Not that being a pawn broker is a dying industry, but making short-term cash advances -- commonly referred to as payday loans -- just happens to be more profitable.
It's why companies that operated primarily (even wholly) as pawn brokers just a few years ago, companies like Cash America (NYSE:CSH) and EZ Corp (NASDAQ:EZPW), are now moving more broadly into making payday loans.
Yet those profits have also drawn the attention of regulators and industry critics, which has caused a backlash to develop and have them seek to limit payday lenders, if not drive them out of business altogether.
Challenges for 2007
Cash America was once predominantly an operator of a string of pawn shops that account for more than 93% of revenues as late as 2003. Steadily, though, as the profit potential of payday loans became more apparent, the company began branching out and opening a series of stores that catered to the same "unbanked" consumer population. By 2005, pawn operations had accounted for just 81% of revenues, and in the third fiscal quarter of 2006, it had dropped to 76% of revenues.
But even as Cash America was making that transition, the regulatory playing field was changing. The FDIC essentially put the typical payday lending business model out of business, requiring many operators to operate as "credit services" companies. State regulators also prompted action, and many lenders had to close up shop in states such as North Carolina, Georgia, and Pennsylvania.
Pawn brokers are heavily dependent upon the price of gold, since jewelry happens to be the merchandise most often pawned for a cash advance. While Cash America has to pay a higher price to the customer to acquire the merchandise when gold is high, it's also able to sell the jewelry at higher prices, increasing its profit margins. Yet the price of gold has eased back lately, which could affect the company's profits.
Payday loans that click
To spread its risk out more evenly in the market, Cash America is having cash-advance services account for more of its revenues. While it's not giving up on being a pawn broker (it's still a very profitable business for the country's largest operator), there are opportunities to advance its profits further by reaching more of the target consumer who might never walk into a pawn shop, but who aren't as reluctant to frequent a payday loan center.
Even so, being able to get payday loans anonymously without having to physically enter a brick-and-mortar office also holds an attraction to leery consumers. Cash America has acquired CashNetUSA, a privately held online payday lender with customers in 27 states, for $35 million. The transaction, completed in September, was immediately accretive to earnings and allowed the pawn broker to raise guidance for 2006 and 2007.
There are a number of other private online lenders catering to the unbanked and under-banked consumer, but even though it was founded just two years ago, CashNetUSA finds itself already profitable. With the marketing capabilities of Cash America now supporting it, the company is expecting earnings growth for the next year of 32% over 2006.
Final Foolish thoughts
Cash America's valuation is ahead of industry averages, however, and while online loans have proven profitable thus far, one has to question how much reach there can be for consumers who typically shy away from traditional financial institutions. Will they have access to and be willing to go online for loans?
On a price-to-sales basis as well, Cash America is richly valued with a ratio in excess of 2, based on trailing revenues. Even going by analyst forecasts of future revenues for 2007 makes the pawn shop operator at best fairly valued, and tipping towards overvalued at the lower ends of estimates.
Although I expect Cash America to continue to grow, I'd wait for the company to offer a discount before I'd reach for the mouse to click "Buy" with my broker.
Reach for these related Foolish articles:
- Cash America Clicks With Payday Loans
- Cash America Rings Up Sales: Fool by Numbers
- Cash America Still Cashing In
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Fool contributor Rich Duprey does not own any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.
