WORLD ACCEPTANCE CORP/DE WRLD
May 15, 2020 - 4:33pm EST by
bentley883
2020 2021
Price: 54.38 EPS 0 0
Shares Out. (in M): 7 P/E 0 0
Market Cap (in $M): 383 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0 0

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Description

Investment Overview:
Taking a contrarian position, we are long the shares of consensus "Sell" rated World Acceptance
(WRLD), one of the largest sub-prime US installment lending companies with 1,243 branches
across 16 states. WRLD has seen its stock fall ~69% in the last 9 months (-50% prior to February)
based on investor’s misunderstanding of recent accelerated growth in WRLD’s business. WRLD
has a 20+ year track record of high teens compounded book value per share growth and 20%+
ROE’s. With ~27% of the float short and ~26 days to cover, we believe now is the time to invest
in WRLD as its share price is temporarily depressed because of investor misinformation around
near-term earnings power and we believe the short thesis will soon be proven wrong.
 
WRLD’s short thesis has been consistently debunked and has evolved over time. For years there
was concern around regulatory scrutiny, yet WRLD was found blameless under one of the most
aggressive enforcement divisions of the CFPB run by Richard Cordray. The new short thesis is
that WRLD is close to its debt covenants because of CECL and that charge-offs, which are
elevated, will keep rising. These are easily debunked - WRLD generated a significant amount of
income and cash flow in the important March quarter and management stated there is a lot of
headroom on their debt covenants. Management has guided that charge offs should start to
come down as the mix on new customers moderate and the portfolio becomes seasoned. The
only reason charge offs are elevated is because WRLD has been growing its loan book rapidly,
and that new customer charge-offs are initially at higher rates. Our calls with both management
and an analyst on the short side indicate that the shorts are misinformed about WRLD’s
business model and strategic plans.
 
A critical part of our investment thesis on the stock is that WRLD’s business has not significantly
changed from a structural perspective relate to the past, and that following a period of a couple
of years where the company has dealt with a number of temporary issues, the financial model
will mean revert back to prior historical levels. WRLD is currently investing in significant new
customer growth, which has temporarily depressed ROE’s and earnings. On normalized
earnings, WRLD is currently trading a P/E of ~5.1x, and we expect normalized earnings to more
than double in the next 5 years. We think WRLD has the potential to be a $250-300 stock in 5
years based on management’s 5-year target of $25/share in EPS, which given the current
~$54/share price, gives us a large margin of safety. Additionally, we view WRLD as a low risk
investment, given decades of consistent growth and profitability and an under-levered balance
sheet.
 
The other significant driver of growth in the next few years will be ongoing buybacks. Prescott
General Partners, a successful Florida-based value fund and longtime board member, owns
~26% and is driving for all of WRLD’s net income to be allocated towards share repurchases. We
expect WRLD to lever back up to its historical 2x debt/equity over the next few years, which will
free up additional capital for buybacks.
 
We believe GAAP consensus sell-side EPS forecasts over the next few years significantly
understates normalized earnings, which we believe are north of $10/share. Historically, WRLD’s
ROE has ranged between 20-30% and book value per share (BVPS) today is ~$59.47, leading to
normalized earnings of $10+/share. As new customer growth moderates and the portfolio
becomes more seasoned over the next few years, the company will return to its 10-year ROE
average of 20%+ and EPS will grow towards $25/share. With the share price cut by ~69% from
the July 2019 high, significant buybacks in the future, and investor expectations low, we believe
a large short squeeze is a likely and will be a catalyst to a drive a significant share increase.
 
 
Steady State Earnings Power:
Below is a model showing our assumptions to arrive at steady state earnings. The average
charge offs over the past twenty years were 14.6%. We are assuming 15% charge offs in our
analysis to be conservative. Stock based compensation should be added back because WRLD
has a unique stock compensation program that is front end loaded on the income statement
and is temporarily depressing earnings. Stock compensation on the income statement will be
de minimis in a few years, and so should be treated as a temporary expense.
 
 
 
Sensitivity of EPS to Charge offs:
The below analysis shows the sensitivity of earnings to charge-offs, and also why earnings are
temporarily depressed. Charge-offs are elevated as WRLD grows their loan book because new
customers charge-offs are initially at higher rates. As new customers become a smaller portion
of the overall book, charge-offs will decline and earnings will increase.
 
 
 
5-Year Steady State Directional Model (FYE March):
The following is a 5-year financial model we created prior to the impact of the COVID-19 crisis
to illustrate the general direction WRLD’s financial model will evolve based on the company’s
growth plans and charge-offs mean reverting back to steady state levels. However, we
recognize that it is likely that results in the next couple of quarters will temporarily weaken due
to the impact from the virus on the economy and lenders like WRLD tightening lending
standards, and as a result FY20 results will fall below our projections. Thus, our estimates are
not intended to suggest precision, but to illustrate directionally how the model should
evolve. As our model significantly differs with sell-side consensus estimates over the next few
years, should the company come anywhere close to delivering on management’s 5-year target
for EPS of $25/share it will likely result in a major shift in investment sentiment, large upward
earnings revisions and significant share appreciation.
 
