Remember that scene in Goodfellas, when Robert DeNiro assaulted Morrie, the hapless toupe salesman, with a telephone cord? He did it because Morrie argued about the usurious interest rate on DeNiro's loan. Not a bright move, Morrie.
Fortunately, here in real life, Fools can be on the right side of the law and still reap the benefits from companies that offer high-interest short-term loans. One such firm is First Cash Financial Services
There are 15,000 pawnshops and 22,000 payday advance stores in the U.S. The four public companies that operate in this universe, including competitors Ace Cash Express
A mighty model
First Cash's business model is simple. Suppose you have rotten credit and can't get a loan from traditional lenders. You need money quickly -- maybe to pay rent or buy a subscription to one of the Motley Fool's newsletters.
You can pawn tangible personal property (jewelry, electronic equipment, tools, sporting goods, and even your banjo) at one of its pawnshops. Using a frequently updated database that records the sale of similar merchandise, First Cash will assign a value to your banjo and loan you a fraction of its determined value, using your property as collateral. You then have 30 to 90 days to return the loan, along with a service charge, and start finger pickin' again.
The vig is up -- way up
Here's where it gets interesting. The annual service charge pawnshops can lay on you varies from 12% to 300%, depending on what state you're in and the size of your pawn.
Let me say that again: 300%. DeNiro could only wish for that kind of vig. Here are the specific rates for some places:
|Texas||12% - 240%|
|Oklahoma||39% - 240%|
|Maryland||144% - 240%|
|Virginia||120% - 144%|
|Washington, D.C.||18% - 60%|
|Missouri||180% - 240%|
|South Carolina||100% - 300%|
If you can't repay the loan, the pawnshop will sell your collateral and keep the proceeds. First Cash loves it when this happens, and not surprisingly: Gross margins from pawn sales hit a whopping 45% in the most recent quarter, and 50% of its revenue is generated by these sales.
First Cash also offers short-term unsecured paycheck advances. You write it a check out of your personal checking account for the amount of the advance, plus service charges ranging from 13.9% to 40% (annualized). When the loan comes due, usually within 30 days, you must pay off the advance with cash or First Cash cashes your check.
First Cash is a great business. Its free cash flow grew 170% from 2002 to 2003 and is on track for 40% growth this year. The company is also using its cash wisely: to pay down debt (only $2 million outstanding), open new stores (another 13 this quarter), and buy back shares (693,000 in this past quarter). Its business is something most people find distasteful, yet its financial filings are detailed and the transactions transparent.
Now, to the financial metrics:
|Market cap (in millions of dollars)||394.73|
|Enterprise value (in millions of dollars)||382.55|
|Trailing 12-month free cash flow (in millions of dollars)||33.54|
|Enterprise value to free cash flow||11.77|
|Projected annual average earnings growth for the next five years||20.00%|
|Return on equity||15.61%|
|Share dilution (2002-2004)||6.50%|
|Revenue growth (last fiscal year)||22.50%|
|Earnings growth (last fiscal year)||36.90%|
To me, First Cash either looks fairly valued or close to it. But we must dig deeper before we commit capital. Once you're done reading this, check out Seth Jayson's article on First Cash.
Risks abound, so buyer beware
Is there an economic cycle risk? Not as much as there used to be. Following the 1990-1991 recession, pawnshops got whacked. The economy improved, jobs returned, and people started earning money again, so the need to pawn items decreased.
Does First Cash suffer when the economy improves? The good news, mentioned earlier, is that 50% of its revenue comes from retail sales. According to the company's chief financial officer, if pawn loans drop during an economic upswing, retail sales should pick up because people will have more disposable income. Payday advances should also not suffer too badly. As employment increases, First Cash's customer base will increase. Not everyone gets a high-paying job, and more paydays means more people in need of payday advances.
The next risk lies with unsecured advances, because they are, well, unsecured. Whereas the local shy can find various implements of destruction to threaten payment, First Cash has no such recourse. Nobody in the payday advance business runs credit checks or examines bank statements of their clients because management already knows these people have poor credit. The result is that First Cash's net bad debt expenses associated with short-term advances during the last fiscal year represented 21% of service charge revenues from short-term advances. Although First Cash's margins indicate it has priced this into its services, if bad debts rose, profitability could suffer.
There is also a legislation concern. There is no pending legislation on the books, and those bills that have tried to restrict these companies have died in various state legislatures. Still, the threat exists because the industry is ripe ground for consumer advocates.
But even if regulation did slap the industry, the long arm of U.S. law does not extend to Mexico, where First Cash's main expansion thrust is and will continue to be. The economic climate in Mexico stinks, so the customer base there is gigantic. And the fact that the company denominates its transactions in dollars eliminates a good portion of the currency risk.
Worthy of consideration
First Cash may not have a sustainable competitive advantage, since its competitors are equally or better capitalized and have similar strategies. You may decide that disqualifies it from Hidden Gems consideration. But the company looks very attractive to me. I love the business model, and based on analyst-expected earnings expectations, I think this company is undervalued. Where else can you invest in a business that legitimately (or at least legally) generates as much as a 300% annualized yield on its loans? Bank of America
For related Fool links, check out:
- First Cash Bash
- Motley Fool Hidden Gems
- The Motley Fool's Investment Newsletters
- Credit Center
- Get Out of Debt
We here at the Fool are consumer advocates. That's why we've set up the Fool Credit Center for you to learn about debt, and how to get out of it so you aren't at the mercy of short-term loan providers.