Atlanticus Holdings: We Are Encouraged By Our Review Of The 2020 Financial Statements

Summary

• Our review of Atlanticus' recently filed financial statements for 2020 indicates to us continued strong performance of the company and upside potential for the stock.
• While Atlanticus' 4Q20 earnings appeared to be less than our expectations due to significant non-cash charges, we observe the more predictable cash from operations to be in-line with our expectations.
• We note that Atlanticus continued to enjoy favorable delinquency trends, which it attributes in part to government stimulus programs and, as such, we expect these trends to continue.
• It appears increasingly clear to us that Atlanticus is producing at least $4 per share of earnings and $5 per share of free cash flow, as well as substantial growth.
• Remarkably, Atlanticus continues to have no sell-side coverage and so we share below our analysis of the 4Q20 financial statements with the hope of providing additional transparency for investors.

Overall, we observe that Atlanticus Holdings Corporation (NASDAQ:ATLC) continued to produce solid top-line growth, earnings, and cash generation in 4Q20, continuing the trend from recent quarters. As the company continues to post quarters such as these, it appears to us that Atlanticus is transitioning (or perhaps already has transitioned) from the turnaround story that we initially discussed here to a more traditional revenue and earnings growth story available to shareholders at a compelling valuation. While Atlanticus' 4Q20 earnings appeared to be less than our expectations set forth here, we observe our preferred cash flow metric to be within 0.1% of our expectation. Earnings came in below our expectations due to significant and higher than expected non-cash provisioning and negative fair value adjustments, continuing what we believe to be management's conservative approach to accounting that we have discussed in prior reports.

We also note that Atlanticus continued to enjoy favorable delinquency trends, which it attributes in part to government stimulus programs and, as such, we expect these trends to continue in light of ongoing stimulus this year. These stimulus programs appear to be sufficiently material to Atlanticus' results that the passage of the most recent COVID-19 relief bill was listed as the only subsequent event in the company's financial statements. As Atlanticus continues to post solid quarterly results, turning our expectations for significant earnings and cash flow into historical results, and making each such quarter look less and less like an anomaly, it appears increasingly clear to us that the company is currently producing at least $4 of earnings per fully diluted share and $5 of free cash flow per fully diluted share, as well as substantial growth, even with what we view as conservative accounting. As such, we believe there is significant upside to the current trading level of Atlanticus' common stock of $30 / share.

Remarkably, Atlanticus continues to have no sell-side coverage that we can find, and so we share below our analysis of its 4Q20 balance sheet, income statement, and cash flow statement with a particular focus on variance analysis to our expectations for 4Q20 set forth in our report on our detailed projections. We will provide additional details of our analysis of the Form 10-K and our updated projections and valuation in our subsequent reports.

Balance Sheet Review

In the table and commentary below, we provide our analysis of our projection of Atlanticus' balance sheet and its actual balance sheet for the fourth quarter of 2020 (dollars are presented in the table in thousands):

1. Overall, the total size of the balance sheet was $67.6 million or 6% greater than projected, which we find to be within reasonably close proximity of our expectations. We note that year-over-year, the company grew its balance sheet by approximately 29%, which we find encouraging.
2. Cash was substantially greater than anticipated coming in at a total of $259.0 million, which was $103.6 million, or 67%, greater than expected. We will get into deeper details on this in our review of the cash flow statement but note that, at the current trading levels of around $30 per share, the company had approximately 40% of its current fully diluted market capitalization in cash as of December 31, 2020. We note that in prior periods, when cash as a percentage of market capitalization was substantial, the company undertook significant shares repurchases and other actions to return cash to shareholders.
3. Loans, interest and fees receivable, at fair value came in $67.2 million, or 14%, less than expected as it appears that Atlanticus invested less than anticipated and accrued greater than expected negative changes in fair value, which we will discuss in greater detail in our review of the cash flow statement and income statement, respectively.
4. Loans, interest and fees receivable, gross came in $47.2 million, or 8%, greater than expected as it appears that these loans liquidated slower than expected.
5. In total, net loans, interest and fees receivable came in $41.3 million, or 4%, less than expected, which we find to be generally within range of our expectations.
6. On the liability side, notes payable came in $85.8 million, or 11%, greater than expected. We will discuss this further in our review of the cash flow statements.
7. Equity was $20.5 million, or 21%, less than expected. We will discuss this further in our review of the income statement.

