Credit Acceptance (CACC, Financial) (4.7% of Sequoia’s capital at year-end, -31% total stock return in 2022)
After nearly doubling in 2021, Credit Acceptance’s shares declined significantly this year, as tight supplies in the used car market impacted the lender’s ability to grow its loan book. For full-year 2022, revenues and earnings are expected to be roughly flat. Versus 2019, revenues and EPS are expected to have compounded an annual rates of approximately 6% and 14%, respectively.
The earnings of Credit Acceptance in any given year reflect the size and performance of its book of outstanding loans, which is driven by the pace of underwriting activity of the previous few years, and the collection experience in the current year. 2022 was highly unusual, with the global shortage of semiconductor chips triggering a shortage of new automobiles, which in turn drove used car prices up by almost 50% from January 2021 to January 2022. This tightness in the used car market drove affordability down and shifted dealers’ focus to prime borrowers, reducing demand for Credit Acceptance’s loans given its position as lender of last resort for subprime credits. At the same time, collections on outstanding loans exceeded expectations thanks to low unemployment and lingering benefits from aggressive fiscal stimulus policies.
In short, the environment was good for collections, which boosts current earnings, and bad for new underwriting, which powers future earnings. Credit Acceptance’s loan volume through the first nine months of 2022 was down approximately 22% from peak volumes in the first nine months of 2019, and we expect this stretch of anemic underwriting to have a temporary impact on future earnings. The good news is that the extraordinary tightness in the new and used car markets is already abating, and Credit Acceptance’s loan volumes should normalize in due course. Importantly, Credit Acceptance has maintained its disciplined underwriting standards during a very competitive time, rather than chase volume by pricing more aggressively.
Auto loan cycles come and go, and Credit Acceptance is expert at navigating them, usually growing market share when other lenders batten down the hatches. The more salient long-term risk to Credit Acceptance is regulatory intervention. Because it lends to a vulnerable population, Credit Acceptance attracts the attention of various regulators and enforcement agencies. While we welcome alert and astute regulation of the subprime auto market, we recognize that regulatory overreach is an ever-present risk.
A complaint from the Massachusetts Attorney General in August of 2020 drove the stock of Credit Acceptance down dramatically. The stock recovered when the suit was settled at a cost of roughly $2 per share in September of 2021. Today, Credit Acceptance faces a similar complaint from the attorney general of New York and the Consumer Finance Protection Bureau, and this has once again cast a pall over the stock. We expect this complaint to take years to resolve, and we anticipate similar complaints from other attorneys general in the future. It is part and parcel of the deep subprime lending business. Our research indicates that Credit Acceptance rigorously follows all existing lending laws, although enforcement agencies may attempt to broaden the interpretation of existing laws through litigation.
At the current share price, Credit Acceptance trades for approximately 8x expected EPS for 2023. We consider this an attractive price for a business that generates industry-leading returns through conservative underwriting, has reasonable prospects for growth and is run by a highly disciplined and extremely shareholder-friendly management team that has bought back over a third of outstanding shares over the past five years.
From Ruane Cunniff (Trades, Portfolio)'s Sequoia Fund fourth-quarter 2022 letter.
