First Cash Financial Services
Value Investment & Growth Stock

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By MrArbitrage
September 5, 2007

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Am I wearing financial beer goggles or what?

The market has been casting aside stock in companies who make "sub-prime loans.

First Cash, Inc. (FCFS) in my opinion must be a case of market obtuseness. First Cash is very much involved with sub-prime borrowers but where the market is clueless is in the fact that they are NOT making sub-prime LOANS. These loans they make are secured by assets which they have in their possession at the time the loan is made.

That is quite different than a mortgage made to a deadbeat borrower. 1. The mortgage given to the deadbeat borrower was more than likely made for an amount far above what the house is worth thanks to dubious appraisals and a speculative bubble driving real estate prices to levels that may not be attained again for years.

2. The mortgage lender cannot liquidate the real estate and recoup their costs as prices are lower and not enough people are buying (obviously).

On the other hand, First Cash, being in the pawning industry is making loans secured by diversified assets that are immediately in their possession, assets that are non-cyclical and are much more liquid than a house. Perhaps most importantly, the loans made against the collateral are closer to the "liquid value" than the retail value. I'm no authority in the mortgage business but I would venture to say that the sub-prime mortgages were made for the full retail value or very close to it. If the loans were made at a more liquid value or say half the homes retail value (implying a 50% down payment), with a first lien (as FCFS has on their collateral) they would cease to be "sub-prime loans" - right?

It is self evident looking at the share price of FCFS that the company has been mistaken for a sub-prime lender when one looks at their current market valuation. Last quarter was not by any sense a good quarter for sub-prime lenders. But if you look at FCFS's numbers, revenue at the pawn store and check-cashing company rose 64% to $93 million & net income climbed 37% to $8.9 million!

Where else can you get 64% revenue growth & 37% earnings growth for 18x earnings????? Somebody is confused. Looking at the following chart that tracks FCFS's earnings since they went public between 1991-1992, it looks like we have a company that has been quite consistent in growing earnings through good times AND bad times.

The arrows pointing upward show the quarters when the earnings were up and point down when earnings were lower. There are not many quarters where earnings were LOWER over the past 15-16 years. It looks like from about 2002 onward they have not had a down quarter. The chart has the stock price escalating dramatically since 2001. I wasn't following them back then but surmise that is when they started aggressively expanding.

As my pseudonym suggests, I am more of a value oriented investor. With most value investments, patience is required because in most cases the company in which I am invested is in an early "turn around" stage or it is in a precarious situation that in either case has knocked the stock way out of favor. What I find unique about FCFS as an investment is that it is both a value investment and an aggressive growth investment. I believe FCFS is so undervalued because it is barely known, trading at an average daily volume of 386,900 shares and it is "out of favor" because of mistaken identity. Most analysts don't cover it and the people who are aware of its existence are clueless.

"Specialty consumer finance" represents a rapidly growing segment of the overall financial services industry. This segment focuses on providing a quick and convenient source of short-term credit to "unbanked, underbanked and credit-challenged customers". They have done quite well during the good times but they are doing even better as times get worse - making this a nice hedge as well. It makes sense to me and here's why.

As we see credit card debt hitting new highs and more and more people getting behind on their payments, that leads me to deduce:

People charged up a lot of "crap" on their credit cards.

They don't have any more credit.

Since the credit card debt is unsecured, they are now using the "crap" they charged up as COLLATERAL for loans from the pawn shops -or- they are taking out payday loans, which First Cash also provides.

If people pay off their loans to FCFS, FCFS makes a nice rate of return. If they don't pay off their loans, FCFS sells their jewelry, electronics, musical instruments or whatever at a discount at their own store and still - makes a nice profit.

The Company is aggressively expanding has opened 153 new pawn stores and 81 new payday advance stores since its inception and currently intends to open both additional pawn stores and payday advance stores in locations where management appropriate demand and other favorable conditions exist. The Company currently operates pawn stores in only seven U.S. states, all of which have licensing and/or fee regulations on pawnshop operations, which includes Texas, Oklahoma, Maryland, Virginia, South Carolina, Washington, D.C., and Missouri.

It looks like First Cash has quite a bit of growth ahead so you tell me - is 18 x earnings representative of "growth at a reasonable price" or am I just wearing the equivalent of financial beer goggles"?

Disclosure: I am long FCFS and just bought additional shares today at 20.68 making this my second largest position behind Tuesday Mornings (TUES).