Eight Diamonds' February 2019 Best Pick - Curo Group

by: Eight Diamonds Advisors

Picking winners is a crucial investment skill that should be continually improved over time.

I plan to select a “best pick” out the companies I profile on a monthly/quarterly basis as a way of monitoring and refining my investment process.

In February 2019, I wrote articles on Enova International, Elevate Capital and Curo Group.

Ranking each company according to four key criteria highlights Curo Group as the February 2019 best pick.

On Feb 07, 2019 I published an article titled “Eight Diamonds’ January 2019 Best Pick - Gaia Inc” found here. My aim was to choose a “best pick” from the company specific articles I wrote in January and then monitor its performance with the ultimate goal of improving as an investor. As shown in the table below, Gaia Inc (GAIA) was the worst performer up to the end of February 2019 particularly when benchmarked against the Russell 2000 (I use the iShares Russell 2000 ETF (NYSEARCA:IWM)). The companies highlighted in my two Top Ideas, Spark Networks (NYSEMKT:LOV) found here and Curo Group Holdings (NYSE:CURO) found here, are faring much better though for all the companies it will take more time for their investment thesis to play out. I plan to write another article on Gaia as its share price fell even further early March 2019 following its 4Q 2019 earnings. One lesson learnt is to place a higher weighting on valuation.

Source: Bloomberg and author’s calculations

The focus of this article is to decide on a best pick from my February 2019 articles. In my Investment Strategy Statement, I mentioned exploring unpopular sectors as a way of generating good investment ideas. During February 2019 I looked at consumer subprime lending, a sector shunned by many investors. This has been a rich hunting ground for me in the past. For example Cash America, the focus of my August 2014 Top Idea article, has returned nearly 4x including the post-merger performance of First Cash Financial Services (NASDAQ:FCFS). This time I wrote articles on subprime sector participants Enova International (NYSE:ENVA) found here, Elevate Capital (EVLT) found here and a Top Idea on Curo Group Holdings (CURO) found here. To decide on a February 2019 Best Pick I once again use the following criteria: strong tailwinds; aligned and skillful management; attractive valuation; and short-term catalysts. I apply a relative ranking system of “1” strongest to “3” weakest in each category.

Strong tailwinds ranking: Enova - 1, Curo - 2, Elevate - 3

Source: Elevate February 2019 investor presentation

As all three companies operate in the same sector, consumer subprime, there is not much to differentiate between them in this category. The non-prime market is very large with strong tailwinds. As shown in the slide above, Elevate estimates subprime is larger than prime in the US with a population greater than 170 million people if the UK is included as well. This is probably only going to grow in a recessionary environment. To rank the companies, I am going to focus instead on company specific aspects such as revenue growth and mix.

Source: Company filings

The main revenue lines for all three companies are derived from installment loans and line of credit. Both Enova and Curo have legacy short-term consumer loan businesses that are shrinking as a % of revenues due to the effects of higher regulation. In particular for Curo, due to regulatory scrutiny and consumer preference, it accelerated the migration of customers from short term to line of credit in 2018 which negatively impacted its margins. Elevate offers line of credit products through a partnership with Republic Bank that covers 40 US states. Curo Group announced a Metabank partnership in April 2018 with a planned launch in 2Q 2019. Partnering with banks helps to broaden the credit product range and gain access to markets where their options are currently limited due to regulation. Ranking the companies in this category by revenue growth and mix, I would put Enova first, Curo second and Elevate third.

Aligned and skillful management ranking: Enova - 1, Elevate - 2, Curo - 3

Enova CEO David Fisher’s total compensation was USD1.6m in 2015, USD2.6 million in 2016 and USD4.7 million in 2017. The equity component of his 2017 comp was 61.4%. His beneficial ownership is around 2.1% which equates to USD18 million. Elevate’s CEO Kenneth Rees earned USD2.6 million in 2016 and USD5.3 million in 2017 (80% equity component) more than Enova’s CEO even though Elevate is less than half Enova’s enterprise value. He has a beneficial ownership of 7% equating to USD13 million. Insider ownership at Elevate is high at 32%. Curo has the largest insider ownership at over 48.0% but this mainly constitutes its three founders’ holdings with each retaining an 15.1% beneficial interest. Its CEO Don Gayhardt’s compensation was USD2 million in 2016 and USD9.6 million in 2017 (77% equity component). He has a 1.75% beneficial interest valued at around USD8.6 million.

Enova has the longest public track record after being spun out from Cash America in November 2014. At that time it faced a raft of new legislation from the UK regulator that caused its UK revenues to collapse from USD335 million in 2014 to USD123 million in 2016. With hindsight, Enova’s CEO David Fisher navigated the regulatory hurdles well and even used the turmoil to establish Enova as a UK subprime market leader. In addition, under Fisher’s leadership Enova broadened its product offering considerably and pursued a path of disciplined profitable growth. Elevate listed in April 2017 and Curo in December 2017. Both management teams need more time to establish a public track record though Curo’s management has already lost some credibility with a 3Q 2018 profit warning. Overall I think Enova deserves the highest rating followed by Elevate with Curo last.

Valuation (risk-reward) ranking: Curo - 1, Enova - 2, Elevate - 3

Sources: Bloomberg and company filings

Curo comes top in this category. It trades at very depressed price earning multiples even though it has industry leading adjusted net income margins of around 8-10%. Its enterprise value is nearly twice that of Elevate and it has the lowest leverage. Enova is also cheap for a company that grew its adjusted earnings per share by 88% in 2018 and is forecast to grow adjusted EPS by 20% in 2019. Enova benefits from a virtuous loop of operating leverage, falling cost of capital and a reduction in outstanding shares due to share repurchases. Elevate is not particularly cheap when compared to Enova which is over twice its size and much more profitable.

Short-term catalysts ranking: Curo - 1, Enova - 2, Elevate - 3

With the lowest valuation multiples Curo has the most upside potential from positive news flow like a clean UK exit and continued stabilization of its Canadian business. For all three companies quarterly earnings are probably the clearest short-term value drivers. If 1Q and 2Q 2019 results demonstrate Curo is tracking management’s restated 2019 forecast (found here) then there should be strong share price appreciation. Enova has consistently delivered strong results since 2016. Its 1Q and 2Q 2018 results drove its share price to all times highs before the 4Q 2018 market collapse. Elevate has shown the ability to grow revenue and adjusted EBITDA but its net income lags. Until it can demonstrate the ability to grow profitably it is likely to continue to materially underperform its peers.

Key takeaways

I am going to give the valuation category a double weighting this time as I think this is one factor I can improve on compared to my January 2019 methodology. Valuation was equal weighted in my January 2019 rankings which did not give enough emphasis to Spark Networks’ depressed valuation (enterprise value/revenue multiple of 1.0x) versus a much more favorably valued Gaia (enterprise value/revenue multiple of 3.9x). By double weighting the valuation category Curo and Enova are joint winners. However, I am going with Curo as my February 2019 best pick. Curo is a market leader whose share price has been negatively impacted by regulatory issues in the UK and Canada. There is a clear path to overcoming both issues in 2019 and therefore Curo has the most upside potential in my view.

Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

Disclosure: I am/we are long CURO, ENVA, GAIA, LOV. 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.