It’s been a little while since I’ve covered FirstCash (NASDAQ:FCFS), and quite a bit has happened since then, including evidence (at last) of a strong recovery in the U.S. pawn market, a more disappointingly sluggish recovery in Mexico, and a major acquisition (American First Finance, or AFF) and entry into new markets (lease-to-own and other credit products).
To be honest, I’m not at all sold on the AFF deal. I can see the appeal, but I think the capital could have gone to expanding the Latin American pawn operations in countries like Colombia and Peru. That said, it does offer another potential source of growth and cash flow and diversifies the business somewhat (only “somewhat” given similar clientele).
FirstCash shares are down slightly since my last update, and at this point, I believe the shares are priced to generate an attractive long-term double-digit annualized total return. That said, I would think that the Street might need a little time to get comfortable with AFF and, likewise, may want to see signs of a stronger recovery in Mexico before really bidding the shares up again.
Because of the inclusion of a bit of AFF revenue and profits in the results, FirstCash’s results are very difficult to compare to prior sell-side average estimates. Where there are comparisons to be made, FirstCash’s underlying performance in the pawn business was somewhat better than expected, though certainly mixed between the U.S. and LatAm operations.
Revenue rose 28% in the quarter, with retail revenue up 28% and pawn fee revenue up 13%. Scrap revenue declined 40%, while AFF made a partial debut in the quarter, contributing $34M of an adjusted $502M in less than a month of FirstCash’s ownership.
Retail revenue beat expectations by around 13%, helped by strong ongoing performance in the U.S. business, where total sales increased 29% and 24% on a same-store basis. In Latin America, growth was also quite strong, at 26% overall and 24% same-store (both in constant currency terms). While retail margins are easing off record highs, they’re still staying higher for longer than expected, with U.S. margin down about two points to 43.1% and LatAm down two points to 36%.
Core pawn fee revenue rose 13%, missing by about 7%. U.S. fees rose 15% overall and 10% on a same-store basis, while LatAm fees rose 12% overall and 11% on a same-store basis. My sense is that most analysts were expecting stronger results from LatAm (I was in my model…), but pawn demand is lagging on a combination of a less dramatic recovery in Mexico and significantly increased remittances to Mexico from the United States.
What concerns me more, honestly, is the pace of pawn loan growth, as this ultimately drives pawn fees. The U.S. remains strong, with 13% same-store growth, but LatAm grew just 6%.
Looking at pre-tax segment earnings, the U.S. pawn business grew 43%, with margin up 330bp to 23.9%, while the LatAm pawn business grew 20%, with margin up about a point to 21.7%. AFF debuted with an adjusted margin of 17.3%.
I’m relatively bullish on the near-term outlook for pawn loan demand in the U.S. operations. While the employment situation is robust, inflation could help stimulate demand if and when wages don’t keep pace. Moreover, given changes to tax items like the child tax credit, I believe there could be less of a negative impact to FirstCash this year, with customers/potential customers getting lower than expected refunds because of how those credits were changed.
In the LatAm operations, I’m still bullish on recovery prospects in Mexico, but the recovery has been sluggish so far and the elections this year could create some turbulence. While overall pawn loan balances aren’t that troubling compared to pre-pandemic levels, there’s definitely been a slowdown here, and FirstCash really needs to reestablish the growth credentials of the LatAm operations (the Mexican operations, namely) – particularly as I think some bears will argue that the purchase of AFF was done to mask/compensate for lower expected growth from LatAm pawn in the coming years.
Buying AFF gives FirstCash a digital-based consumer finance business focused primarily on lease-to-own (similar in some respects to rent-to-own operations like Rent-A-Center (RCII)), retail installment financing, and bank lending to a similar customer base (i.e., customers that cannot easily access traditional sources of credit).
Paying around 10x forward EBITDA for a business with solid mid-teens EBITDA margins isn’t too bad, but AFF does bring risks. First, while AFF operations aren’t covered by the CFPB, they’re regulated at the state level and that brings some risks back into the story that the company left behind when it exited payday lending.
Second, it’s a different type of business and that always carries risks, even with the existing operations largely left in place. FirstCash amply demonstrated over the years that they understand the pawn business, but it remains to be seen how they fare in the point-of-sale financing business, particularly with this space attracting a lot more attention and competitive entry of late.
Cost synergies won’t be any real factor here, but there could be some operational synergies down the road. Surrendered merchandise from AFF’s leasing operations can go to FirstCash pawn stores, expanding their assortment, and AFF’s financing services can be used to fund in-store retail purchases at FirstCash stores, potentially opening the door to the sale of higher-ticket items to a wider customer base.
I also do like the fact that AFF uses a capital-light model – AFF doesn’t own and stock stores, but instead partners with merchants to offer their services. I know that a substantial amount of AFF’s business is based in furniture (and they do business with 10 of the 50 largest furniture retailers), but inputting my old zip codes into their merchant partner database turns up a lot of jewelry stores and auto service stores, so I like the angle here of AFF funding services like auto repairs.
Adding AFF into the model certainly adds to the modeling risk, but the business should see overall demand trends roughly similar to that of FirstCash. Given the volume of new entrants into POS financing, I’m reluctant to assume that AFF will meaningfully boost FirstCash’s long-term organic growth rate, but it does at least expand the base of business. At the same time, though, I admit to being more concerned about the growth trajectory of the LatAm operations and the question of why management isn’t putting more capital into growing geographies like Colombia and Peru.
I’m modeling around 7% long-term revenue growth using my 2021 estimate as the starting point (to neutralize the inorganic boost from AFF). I’ve modestly trimmed back my longer-term margin assumptions, mostly on concerns about LatAm and conservatism with my initial expectations for the AFF business. Even so, I’m looking for long-term adjusted FCF margins in the low double-digits and growth in the high single-digits. I’ve also increased my discount rate to account for higher risk – more debt, slower growth in LatAm, and the risks of entering a new business line.
I like the prospects for a strong recovery in the core pawn business, including the possibility of higher-for-longer retail margins, and while I’m more concerned about the LatAm operations, I still see them as a growth driver. With AFF, I’d describe my feelings as more “guardedly optimistic”; management has earned the benefit of the doubt, but I will need to see some proof that this was a better use of capital than expanding the ex-Mexico LatAm pawn operations. Running my new estimates through my valuation model, I still get a significantly higher fair value than today’s price, and I believe FirstCash is priced for double-digit long-term annualized returns.
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Disclosure: I/we have a beneficial long position in the shares of FCFS either through stock ownership, options, or other derivatives. 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.