The core pawn business at First Cash Financial (NASDAQ:FCFS) has definitely slowed, with weak conditions in both Mexico and the U.S. That the company has managed this better than most of its rivals is not all that much comfort, particularly as weaker scrap and retail margins coupled with higher store expenses has actually led to shrinking operating income.
The good news is that conditions may be already starting to improve in Mexico. Discount retailers are seeing improving traffic and are starting to pull back on more aggressive discounting, while consumer confidence and job growth are back on the way up. This may not be a sharp rebound year for First Cash, and investors are likely getting restless in regards to seeing/hearing more about expansion into new markets, but the valuation is attractive enough to make it all worth the wait.
Not A Bad Set Of Results For The First Quarter
First Cash management seemed to do a good job of managing expectations going into this quarter. Revenue rose 8% for the quarter, beating expectations by a small margin. Core pawn revenue rose 20% as reported, but only 1% on a same-store basis as a modest increase in same-store merchandise retail (up 3%) was offset by a similarly-sized decline in pawn fees tied to smaller loan amounts.
Merchandise revenue rose 24% for the quarter, nearly 5% better than expected. Pawn fee revenue was up just 13%, though, and fees in Mexico were up just 6% on those smaller loan amounts. Scrap revenue was down 41%, while payday lending-based revenue was down 17%.
While revenue was a little stronger than expected, margins were a little weaker. Gross margin declined 30bp as scrap margins declined more than a point from last year but did improve significantly from the fourth quarter as the company has implemented new strategies and benefited from rising gold prices. Merchandise gross margin declined about three points due in part to a shift away from jewelry toward more "general merchandise" in pawn lending.
With store operating expenses up about 13%, the end result was to push operating income down 4%, with operating margin down about two points. The good news, if you want to call it that, is that the end result operating profit was pretty much in line with expectations. Below the line, there was a significant ($0.12/share) tax benefit, though the company also saw an $0.08 impact from the scrap and payday businesses.
Better Times Ahead?
First Cash has used acquisitions to rebalance the business a little more equally between the Mexican and U.S. operations, but the reality is that the Mexican operators remain the growth driver. While the U.S. operations can benefit from scale and operating synergies, it is Mexico where the company is likely going to see the significant growth in pawn activity over the next few years.
To that end, there have been some encouraging signs. First Cash saw pawn loan balances increase 6% in Mexico this quarter, which is still below-trend, but better than the prior quarter. It also looks like same-store sales at Mexico's retailers are improving, with Walmex (OTCQX:WMMVY) and Soriana (OTC:OGZSY) both showing signs of bottoming.
Retail sales in Mexico tend to follow government spending with a roughly three-month lag and government spending has been accelerating since the beginning of the year. Construction jobs are rebounding and consumer confidence appears to have bottomed in Mexico. Department stores are pulling back on their credit offers (which they were using in an attempt to maintain traffic/volume) and it looks like consumers are coming back.
If that all holds up, First Cash should see the Mexican pawn business improving as the year goes on. Management left guidance where it was, though, with a shift toward the lower end of the $3.00 to $3.15 range due to higher interest expenses from the recent senior note offering.
Does The Note Mean Something Larger Is Coming?
During the first quarter First Cash successfully offered $200 million in senior notes. The company got a pretty good price for a specialty finance company (paying 6%), but that was still an expensive move relative to the company's prior credit facility. While I suppose the company could use that debt to fund a larger share buyback, management would have likely telegraphed that by now.
While I might well live to regret saying this, I wonder if the note offering (combined with a new $160 million credit facility) was part of a plan to get ready to do something large and strategic. Investors have been waiting for years for First Cash to take that successful Mexican pawn model on the road and into countries like Colombia or Peru. Management has repeatedly said that they want to do this via a strategic acquisition of an existing large-format operation, but there aren't that many to choose from that have the right combination of business mix (not overly reliant on jewelry) and price.
I'll say it again - investors have been waiting for a while for this to happen, so any particular prediction that now is the time could well be wrong again. Even so, I can't really reconcile why management would have done this deal if it didn't have something in mind - paying more than it needs to in interest expense is not consistent with how management has operated this business in the past.
The Bottom Line
The weak performance of First Cash in 2014 (down 15% over the past three months and down 20% YTD) is a good reminder that this has long been a volatile stock. On the plus side, I continue to believe that the company can grow revenue at a long-term rate of 10% with a FCF growth rate about three or four points higher. Discounted back at an 11% rate, fair value of nearly $65 seems reasonable. With that sort of potential, and the prospect that the company's core customer base in Mexico is seeing a turnaround, I still like these shares.
Disclosure: I am long FCFS. 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.