Income Statement Review

In the table and commentary below, we provide our analysis of our projection of Atlanticus' income statement and its actual income statement for the fourth quarter of 2020 (dollars are presented in the table in thousands):

1. We note that the income statement presentation has been changed compared to prior periods. The company has moved all revenues to the top of the income statement. As discussed in our previous reports on Affirm Holdings here and here, we welcome this change in presentation as it is more consistent with the presentation of companies such as Affirm Holdings and also allows for the reader (and perhaps potential suitors such as Affirm Holdings and its high-multiple peers) to get a clearer picture of the size and growth of Atlanticus' top-line results. We also note that the company has made certain re-allocations between line items and created "other revenue" and "other non-operating revenue" line items, although the prior period net income numbers have not changed. As we only projected one "other income" line, and the prior quarters did not have this break-down, we have combined the company's two "other revenue" line items for comparison purposes. As most of the "other revenue" in 4Q20 appears to be "operating revenue", we have combined those two lines there.
2. As noted above, we appreciate that the company has changed the presentation of its revenues, as we can now clearly see the strong period over period growth. As discussed in the company's press release, for the full year of 2020, Atlanticus generated total operating revenues of $560 million, which was 63% greater than the prior year. We view this as an impressive result, particularly for a company we estimate currently is trading around 5.5 to 7.5 times current free cash flow and earnings, respectively.
3. We observe that total revenues came in at $157.6 million for the quarter, which was $13.3 million, or 9%, greater than we expected. This was driven primarily by the fees and related income line item, which came in $12.0 million or 36% greater than expected. We are encouraged to see continued strong growth here, particularly in light of the fact that, as discussed above in the balance sheet analysis, earning assets ended the year lower than expected.
4. It appears to us that the company continues to aggressively provision its legacy amortized cost portfolio, which, as discussed in prior reports, is the portfolio originated prior to January 1, 2020. In the fourth quarter of 2020, the company recorded a $25.8 million provision, which was $17.3 million, or 203%, greater than the $8.5 million we anticipated. This is a marked turnaround from prior quarters where the provision had been declining around 50% in sequential quarters as the portfolio liquidated, declining from $67.3 million to $32.5 million to $17.0 million in the first, second, and third quarters, respectively. The total provision now stands at 19% of gross assets. In contrast, in the press release issued by the company regarding its 2020 results, the company highlighted that the "combined net charge-off ratio, annualized" improved to 13.4% for the three months ended December 30, 2020 from 22.5% for the three months ended December 31, 2019. So, it appears to us that the company has reserves equal to 19% of its remaining amortized cost portfolio while the current net charge-off ratio (during a seasonal period that typically has more delinquency) is running at 13%. We suspect that if management believed this level of provisioning reflected its base case expectations, it would not continue to grow originations. That said, it is likely hard for us (or auditors) to argue with management's cautious approach in light of the potentially unknown impact of COVID-19. However, to the extent the current trends (including ongoing government stimulus and relief measures, which the company credits with benefiting its results) continue, we suspect that these provisions will later effectively be released into earnings, providing an additional tailwind for the Atlanticus' future results.
5. We also observe that the company substantially increased its changes in fair value expense for 4Q20 to $50.3 million, which was $17.3 million, or 53%, greater than our expectation of $33.0 million. This compares to $25.6 million and $32.4 million in the second and third quarters, respectively (the first quarter of 2020 was the first quarter of the company's current use of the fair value accounting and thus the figure there does not appear relevant for comparison purposes). We note that, in note 6 to the financial statements, the company discloses that the weighted average expected principal credit loss rate used in its discounted cash flow methodology to determine fair value was 24.8%. While the company acknowledges that they "have included some expected degradation in our model ... above the level that historical trends would suggest", we believe the difference between the assumption mentioned above and the actual net charge offs of 13.4% discussed in the press release is significant (particularly in light of the fact that the company acknowledges that the ongoing government stimulus has benefited its results).
6. Atlanticus' operating expenses came in at $37.0 million, which was in-line with our expectation.
7. The company's income tax expense was favorable compared to our expectation due to lower pre-tax income and a lower effective rate (15%) than expected (20%).
8. Net income attributable to non-controlling interests and preferred dividends were in-line with our expectations.
9. As a result of the above, and primarily driven by higher than expected non-cash provisions and fair value adjustments, net income attributable to common shareholders was $21.9 million, which was $15.9 million or 42%, less than expected.

