Benefactors from the subprime fallout and the tightening credit aftermath

Back when I didn't know anything about stocks, I discovered stock screeners, such as the ones on Yahoo Finance. I thought I was some sort of genius and used that to cut down a list to around ten stocks. I have no idea what numbers I put in as the requirements, but one of the first stocks I ever put money into, either second or third, was EZCorp. Maybe my mind is filled with too much useless stuff right now, but I happened to check out the stock price, and adjusted for stock splits and such, I would’ve made a cool 600% had I stayed in. Cool.

I looked at the stock again because of the dire situation the economy is in right now. First off, let me explain how EZCorp and other companies within the specialty finance groups do business.By specialty, I mean these groups are often pawn shops – I know what you are thinking already… these shops are simply shady mafia hangouts chase you down if you don't pay.

However, starting in the 1984, Cash America pioneered the first publicly owned national chain of pawn shops. These small, dark shops have burgeoned into an actual financial center, even offering online lending services. The major players in this industry are EZCorp, First Cash Financial, and Cash America International. Their revenues are earned in two main ways:

• First, they make pawn loans, which are usually very small, non-recourse loans collateralized by personal property in the form of gold, watches, and other tangible goods. So to make this very clear, imagine going into a pawn store, giving in your gold watch. The associate will weigh the watch and determine how much the gold can be sold for, puts in a margin of safety and profit. So let’s say he determines the watch’s price at $250 and loans you $200. With such small loans, the margins are even higher. Many times, the watch isn’t even redeemed, as the customer is given that choice.
  
• Second, there are unsecured loans, which are like loans at the typical banks, except these are in smaller amounts, usually averaged in the several hundreds of dollars, and rates can vary and is dependent upon state regulations, but can be up to more 400%. With the economy where it is now and these companies expanding aggressively during the past decade, they simply seem to be at the right place at the right time.

So as I go through comparing these three companies, I will look for the different ways that these companies intend to continue growing. I also want to know how they deal with the high level of competition in the signature loan industry and whether this will lead to lower margins in the near future, and the other major risk factors. Let’s first differentiate these three companies, giving some facts and also some of their flaws.

EZ Corp

• two divisions - pawn loans, short term cash advances & short-term loans
• expanding into mexico in the past year or so- only several stores
• will look for growth in signature loans division, offering innovative new loan packages, and mexico expansion
• no debt - cash flow is supporting its own expansion
• disadvantage is that its too heavily concentrated in texas

Cash America International

• largest pawn chain in the country
• says its international but not really, minimal exposure internationally
• looks for growth to be in online lending, completely differentiating itself from any other pawn chain company that is listed, already running America online and just started offering loans online in UK
• disadvantage is whether it can still grow its earnings at the pace of its competitors and if the online will really be profitable … could it be the cause of their heavy debt compared to peers

First Cash Financial

• store count is 475, with 205 of those stores in mexico, heavily spread throughout mexico
• revenues in 2007 from mexico grew 32%, and looks for more growth there
• disadvantage is their auto master division where their loans issued are defaulting and thye had to raise the amount of loan provisions, and expect deteriorating economic conditions to affect this division through 2009

For a comparison of the basic numbers:


Margins like those are out of this world, and that’s why the government regulations are a major risk factor on pawn companies. We can see profit margins as well as return on equity are highest at EZCorp. What is more impressive is that they are doing this without cash. Instead, they are using some other sort of financing which I have yet to find out about.

This makes me wonder whether EZCorp would benefit from using this debt to expand. Either way, their debt is nil and Cash America’s is unusually high compared to peers. Perhaps, their internet ventures are needing lots of costs upfront, making it riskier than the others although it is larger and much more diversified. As a result, EZCorp does not have too much intangibles making up their assets (20%), compared to Cash America and First Cash which have 41% and 25%, respectively. Cash America also has cash flow growing slower, once taking out the selling of assets Cash America has been doing for the past couple years, which is due to various reasons, including legislation changes for lending rates.

I feel EZCorp is the best positioned going forward, as they have just started expanding to Mexico. There are opportunities for organic growth as many of their stores are barely over a year old, have no debt, and does not trade at so many multiples about their tangible book value, making it safer than a larger company such as Cash America International. All these companies are still in the growth stage, but First Cash Financial can be negatively affected by the subprime mortgage because of their Auto loans division.

I felt that maybe Cash America would be the most experienced and well-diversified. However, it has been dumping cash into their online lending venture that has not shown results to compensate for their spending. Although all three companies are going into 2008 and 2009 with record earnings increases year over year, their stock prices have been taken lower by the subprime crisis and associated credit crunch.

While the conditions are all lining up for another breakout year for these companies, EZCorp is clearly the most efficient while still not selling significantly above its competitors, . Pawn shops have taken on a different face, now they are corporatized and expanding rapidly over America and abroad. EZCorp is benefitting from the subprime fallout and the tightening credit practices that will follow, but its stock price does not completely reflect the earnings growth acceleration we can expect.