Many people don't have credit cards, are sick of asking friends for help and sure don't want to bounce a check that'll cost $60 or more in fees. To serve this cash-strapped demographic, an alternative style of lender entered the marketplace some twenty years ago and started making short-term cash advances with nothing more than a promise on the borrower's part to repay the loan. This concept is known as payday lending.
EZCorp (EZPW) is one of several public companies that make payday loans, also known as cash advances. It also offers pawn services. The payday business can be lucrative, as these companies make about $15 for every hundred dollars borrowed. The collateral is nothing more than a post-dated check the borrower leaves behind, for the lender to cash on the customer's next payday. Amazingly, only 5-8% of loans are defaulted. This tells investors that customers with a need for this product know it's thelender of last resort and they aren't about to default, lest they need another loan.
Cash advances are permitted in more than thirty states, although recent legislation has forced lenders out of several large markets. Nevertheless, the product remains viable, and provides strong revenue for EZCorp and its competitors.
Cash advances are not the only service the company offers. It also makes pawn loans, a kind of lending that's been around for thousands of years, in which a person drops off some item of value and receives a loan against it. If the customer returns within the proper time period to buy back the item, he gets it back.
Pawn stores usually make very nice returns on these loans, usually 10-25% a month. If not, the customer forfeits the item. The pawn store, which lends the item out at substantially below fair market value, can then sell it to the public. Merchandise sales like these have gross margins of around 40%. In addition, with the price of gold near an all-time high, EZCorp can take items like jewelry and melt them down, extract the gold and sell it at near-spot prices. This makes item forfeiture particularly attractive for the lenders.
This is a relatively easy business to understand. It takes capital to open a store, operate it, and lend money. As long as the store makes more money than it loses in defaults, it's a winner. EZCorp has 476 payday loan stores and 371 pawnshops in the United States, as well as a 30% interest in a pawn operation in the United Kingdom. Its U.S. payday operations contribute to 25% of revenue, with pawn operations contributing about 70%.Risks have been growing for the industry. Some federal legislative scares still may not have entirely vanished and states are still looking closely at the businesses. To counter these risks, and because the payday loan store model in the United States appears to have matured, EZCorp is expanding its pawn operations into Mexico -- and the move has been a blockbuster success.
There are two extremely attractive factors about the Mexican expansion. First, Mexico does not have a usury cap, and creating one would require a constitutional amendment. Second, whereas perhaps 20% of American's population might be a potential pawn customer, some 70-80% of Mexico's population is, according to the company. As a result, EZCorp has opened 79 pawn shops in Mexico so far, with another 40-50 planned to open this year alone. With each store contributing about $160,000 in revenue each quarter, EZ should see revenue climb another $32 million annually once the stores mature -- a +9% revenue boost for the company as a whole.
EZCorp has $122 million in net cash, which the company is using to aggressively expand into Mexico. The company also threw off $60 million in free cash flow last year. This gives the company plenty of cash to expand.
While the big contributor going forward will be Mexican pawn operations, the company is also opening 50 payday loan stores in Canada, which recently passed legislation permitting fees of more than $20 per hundred dollars borrowed. This could generate as much as another $30 million or so in revenue annually. Mind you, that's just this year's expansion. There'll likely be more to come.
Action to Take --> Buy EZCorp for the medium to long-term. The company is in the beginning phase of a strong growth cycle with no end in sight, has excellent margins and a strong financial position. In addition, it is wildly undervalued at only nine times earnings, while growing at a rate of +30% annually.
-- Frederick M. Steier
Disclosure: Frederick Steier owns shares of Neither StreetAuthority and LCC nor the editor hold positions in any securities mentioned in this report..