The CFPB Is Not Armageddon, So Buy These Stocks

by: Larry Meyers

Last year, I wrote about the Consumer Financial Protection Bureau, and what it might mean to various financial stocks. Since then, the CFPB has set out to fulfill its mission and, contrary to everyone's fears of Armageddon, reports suggest that the bureau is doing exactly what it was created to do: protect consumers without overreaching.

In the world of short-term credit, which is my specialty, some companies from the batch that includes First Cash Financial Services (NASDAQ:FCFS), Cash America (NYSE:CSH), QC Holdings (NASDAQ:QCCO), EZCorp (NASDAQ:EZPW) and DFC Global (NASDAQ:DLLR) have undergone "supervisory exams." Reports are these are multi-week examinations of every aspect of company business, the details of which can even be found online, as the CFPB publishes the basic exam manual. When I say, "every aspect" of business, I'm not kidding. The feedback I'm getting is that the CFPB is being very diligent in gathering data, and as a result, is cultivating a solid understanding of this sector. This is vital for the agency, as it permits director Richard Cordray and his agents to get as transparent a picture of short-term credit as they will ever get, without the taint of bias provided by mercenary activist organizations like the Center for Responsible Lending.

There is every reason to expect that the CFPB will eventually issue reports and make rules that codify all the consumer protections that members of the payday loan trade association already manifest in every transaction. Some of these are created by statute, but many exist in the association's list of Best Practices, which all member companies must follow. If they don't, they get kicked out or they must exit - which has happened with more than one large private company.

I am, in general, skeptical of government regulation. However, it can serve a purpose and in the world of short-term credit, it will further consumer protection. That's a good thing, and the industry has been in dialogue with CFPB, according to all my sources. Both the industry and the CFPB are trying to make their way through the complex legislation known as Dodd-Frank, and they are cooperating in that regard.

Because these companies all have specific and rigorous compliance procedures already in place, adding another layer of federal rules will be challenging. Large companies can afford to this. Smaller ones may not, and that will be difficult for them to absorb. There will always be costs to the public players to institute these procedures, but they should not materially impact earnings.

How is this actionable?

In the broad picture, I see stocks in this sector with discounted multiples due to regulatory risk. I do not, however, believe these discounts to be warranted. Public companies already are under intense scrutiny internally, by the trade association, by the SEC, by the media, and by the markets. If any of them were up to no good (despite the insistence of opponents that they are), the markets would be aware of it by now. I do not expect any of these companies to be slapped with an enforcement proceeding and heavy fine.

More importantly, the payday loan industry is not going to be put out of business by the CFPB. Mr. Cordray has publicly stated, more than once, that he recognizes the need for short-term credit in America. He's looking for the bad apples, and I believe he will probably levy some kind of huge fine against two or three really bad apples. I do not believe, however, that the public companies are those bad apples.

So presently, these stocks sell at a discount. It wouldn't surprise me if, months down the road, when those fines get levied, that the market will freak out. People will think Mr. Cordray is coming after all payday lenders, and they will sell the stocks off. But enforcement actions and fines come after supervisory exams, so the danger will have passed. That will be a time to buy in again, but you might want to think about doing so now.

The great irony here is that all the payday lenders are moving away from payday lending. They've all instituted installment lending, and other products, as payday itself has more or less matured in the domestic market anyway.

The absolute screaming value right now is EZCorp, trading at 8 times earnings, with long-term growth projections at 12%. I believe this number is too low, and should be closer to 15%. The company stumbled in 2012 as expansion and new global infrastructure impacted earnings. However, with many new stores coming online in a market that has probably cut out all the fat after a five-year contraction, these stores will mature and add to EZ's already robust cash flow. The company also just purchased an online platform, GO Cash, from which it will finally enter the outrageously profitable area of state-licensed internet lending. That platform will likely be upgraded to take on foreign internet lending as well. Cash America's internet platform has seen 29% revenue CAGR and 39% EBITDA CAGR since 2009. I expect similar from GO Cash. EZ has also diversified its product line, with auto title loan balances up 29%, installment balances up 20%, and a new CFO who specializes in acquisitions.

First Cash continues to execute flawlessly in Mexico, where it is the pioneer in large format pawn shops. Pawn balances are up 29% YOY, with Mexican same-stores sales up 7%. Net income was up 15% YOY, and the company has insulated itself from payday lending by only generating 8% of revenue from that product. Its EV-EBITDA ratio is 12, twice that of EZ's, but with a P/E ratio of 17 on 15-20% long-term projected growth. Thus, EZCorp seems tremendously undervalued in comparison.

Cash America's loan assets come from pawn (36%), internet payday (52%), and the rest from storefront payday. Its internet product is aggressively expanding into Canada, the UK, and Australia. Its P/E is 10.6 against 10-12% near-term EPS growth and 15% in long-term growth. With an EV-EBITDA ratio of 6.6, it is also arguably undervalued.

DFC Global is tremendously diversified in both product and geographical locale. 49% of revenues were from the UK, 30% from Canada, and only 12% from the U.S. - so concerns over CFPB's impact here are particularly overblown. The company may also be discounted because of its billion-dollar debt load, but its cash flow can easily service the debt. With a P/E of just 8, and near-term EPS growth of 12%, and an EV-EBITDA ratio of only 5.2, DFC is also cheap.

QC Holdings is struggling with its several hundred monoline stores. However, the company is making a move into internet lending in Canada, which should prove fruitful. The market has sold it off to an EV-EBITDA ratio of 2.8, which is probably deserved. However, the stock trades at only a bit over tangible book. This suggests to me that, once the federal regulatory situation becomes clear, QC may very well be an acquisition target.

As with any articles regarding investments, you should never rely on information you read without doing your own due diligence. My articles contain my honest, forthright and carefully considered personal opinion, and conclusions, containing information derived from my own research. This may include discussions with management. I do not repeat "talking points" but may quote management from an interview. I am never influenced by third parties in arriving at my conclusions. Do not solely rely on my articles or anyone else's when making an investment decision. Always contact your financial advisor before investing in any security.

Disclosure: I am/we are long EZPW.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.