Selling a Pawn Business Is Complicated Selling a
Value Idea: Cash America International (CSH) — Where Cash Is King
Currently trading at $51.03
Shares outstanding 29.59 million (steady)
Repurchasing 2.5 million shares (announced January 2011)
Market Capitalization: $1.50 billion
Enterprise Value: $1.53 billion
Cash America International was the first to take what was considered the dark business of pawn shops and turn it into a first-class twenty-first century leading financial lending industry and pawn shop that has a total of 1,081 locations as of 2011. The industry today looks quite healthy and exciting compared to the major financial companies that have been decimated over the last several years. Their locations offer specialty financial services to consumers, including short-term loans and check cashing services. Loans can be made through the 779 lending locations or over the Internet virtually from anywhere.
This industry serves what are known as the 60 million Americans who are “unbanked” or underserved by the current lending industry. Years have gone by when savings and loans or banks offered small short-term loans to consumers to fill a short-gap need. The lending institutions of old have abandoned this need and today companies such as Cash America have filled the void. Today, most the loans are for less than one month and the so-called predatory charges are usually less than one might pay for an overdraft at a bank.
Their locations include 23 states for their primary business, 32 states for their Internet lending business, and throughout Mexico, Canada, Australia, and soon Central America.
The payday loan industry is one of the fastest growing segments in the financial industry and consists of approximately 15,000 locations nationwide. It extends credit of approximately $25 billion annually in the form of short-term loans. While expectations of extreme regulation implementation have been expected, regulation has passed various forms, but not to the extent expected. This is largely due to organizations such as Community Financial Services Association of America, which helps provide reality checks for determined regulators, indicating the truths and myths behind the business.
Cash America has a great balance sheet, income statement and cash flow statement. Growth is steady and rising.
Revenue Growth 5-year average: 16.7%
Ebitda Growth 5-year average: 22.8%
Free Cash Flow Growth 5-year average: 11%
Book Value Growth: 16.2%
Net Income Growth 5-year average: 20.82%
EPS Growth 5-year average: 19.92%
Current Ratio: 4.6
Quick Ratio: 3.34
Currently in the portfolio of Mario Gabelli and with the exception of the P/E (TTM) at 12.57, this would currently meet all of the other criteria of a John Neff stock pick.
Cash America has a current price of $51.03 with earnings (TTM) of $4.06, arriving at a current P/E of 12.57 which at face value appears to indicate value. Further, the P/S and P/B ratios clearly indicate value, especially next to its greatest competitors. I use several valuation techniques to arrive at an intrinsic valuation number, sometimes throwing out one or more of the elements that may distort the average if deemed prudent.
If it is assumed that the approximate value of a stock is equal to ten times Ebit or fifteen times FCF, then your margin of safety will be the difference between those numbers and the multiples it is currently selling for. I use enterprise value rather than market capitalization.
|Cash America Int’l||First Cash Financial Services||Ezcorp Inc.||World Acceptance Corp.|
In our case CSH is selling for 3.94 times Ebit and 5.18 times FCF, which is a huge discount. If we use the 10 times Ebit and 15 times FCF to determine company value, the price per share or intrinsic value of the stock would be approximately $135-$156. Our margin of safety would be already greater than 50%, indicating Graham would love it, however; let’s explore the valuation further and make our numbers more conservative and/or realistic.
The first technique used is simple discounted cash flow. Fortunately, Cash America has plenty of cash and has grown it steadily. The last five years indicate FCF of 115, 203, 197, 224 and 292, and currently a FCF (TTM) of 308. Taking an average FCF of the last five years at 206.2, discount rate of 12%, perpetuity growth rate of 3% and assume a 5% FCF growth rate, I calculate an intrinsic value at $87.77.
The second technique is a 10 year acquisition model based on book value. Slowing down the earnings growth rate to 15% (from nearly 20%), using a 12% discount rate and an acquisition book value of 1.50, I arrive at $80.33.
The last technique in this model is discounting the present earnings. Slowing the growth to 15% and assuming a P/E of 12, projecting the EPS for five years gives me an intrinsic value of $99.08.
Therefore, the average of our numbers is $89.23 or $90 and between our multiples and intrinsic value calculations, indicate that we should have an intrinsic value at a low end of $90 and perhaps as high as $135. At the low end, this still gives us a margin of safety of 43%. This is a strong pass for me.
The CEO and President is Daniel R. Feehan, serving in that capacity since 2000 and as President and COO since 1990. He started with the company in 1988.
Their CFO is Thomas A. Bessant Jr., who has been in this position since 1998.
Warren Buffett has emphasized rational and candid management that is able to resist the institutional imperative and not be afraid to change direction and admit its mistakes. This management team of Feehan and Bessant is truly fashioned in the style of Buffett. Reading the annual reports will quickly give you insight into the candor of its CEO. He is not afraid to take on government regulators or confront what many see as a predatory type of lending business. He clearly has direction, is able to admit mistakes, but he is amazingly capable of addressing the harshest of industry critics by clearly showing that this business is not only a great business, but that it is clearly not predatory and fills a great need among the unbanked.
One attribute that stands out in the introduction to the Annual Report and continues throughout is clarity of the importance of the company delivering value to its shareholders.
The company, once again in Buffett style, manages to take its retained earnings and earn shareholders approximately 17.9% on the earnings they’ve kept. Margins have been growing steadily, along with a steady and rising book value. Debt/equity has been nearly cut in half in the last four years. Management has just announced a nearly 10% repurchase of shares.
The board of directors reviews compensation and bases it upon several companies of equal size, including Radio Shack (RSH), EZCORP (EZPW), Pier One (PIR), Zales, World Acceptance Corp. (WRLD), and others.
Mr. Feehan receives yearly compensation of $700,000 with stock options, which I consider reasonable and in line with competitors. Mr. Feehan holds no punches in addressing the problems before the company and is noticeably concerned with share valuation, speaking candidly about closing the valuation gap between Cash America and its competitors. He is also not afraid to take the responsibility.
“So, if an unwarranted valuation gap exists, we have nowhere to hide. Our responsibility is to you to close that gap.”
This is a great management team.
The risks mostly are proposed government regulation, a constant source for the entire financial industry. This part of the industry is not any less exempt.
Anyone interested in researching all of the risks and myths behind this type of financial business only need go to the website of Cash America International. The site offers many academic studies done from large universities that have studied this industry in detail.
The critics of the industry don’t appear to be the ones using it and once again; this appears to be a situation where government interference is actually hurting those it is intending to protect.
The most frequent charge of predatory lending by the use of high interest rates. The claim is that the payday advance carries high or usurious annual rates of interest of approximately 391%. This is a disingenuous argument. The loans are for only approximately two weeks, and the supposed APR is not as bad as one thinks when shown in perspective.
$100 typical payday advance with a $15 fee = 391% APR
$100 bounced check with a $56 Non-Sufficient Funds and merchant fees = 1449% APR
$100 credit card balance with a $37 late fee = 965% APR
$100 utility bill with $46 late/reconnect fees = 1203%
No better example of misguided regulation has occurred in this industry than in Indiana. In 2001, the state had mandated a maximum APR of 72% which caused the local industry to withdraw precipitously. Since then, Indiana has revised the law to current standards and the industry has since revived.
The current economy is driving a great need right now, and the company is expanding into South America.
Hope you all enjoyed the read, we are putting a BUY recommendation on Cash America as well as EZ Corp and First Cash!
All of these companies are enjoying the lofty values of gold, a depressed economy globally and unlimited cheap capital!
Pawnshop Consulting Group, Inc.