EZCORP (EZPW), which is engaged in the second oldest business in the world, is a very good value investment play.
EZCORP, Inc., with a current market capitalization of $40 million, operates 283 pawnshops in twelve states primarily in the southeast. Roughly 80% of their stores are in Texas, Colorado, Oklahoma and Florida. Through its lending function, the Company makes relatively small, non-recourse loans secured by pledges of tangible personal property. The Company contracts for a pawn service charge to compensate it for each pawn loan. Pawn service charges generally range from 12% to 300% per annum.
The company generated EBITDA in the range of $20 to $21 million in 1997, 1998, and 1999. During this time they expanded the store count from 249 to 331 financed mainly with additional debt. At the same time, poor management, systems and operating practices caught up with the company. 2000 was a dismal year, with EBITDA of $5 million. This crisis ended up being a good thing. The company brought in a new management team headed by Joe Rotunda, who had previously been Chief Operating Officer of G&K services (symbol – GKSRA- current market cap $840 million. Prior to G&K, Mr. Rotunda was COO of Rent a Center (RCII – current market cap of $1.2 billion).
The new management team closed 54 under-performing stores, began a program to improve store operations and operating results, and reduce debt, which peaked at $83 million. This plan is working. EBITDA improved from $5 million in 2000 to $17.6 million in 2001. The EBITDA improvement centered around bringing average store pawn loan balances (per store) up closer to historical norms, reducing G&A expenses and better inventory turns and control. Debt was reduced from $81 million at the end of 2000 to $60 million at the end of 2001 mainly through store sale-leaseback transactions and use of free operating cash flow. Debt has further been reduced to $37 million at the end of March 2002 from the same means. Maintenance CAPX is less than $5 million a year for existing stores. The company does not plan to add stores until the turnaround is much further along.
Now lets look at the current value of the company relative to its performance and future potential. The company now trades at $3.30 share. The company has a book value of $8.62 share. The book is made up mainly of pawn loans, merchandise inventory and property and equipment. Tangible book equals $7.50 per share.
Enterprise value (equity value of $40 million; plus net debt of $37 million; less market value of EZPW’s equity investment in Albemarle & Bond of $16 million --A&B is a public London based pawn operator in the UK--) equals $61 million. EV to last years EBITDA equals 3.5X. EV to fiscal 2002’s projected EBITDA of $18.5 million, (with two quarters already in the books), equals 3.3X. Because of declining interest expense and improved operations, earnings per share should increase significantly this year. For the first six months earnings equaled $0.20 versus $0.09 cents last year. Full year earnings in fiscal 2001 were ($0.05). I think EZPW can earn $0.35 for full fiscal year 2002.
Historically, before EZPW’s meltdown in 2000, EZPW consistently traded at or above book value. Two other public pawn companies Cash America and First Cash currently sell at 110% and 102% of book respectively, and unlike EZPW, these companies book value includes significant non-tangible assets – mainly goodwill. I don’t think its to big a leap to conclude that if EZPW can trade at 90% of book value and 100% of tangible book value within a year if the turnaround continues. This would provide a return 131% from the stock price today.
NOW FOR THE GOOD PART - What is the catalyst to turn EZPW from a good solid value turnaround play in the short term with 100% price appreciation into a 300% to 400% gainer two to three years out -- based on a growth component? PAYDAY LOANS. Let me explain.
Payday loans are a fairly new financial product. They are short term unsecured loans “advanced” to the customer averaging 15 days. The typical net “fee” on the advance is $14 to $18 per hundred (for a 15 day period). The average “advance” size is $200 to $300. This works out to an interest rate of approximately 30% per month or 360% per year on the loan portfolio. EZPW had a payday loan portfolio balance of approximately $1.8 million at the end of December 2001.
A $1.8 million payday loan balance (which was the approximate balance at the end of December 2001) time’s 30% interest for three months equals $1.65 million. Subtract from that bad debt which averages approximately 20% and the net is a little over $1.3 million. They charge off to bad debt immediately any loan, which is not paid in full. Historically, they latter collect about ½ of this amount. At the time of collection, bad debt expense is decreased by the same amount. EZPW numbers and ratio’s are in line with others in the business if not slightly better to date. EZPW confirmed in its last conference call that payday loans added approximately $1.5 million to income for the quarter.
EZPW ‘s current payday loan balance is in range of $8,000 per store – on average, and is currently offered in 217 out of 280 stores. Stand alone payday loan stores can create payday loan balances of $50,000 to $150,000. EZPW is now just in the initial stage of building the payday loan product business in their existing pawn stores, adding to each store’s operating leverage. Let’s say that EZPW created even $25,000 average payday loan balance per store. With 280 stores, $25,000 average payday loan balance per store would create a portfolio of $7.0 million and would add $20 million to EBITDA (with current economics of the product). Now you have a company with $40 million EBITDA (without any other improvements). Give it a multiple 5X and you get a $200 million valuation. Deduct net debt (debt less value of their investment in Albemarle & Bond) and you get a share price of $15.00, a multiple of 4 times the current share price.
Will the payday loan product eat into the pawn loan business, as it becomes maturer? (Pawn loan balance per store for EZPW equals about $150,000 currently). EZPW management says that they tend to be slightly different markets, all payday loan customers must have a bank checking account, since they write a postdated check to the store at the time the “advance” is given. Most pawn customers do not have a bank account (in fact 30% of all adults in US do not have a bank account).
The operational turnaround --in process for last year and a half -- reverses for some reason.
Some sort of negative legislation regarding payday loan product. There has been some consumer groups lobby against the product, but not much impact to date.
Company is unable to refinance its credit facility, which is due later this year.
Not much liquidity in the stock now. Very thinly traded. This may change for the better if company continues to post better results.
Continuation of operational turnaround at the stores
Growth of payday loan product
Refinancing of credit facility expected later this year