Thesis

America’s Car-Mart is worth 30-50% more than current market prices at which point it will trade for ~5x FY2015 EBIT. The Company is a well-capitalized, self-funding franchise with strong asset origination capabilities.   The typical bank is highly leveraged, low-return and starving for loan and core deposit growth.  Yet by comparison, CRMT is self-funding (when not growing new units), has strong organic asset origination, and has high ROE’s with very little leverage. 

Since the stock trades at such a discount to appraisal value, it appears that most investors do not appreciate what a great and growing business this is.  Granted, there are effectively no barriers to the used-car business, neither on the auto-sales side nor on the financing side.  There are periods when the industry does earn high returns, but over the long term, across cycles, there appears to be little enduring economic profits.  Whenever the business heats up, there’s plenty of new entry, especially on the financing side.  Yet since coming public in the mid-90s, CRMT has averaged mid-teen ROEs, employing very little leverage (~1.5x assets/equity).  These high returns are derived from a combination of its strong management team and its small town focus.  These do not equate to an enduring moat, but they are nonetheless a moat today.  In essence, CMRT is a finance and relationship business.  Most used car dealers rely on outside financial institutions to supply the bulk of their customers’ financing, but CRMT totes the note on each car it sells.  Just like with a small town, relationship-based bank, strong management can earn high returns.  On this front, CRMT’s management is grade A.  Most of the top brass, including CEO Hank Henderson have been with CRMT over 20 years.  The COO started as a dealership manager in 1984.  Recently, they’ve recruited execs from nearby Wal-Mart.  Since it operates only in small towns, CRMT is better equipped to underwrite character-based loans.  “In our small towns, we know who has bad reputations.  Besides, customers know they’ll run into us Friday night at the high school football game or Sunday in church.”  The buy-here-pay-here business is literally that.  80% of customers make payments onsite every 2 weeks.  This repeat face-to-face interaction improves collections and drives repeat purchases, leading to lower loss-rates, higher sales, and better ROIs. 

I appraise the current earnings power of the business at ~$40-45 (no unit growth), which implies just a 9% return on reproduction value.  Yet we have confidence that over time this management team should be able to steadily grow the business at high incremental returns. 

Financials

Background

Founded in 1981 CRMT is one of the largest buy-here-pay-here(BHPH) used car dealers with 110 dealerships in small towns (less than 50K persons) across 9 states in the south-central US.  Approximately 45% of revenues are derived in Arkansas.  This is as much a finance business as it is a used car business.  Through its Colonial Auto Finance subsidiary, CRMT carries the paper on each car it sells.  The average lot sells ~28 units/month.  As dealerships age, average unit sales rise due to a growing mix of sales to repeat customers.   About half of its lots are now mature (10+ years), though this mix will decline now that the company is again ramping dealership growth.  Management aims to grow the dealership base organically by about 10% annually.  This team is conscientious about properly managing growth since they screwed up on this front several years ago.  They stumbled as they realized that they didn’t have an adequate corporate infrastructure to support unit growth.  Hence, they halted dealership growth, while they worked on building up this infrastructure as well as correcting sub-managed new dealerships (mostly in Texas).  They have since recruited some senior talent from neighboring Wal-Mart (in IT, collections data analytics, and HR), and today management is confident that they have the infrastructure in place such that their platform could now support up to $1 billion in sales.  Its lack of online initiatives, however, could be a concern in time if they continue to neglect this avenue for marketing and collections.  CRMT has a healthy balance sheet (only 1.5x assets/equity) and has been strongly free cash flow positive (which mgmt has used to buy back almost 20% of its stock in the past 2 years).   Customers– CRMT sells to the lowest tier of the BHPH industry, serving less affluent, blue collar customers who have limited financial resources and bad or limited credit history.  CRMT focuses on providing great customer service as much after the sale as before it.  Sales reps hold the customer’s hand through the entire loan process, from the application, through the life of the loan (which averages 27 months), right down to the last payment.   About 80% of its customers make payments in person every couple of weeks at the dealership.  This constant face-to-face interaction builds relationships, which both improves collections and improves the odds that the customer buys their next car at CRMT.   At mature dealerships (+10 years), ~40-50% of the customers are repeats or referrals.  A Typical Sale – The customer puts down 4-10% on a $9,500 car (which cost CRMT $3,000-6,000), and finances the balance with a loan that has a 15% interest rate and 26 month term.  Loan losses hover pretty consistently between 20% and 22%.  Primary research contacts tell us that, relative to competitors, CRMT’s short payment terms and comparatively low interest rates are impressive, especially in this environment.  Although its customers are price sensitive, ~90% elect to buy a 5 month/5,500 mile service contract for $395 and a payment protection plan for about $325.  These add-on products are negligible in terms of profits to CRMT, yet they greatly improve the odds of keeping the customer current on their payments, since they help ensure the auto remains in working condition.  (Customers stop paying if a car dies on them.)  Repossessed vehicles are typically sold to the wholesale market and increase the company’s COGS, thus crimping GM’s.  Although repossessions are up modestly, so are wholesale used car prices, which has fortunately mitigated some GM pressure.  Competitors – Primary competitors include numerous small BHPH dealers, independent dealers, franchise dealers, and on the financing side, banks and 3^rd party lenders.   The number of independent BHPH dealers has fallen 12% since 2007, yet companies like J.D. Byrider (180 dealerships), CRMT (108) and Drive Time (86) have scaled.  Still, the market is highly fragmented, considering these top 3 companies collectively make up less than 6% of the total BHPH market.  Geographically, these 3 competitors largely stay out of each other’s way, and each specializes in a slightly different customer (CRMT focuses on the lowest-end).  After many subprime lenders exited the market following the ‘08 crisis, many have begun to re-enter.  During the crisis, however, subprime loan approval rates dropped from 69% to as low as 13% by the end of 2010.  Primary research calls indicate, however, that subprime lenders are slowly coming back.  Unit sales per independent dealer increased ~16% from 2007 to 2010, and thanks to the tightening supply of used car inventory, ASPs rose 5% in ’09 and 7% in ’10, the second largest increase in over 16 years.  The next cycle of inventory is expected to hit the wholesale market in 2014-2015.  Economics -  The BHPH is a lending business, and thus a people business predicated on sound underwriting and the ability to keep delinquencies and charge-offs to a minimum.  There is no real moat on this business.  Like a good restaurant, it’s all about management and their ability to execute.  CMRT focuses on small towns, so like any well-run small town bank, they should have a modest advantage over competitors operating in larger cities, since it is easier to know the character of its borrowers.  As management says, “Our borrowers know that they’ll see us at the high school football game on Friday night and in church on Sunday.”  Still, CRMT has no local scale advantage.  Hence, we should not assume it current moat is enduring long-term.