America's Car-Mart: An Undervalued Growth Story

| About: America's Car-Mart, (CRMT)
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The comparisons to a certain other retailer are obvious. America's Car-Mart (NASDAQ:CRMT) is a retailer that caters to a lower income demographic in the southeastern United States, from its home base in Bentonville. It is highly profitable, possesses better technology than its competitors, avoids major cities, and has a name ending in "-Mart." But the comparison with Wal-Mart (NYSE:WMT) breaks down in a few important ways. CRMT has a huge amount of domestic growth ahead of it, as they currently have locations in only nine states. The company has guided towards a 10% annual growth in store count, and recent same-store sales growth of 8.8% means they have meaningfully grown revenue. In short, this is a growing, vibrant business.

America's Car-Mart is a finance business, not a car sales business. They sell cars to those who do not qualify for a conventional auto loan, and collect the payments in store, with payment frequencies tied to their customers' payday. The company says, "Collecting customer accounts is perhaps the single most important aspect of operating a buy here/pay here used car business and is a focal point for store level and corporate office personnel on a daily basis. Substantially all incentive compensation is tied directly or indirectly to collection results." These incentives, and its rigid collections system tied to its technology platform, are Car-Mart's competitive advantage. It has scaled a business where its competitors are mom and pop type operations, which lack scale, technological innovation, and its ability to buy cars across the country wherever prices are best. Car-Mart also focuses on small towns, which insulates it from the large chain type dealers. The systems it has are an advantage, but this is ultimately a people business, getting staff to collect debts from those who have not demonstrated responsibility with money. Car-Mart trains its staff, and promotes from within. This gives it a cohort of managers who know the system inside out, and are motivated as their compensation is directly tied to the store's success. These factors give Car-Mart a durable competitive advantage.

CRMT is also a business that is profitable and trading at a fair price. The company has earned a total of $3.40 in its most recently reported four quarterly periods, which at the recent price of $47.96 gives it a P/E of 14. These are also quality profits, with a return on equity exceeding 15%. Car-Mart is also not borrowing excessively to finance this growth, in the last 3 quarters their outstanding loans to customers and inventory assets increased by $45 million dollars, while their borrowings increased by only $31 million. They have also been able to buy back a large block of their own stock, ~25% of the shares outstanding over the last 3 years.

If they grow earnings by 10% a year for the next three years, and buy back 25% of the stock once again, EPS would be $5.32, which would at the same 14x earnings would give a share price over $74.

There are also a number of hidden sources of value in the books of CRMT, which provide a margin of safety to the valuation. The biggest risk factor to this business is loan losses from their customers. They finance essentially all of their sales, and the bear case has always been that these loans are subprime and risky. However, their charge-offs have been steady between 21% and 26% of their receivables for the last five years, and their pricing allows for this level of charge offs. They are also consistently being conservative in their provision for credit losses. For example, in the most recent nine months they had provisions of $70.5 million, but actual charge offs were only $60.8 million. This extra provision reduces earnings, and those "hidden" earnings provide a margin of safety to the investment, by making the valuation less demanding.

The second hidden source of value in CRMT is their dedicated customer focus. This is a business dedicated to customer success. They truly want their customers to be able to have reliable transportation at a fair cost, and to be able to repay their loans. They have demonstrated by keeping loan terms short (less than 30 months) to allow customers to build equity in their cars. They do this even though longer terms (and the associated lower payments) would allow them to increase market share and earnings over the short term. This focus on customer success has allowed them to secure a significant number of repeat customers, which are more profitable and better credit risks. The best way to gain comfort with management's consumer friendly focus and how this is a competitive advantage is to listen to the conference calls, which occur every quarter. Past calls are available or transcripts are on Seeking Alpha.

Like that other Bentonville retailer, Car-Mart is a compounding machine, with a chance to buy in early in its growth phase at a fair price for the current size of the business. The growth plans are a bonus that makes the valuation exciting.

Disclosure: I am long CRMT. 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.