“Because Credit Acceptance has a disciplined and differentiated approach to underwriting loans, we believe it would continue to thrive in a recessionary environment and may well grow market share as competitors struggle with losses.”
- Ruane Cunniff (Trades, Portfolio), March 3, 2020
The recessionary environment has arrived, and Credit Acceptance Corp. (CACC, Financial) is available at a bargain price. Should it get a careful look from value investors?
On its website, the company introduces itself as follows:
“Since 1972, Credit Acceptance has offered financing programs that enable automobile dealers to sell vehicles to consumers, regardless of their credit history. Our financing programs are offered through a nationwide network of automobile dealers who benefit from sales of vehicles to consumers who otherwise could not obtain financing”.
In other words, Credit Acceptance provides auto financing for consumers with no credit or bad credit. That’s obviously good for these consumers, and for the auto dealers who are able to make sales that would not have been possible otherwise.
As I pointed out in a 2014 article, the firm can make loans to those with poor credit risks at a profit because of its sophisticated practices and technologies. It makes advances on loans to dealers, rather than outright loans. Its software and algorithms allow it to instantly assess credit risks and price the loan accordingly, and it uses technology to be proactive on potential payment problems.
Of course, having a great system is fine, but if consumers slow down their shopping for new and used cars, the companies that finance them are likely to face a slowdown as well. We have yet to receive official reports, but auto sales are expected to decline in the first and second quarters of 2020, and perhaps beyond.
GuruFocus contributor Steven Chen described Credit Acceptance as a “high-quality capital allocator” with shareholder-friendly management. The latter refers to the company’s focus on returns rather than growth. Chen also gave the company credit for only buying back its shares when they were available at a price below their intrinsic value. Despite that stricture, the company reduced its share count by 40% in the previous decade.
One alert for investors is that in the Sequoia Fund’s report on 2019 performance, Ruane Cunniff (Trades, Portfolio) warned, “A change in accounting rules will sharply curtail the company’s GAAP earnings in the coming year, but the change in accounting optics has no bearing on the economics of the business.”
To quantitatively assess Credit Acceptance, we will use the Macpherson model, which is a conservative value investing model, along with data from GuruFocus. The model allows us to quickly assess a company’s competitive moat, financial strength, profitability and the degree to which it is undervalued.
Moat
Thomas Macpherson has two key criteria for assessing moats using a technical perspective:
- Return on capital (ROC): 10-year median ROC is 13.5%, and we should note the return has been slipping down since 2010. It misses the target of 15%.
- Return on tangible equity (ROTE): The 10-year median ROTE has been 27.34%, well above the threshold of 15%.
Overall, it seems reasonable to assume that Credit Acceptance does have a moat, one that will protect its pricing, margins and earnings.
Financial strength
To pass this threshold, a company should have at least a 9 out of 10 on its GuruFocus rating for financial strength and a Cash-to-Debt ratio of at least 100 (which essentially excludes companies bearing debt). This screenshot shows Credit Acceptance fails on both counts:
While the company does fail these tests, note that its return on invested capital (ROIC) is more than double its weighted-average cost of capital (WACC). This means it has been able to create more than $2 worth of returns for every $1 in equity and debt.
Profitability
That ability to profitably invest the funds available to it helps make this one of the most profitable companies in America. The Macpherson model calls for a GuruFocus rating of at least 9 out of 10, and Credit Acceptance beats that with a 10.
Note the exceptional numbers in this table, and then look at the company’s price chart over the past 10 years:
Between April 2010 and April 2019, the stock price rose from $44.42 to $496.02, a more than 10-fold increase. Since then the price has slipped back to $276.84 at the close of trading on April 15.
Valuation
That price retreat over the past year explains why Credit Acceptance made it onto the GuruFocus Undervalued Predictable list.
To test whether the stock belongs in the portfolio of a value investor, we check to ensure that the market price is suitably less than the intrinsic value for a margin of safety.
The tool we use is the discounted cash flow (DCF) analysis, specifically earnings-based DCF (which is recommended by GuruFocus). Currently, the earnings-based DCF is $987, well above the market price of $276.84. Indeed, the current price is a 72% discount to intrinsic value.
Overall, Credit Acceptance has made it over the hurdles of moat protection, profitability and low valuation, though it failed on financial strength.
Ownership
Only one of the gurus followed by GuruFocus has a significant holding in Credit Acceptance, while four others have modest holdings. Cunniff of Sequoia is the most committed investor, with 1.15 million shares. Other holders are Jim Simons' Renaissance Technologies, Jeremy Grantham's (Trades, Portfolio) GMO, Lee Ainslie's (Trades, Portfolio) Maverick Capital and Paul Tudor Jones (Trades, Portfolio).
Of the 10 most recent transactions among gurus, eight were sell-outs or reductions and two were add-ons or new buys.
Conclusion
Like many other companies that serve the auto industry, we can expect Credit Acceptance to endure some tough months and perhaps even some tough quarters ahead. That will continue to depress its stock price in the short term.
In the longer term, however, I believe this company and stock should continue to do well, although not necessarily as well as in the past decade, when its price grew more than 10-fold. On quantitative measures, its only weakness was on the financial side, but as we saw, it has previously delivered more than $2 in returns for every $1 investment of equity or debt.
For investors who can tolerate some debt, Credit Acceptance is a company worth considering as a longer-term investment, in my opinion.
Disclosure: This article is only an introduction to the company and investors must do their own due diligence. I do not own shares in it and do not expect to buy any in the next 72 hours.
Read more here:
- Discovery: Looking Beyond the Undervalued Price
- Hanesbrands: Big Bargain, Big Debt
- Book of Value: Buffett, IBM and the Refutation Process
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