In order to calculate earnings per share, we reviewed our previous assumptions for diluted shares outstanding as set forth below (shares are presented in the table in thousands):

We calculate the actual basic shares outstanding by looking at the shares outstanding on the cover of the Form 10-K and subtracting the loaned shares to be returned (see here for our discussion on this topic). We then add in the convertible securities and employee stock options (without any treasury repurchase) to calculate the diluted shares outstanding. We note that the company uses diluted shares outstanding of 20.1 million in its calculation of diluted EPS. The difference appears to be that, due to the fact the stock traded at lower prices during the year, the company did not include all of the Series A convertible shares and employee options and did not include any of the convertible senior notes, which convert at $24.61. Given that the stock now trades around $30, we have included all of these securities in our calculation.

Finally, we calculated earnings per share for the fourth quarter and the multiple of earnings for the company's stock (dollars except with respect to per share figures and shares are presented in the table in thousands):

We note that Atlanticus reported full year EPS of $3.95 (which included a near break-even first quarter of 2020). As discussed above, the company's significant provisioning and negative fair value adjustments weighed on earnings per share for the quarter. Nonetheless, we believe that a 7.5x price to earnings multiple based on annualized 4Q20 earnings per share is substantially lower than warranted particularly given the strong growth that the company is generating. We note that oft-mentioned "peers" such as Regional Management Corp. trade at 14.5x earnings despite, in our view, a less compelling business model, revenue growth of 5% (vs. 63% for Atlanticus), and earnings declines of 37% (vs. 138% growth for Atlanticus). World Acceptance Corp. trades at a similar valuation despite also posting revenue declines in its most recent period. As discussed above and in the above referenced prior reports, we also believe that, given the similarities in business model and growth rates, we should also look at companies such as Affirm Holdings for comparison. Despite its recent pullback, we read in reports by other contributors, such as found here, that Affirm Holdings, which is historically unprofitable, continues to trade at an enterprise value to forward revenue multiple of 20 x (compared to around 2 x for Atlanticus based on 2020 results and not incorporating any continued growth). We continue to believe that for these relative valuation and earnings accretion reasons, as well as due to the value of their well-established origination, servicing, and technology platform, Atlanticus is an attractive acquisition candidate for Affirm Holdings and its high-multiple peers.

Cash Flow Statement Review

In the table and commentary below, we provide our analysis of our projection of Atlanticus' cash flow statement and its actual cash flow statement for the fourth quarter of 2020 (dollars are presented in the table in thousands):

1. While, for the reasons discussed above, net income for 4Q20 was $15.9 million less than expected, net cash provided by operating activities of $65.0 million was in-line with our expectations. As discussed in prior reports, we prefer to look at Atlanticus' cash flow metrics, as they are not subject to the substantial impacts of the company's decisions around non-cash provisions and changes in fair value. Therefore, we were encouraged to see that Atlanticus' cash provided by operating activities was in-line with our expectations.
2. The company's investments in earning assets for 4Q20 came in at $377.8 million, which was $22.2 million, or 6%, less than expected although generally in-line with our expectations. It is encouraging that Atlanticus was able to generate more revenues than expected with lower investments in assets than anticipated.
3. We note that proceeds from earning assets in 4Q20 was $265.9 million, which was in-line with our expectations. We are encouraged to see the liquidation trends continue as expected in 4Q20 as this ultimately drives earnings for the company.
4. We also note that Atlanticus borrowed $338.9 million in 4Q20, which was $88.9 million, or 36%, more than expected. Given the low interest rate environment overall and the favorable terms the company appears to receive, it is hard to find fault with the decision to borrow additional available amounts. Interest expense was generally in-line with our expectations, so it appears that these borrowings may have been done later in the quarter.
5. As a result of the company's lower than expected investments in assets and higher than expected borrowing, Atlanticus generated $103.6 million more cash flow than expected.

