion is fair. The ability to grow business is undoubtedly affected as demonstrated by the above, however the underlying business remains strong. The interest rates are at all times low, which allows CACC to borrow cheaply and the pervasive bullishness in the general stock market may continue driving the stock up. On May 1st the stock dropped to $98, which would naturally be a more lucrative entry point than $111, but I will nonetheless pick up some share now in order to avoid foregoing further gains.

    Disclosure: I am long CACC.

    Stocks: CACC
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