Thursday, April 25, 2013

EZCorp As Pie

Though the rising market has definitely made it harder to find value, some companies nevertheless are falling through the cracks. I recently read a compelling case for investing in cash advance provider EZCorp here. The company trades with a P/E of 6 and debt that is offset by minority stakes in two publicly traded companies.

While the share structure leaves a lot to be desired (publicly available shares are non-voting), it's hard to argue with the company's track record. The company sets a 20% unlevered ROIC hurdle for its investments, and it appears to deliver market-beating returns year after year. Both ROA and ROE have been in the double-digits for the last 6 consecutive years, as the company has expanded both organically and through acquisition.

In the past, I've been worried about new legislative or regulatory hurdles companies in this industry might face, as the country has shifted towards left-leaning leadership. This article does a pretty good job discussing these issues, finding that such issues don't appear to be material in the near-term. At the same time, EZCorp has diversified into more states (reducing the risk that a state in which the company has a concentrated presence can hurt results), and further internationally (e.g. Mexico), where legislators have more pressing concerns than whether to suppress the freedom of willing trading partners in the consumer loan market.

There is some question though, as to whether this type of business has benefited over the last decade simply due to the appreciation in the market price of gold. Whereas gold is used as collateral on a good percentage of the company's loans, and whereas a good percentage of this collateral is often forfeited (after all, the company is not dealing with the most responsible borrowers around), the company sees great inventory gains as the price of gold appreciates.

But what happens if/when gold retreats? The company has put forth a presentation on this topic here. While the company has done a decent job diversifying away from its reliance on gold, it is undoubtedly still a big part of its business. Moreover, I'm not sure the presentation captures how the business would be affected were the price of gold to crash, and not just trend sideways or downward. Considering what happened to the price of gold last week, we may get some of management's thoughts on this issue when the company reports next week.

This one bears watching!

Disclosure: No position


Sidekick said...

Given the short term nature of these loans, I wonder what their average holding time is between the receipt and sale of the gold collateral. If it isn't too long then this reduces the risk.

Also I assume they have detailed records on the amount of gold they hold and eventually sell throughout the year, they could easily start hedging to protect against gold price falls.

The main problem would be a decline in customers if gold becomes worth far less, less people will have the collateral required for the loan.

Anonymous said...

I recently (6-9 months ago) had a look at Cash America and the industry. I was attracted by the same things your were looking at high ROIC, strong balance sheets and cheap valuations.

A key point to add would be the affect of the housing sector crisis, overall levels of unemployment creating weaker household balance sheets and higher credit risks for traditional banks. These traditional banks are also tightening their lending standards on the back of capital constraints and extremely weak lending standards pre-GFC. This creates a massive new market for EZCorp as more and more people move outside of the traditional banking sector due to weak credit. Particularly if you think this economic malaise will continue.