Below we calculate the annualized diluted level free cash flow per share for the quarter as well as the trading multiple thereon (dollars except with respect to per share figures and shares are presented in the table in thousands):

We note that, while this is intended to be a cash flow metric showing the company's available free cash flow (i.e., cash flow prior to growth investments and financing activity), the increase in net loans outstanding (and thus the add-back for the increase in net loans outstanding) is materially impacted by the substantial accruals undertaken by the company inasmuch as the December 31, 2020 ending net loan balance is reduced by the loss provisions and negative fair value adjustments. We have not attempted to make any adjustments for what we would consider more normalized provisions and fair value adjustments and present these figures as reported by the company. Notwithstanding the above, we calculate that Atlanticus generated $5.56 per share of annualized level free cash flow and, at the current trading levels of around $30 per share, the company's common stock trades at 5.4 times such metric. We believe this is a compelling valuation, particularly in light of the strong growth being generated by the company.

Conclusion

Overall, we observe that Atlanticus continued to produce solid top-line and bottom-line growth, earnings, and cash generation in 4Q20, continuing the trend from recent quarters. It appears to us that Atlanticus is transitioning (or perhaps already has transitioned) from a turnaround story to a more traditional revenue and earnings growth story available to shareholders at a compelling valuation. As Atlanticus continues to post solid quarterly results, turning our expectations for significant earnings and cash flow into historical results, and making each such quarter look less and less like an anomaly, it appears increasingly clear to us that the company is currently producing at least $4 of earnings per fully diluted share and $5 of free cash flow per fully diluted share, as well as substantial growth, even with what we view as conservative accounting. As such, we believe there is significant upside to the current trading level of Atlanticus' common stock of $30 per share. We will provide additional details of our analysis of the Form 10-K and our updated projections and valuation in our subsequent reports.

Analyst’s Disclosure: I am/we are long ATLC. 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.

WE HOLD A LONG POSITION IN THE COMMON STOCK OF ATLANTICUS HOLDINGS CORPORATION (ATLC) AND ENGAGE IN PURCHASES AND SALES OF THE STOCK FROM TIME TO TIME. THE INFORMATION AND OPINIONS IN THIS RESEARCH ARE PROVIDED TO THE BEST OF OUR KNOWLEDGE AND BELIEF BUT NO REPRESENTATIONS OR WARRANTIES ARE PROVIDED AS TO THEIR ACCURACY OR COMPLETENESS AND MATERIAL ERRORS AND OMISSIONS MAY EXIST. MATERIAL RISKS EXIST WITH RESPECT TO AN INVESTMENT IN ANY OF THE SECURITIES DISCUSSED HEREIN, INCLUDING, WITHOUT LIMITATION, AS SET FORTH HEREIN AND IN EACH OF THE RESPECTIVE COMPANY’S PUBLIC FILINGS. EACH INVESTOR SHOULD PERFORM HIS OR HER OWN DUE DILIGENCE IN CONNECTION WITH ANY INVESTMENT DECISION WITHOUT RELIANCE ON ANYTHING CONTAINED HEREIN. THE INFORMATION CONTAINED HEREIN IS FOR INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE CONSTRUED AS INVESTMENT ADVICE OR A RECOMMENDATION TO TAKE ANY PARTICULAR ACTION.

Comments

[astute pathways]

Are they currently doing buybacks?

[Deep Value Report]

@astute pathways Yes, the company has been continuously buying back common stock and convertible notes in recent periods. We cover this in greater detail in our first report on the company. In the fourth quarter, they repurchased 111,536 shares of common stock (a portion of that was related to withholding tax-related stock repurchases in connection with employee stock option exercises).

[InvestorMan Sr.]

At roughly 8x earnings and 6 x FCF I would think it's just a matter of time before ATLC gets REALLY noticed. I'll just hold it for awhile.