Larry Meyers'  Instablog

I wanted to take a look at the undervalued payday loan sector and see if crunching numbers might reveal something behind the overall state of the sector.  So I put the companies side by side and ran some basic calculations.  The companies in the sector are First Cash Financial Services (FCFS), EZCorp (EZPW), Cash America (CSH), QC Holdings (QCCO), Dollar Financial (DLLR) and the venerable Advance America (AEA).

I also like to check each company’s price-to-book ratio, because this is one of those sectors where book value is very close to liquidation value and can reveal some outrageous bargains.  Such a thing occurred a few months ago when Advance America was trading at 86 cents per share.

In this case, Cash America appears to be priced for disaster.  While the company does have significant exposure in Ohio, where it did close down some 50 stores in response to more restrictive legislation, any further attacks appear to be unlikely.  The grandstanding political hack by the name of Rep. Matt Lundy introduced a bill designed to kill lenders late in the session.  Not only did it fail to ever even get heard, the original backers of last year’s legislation have all but admitted it was political theatre, and Lundy’s bill would harm other lenders besides payday lenders. 

Cash America is well-diversified across both payday lending and pawn shop operations.  It just closed a deal for $100 million in bonds, is on track to earn $3.05 per share this year, up 13%.  It generated operating cash flow last year of $253 million.  While it’s Return on Equity is not as high as its peers, it is nevertheless a solid operation. I like it at these prices.

I also like EZCorp at these distressed levels of $10.25 per share.  I love profit warnings.  Very often, the market sells a stock off more than it deserves, leaving shares to be picked up at a significant discount to fair value.  Such a thing happened to EZCorp (EZPW) recently, and the stock is ultra-cheap even on the most conservative of valuation methods.

The company is now forecasting $1.42 in earnings for this fiscal year, which is a 17% expansion on earnings from the previous year, which gives it a price-to-earnings ratio of a little over 7, giving it a PEG ratio of .28.  We know that the economy is squeezing payday lenders a bit because one must have a job to get a loan, and one must have disposable income to buy a pawned item.  Eventually, however, the economy will improve and in the meantime, people will discover the great deals they can get buying diamonds at reduced prices at a pawn shop.   In addition, EZ is having great success in Mexico despite the economy.  They have plenty of cash on hand, and have barely touched their $160 million credit facility.  Many of their stores are newer than those of their peers, so they have more room to grow.  They see higher net margins than their peers, and the lowest EV-to-EBITDA ratio among its multi-product competitors.  I think this is a solid play here and far below its fair value.

Mind you, I like the other players in the sector for the long term.  The monoline operators will need to innovate to add to their product mix, but they’ve shown how resourceful they are, especially when confronted by regulatory challenges.  Speaking of those….

Regulatory Update

The stocks may be under pressure because the market does not understand how Obama’s new proposed consumer finance regulatory agency will affect the sector.  Well, I have good news.  Sec. 122(g) specifically states, “g) NO AUTHORITY TO IMPOSE USURY LIMIT.—Nothing in this title shall be construed as conferring authority on the Agency to establish a usury limit applicable to an extension of credit offered or made by a covered person to a consumer, unless explicitly authorized by law.”

So while anything can happen in politics, it appears that should this agency actually be allowed to exist over the objections of the massive banking lobby (no sure thing), then payday lenders won’t be facing any onerous regulation.  And since they abide already by strict federal and state statutes and regulations, there’s no concern.

Legislative Update

Not much to report here.  I am still waiting to see the markup on Rep. Gutierrez’s payday loan bill.  Again, this bill won’t have much impact if it passes in its present form, but everyone including myself is opposed to it, even consumer activists (because they want a ban on payday loans).  Gutierrez said he wouldn’t accept any more donations from the payday loan industry to avoid the appearance of impropriety, but that doesn’t signal antagonism towards the industry.  If it did, the $15 per hundred cap in non-regulated states would be replaced by that nutty 36% APR cap the wacko activists are pushing for.

Overall, there’s value in the sector.

Full Disclosure:  Long EZPW