 WRLD - 5-Year Directional Model
 
 
The above model assumes 30 branches per year (per management estimates and recent
trends), as well as 5% SSS growth in loans, also in line with recent trends. We assume WRLD
returns to a 30% EBIT margin, which was its average EBIT margin over a 17-year period from
2000-2017 (we exclude 2018 and 2019 because EBIT margins were depressed due to higher
than normal growth and temporary costs dealing with their Mexico division). We would also
note that our 5-year growth assumptions could prove conservative; WRLD grew revenues in the
teens for 14 years in a row (including 2008/2009). We think it is very possible WRLD can
compound revenue growth higher than our estimates.
 
Growth Accelerates But At A Temporary Cost:
With the regulatory issues behind the company, new CEO Chad Prashad has instituted a
number of internal changes focused on growing the business. These include improvements to
marketing programs, enhancing the company’s digital footprint, revised employee incentive
programs, expanding the income tax preparation business, and opportunistic acquisitions. The
result is that over the last 18 months, WRLD’s organic growth has improved with a significant
increase in its base of new customers and an acceleration in the company’s gross loan portfolio.
Additionally, following a period of stagnant growth in new branch openings in the FY14-FY17
period, there has been a renewed focus on opening new branches on a de novo basis as well as
thru acquisitions and asset purchases.
 
 
As a result of WRLD’s growth initiatives, over the last 6 quarters, there has been a notable
acceleration in the growth in WRLD’s gross loan portfolio. This is illustrated in the chart below.
Noteworthy, the increase in the recent March quarter came despite a 2+ week impact from
COVID-19.
 
 
Over the last 3 years WRLD’s gross loan portfolio has grown by 28%. The following table
illustrates the acceleration in growth over the last 3 years and the change in mix of the loan
portfolio:
 
 
The acceleration in growth, especially from new and acquired customers has come at a
temporary cost. The rapid growth in new customers during the last 3 years, from 27.2% in FY17
to 34.5% in FY20, has dramatically shifted the portfolio weighting of customers who are new to
the company. After declining in the FY15-FY17 period, new customer growth has increased
significantly in recent quarters. At the end of the March 2020 fiscal year there was a 63%
increase over the last 3 years in the total loan portfolio from customers who have been with
the company less than two years compared with 15% growth from customers with more than 2
years tenure.
 
While it is very profitable to acquire customers over the long term, in the short term, new
customers have higher charge-off rates. As a result, over the last few quarters charge-offs have
increased notably above the long-term average. The investment in growing new customers is
temporarily depressing earnings; in the March quarter charge-offs jumped to a record high of
20.1%. Over the last 4 quarters charge-off’s have averaged 17.8%, which is well above the 10-
year average of 14.6%. Noteworthy, management indicates that charge-offs from seasoned
customers of over two years have remained consistent. The following table presents the
Company's charge-off ratios over the last 20-years since FY 2000.
 
 
Due to current FASB accounting, the increase in overall charge-offs have increased the
provisions expense flowing through the income statement, depressing both GAAP profitability
and ROE. The chart below shows the recent decline in WRLD’s ROE, which is currently well
below its 20-year through-the-cycle average of 21.4%. We believe once charge-offs begin to
mean revert back to historical averages, ROE will also return closer to the company’s traditional
returns as new customers season and WRLD recognizes the high LTV of that customer.
 
 
Why The Sell-Side is Wrong:

The shares of WRLD are unloved among sell-side analysts. As per FactSet, three of the four analysts covering

the company have a "Sell" rating on the shares, with a consensus price target of $43/share. Consensus EPS

forecasts for FY21/22 (March fiscal year) are for $5.18/$5.65 per share. The take-away's are that investor

expectations are very low and it appears that consensus forecasts do not assume much impovement in

charge offs looking out 12-24 months.

 
After speaking with management we decided to discuss our thesis with one of the sell-side analysts.
We found it interesting to compare the notes from our call with the CFO with our notes with a
sell-side analyst to highlight why we believe the sell-side is misinformed and wrong. We think
the contrast between the two highlights why the mispricing exists.
 
Notes from our call with John Calmes, WRLD’s CFO:
 
New customers charge off at a much higher rate, but over time that will stabilize, at which point
the provision comes down significantly, but as they become a smaller portion of the loan book
revenue remains stable and margins expand. The market seems to have taken the position that
this is not the case but long-term shareholders understand the story. We can absolutely get
back to 9-10% ROA’s and 20%+ ROE’s. The $25/share target was made with the idea that it was
achievable. BVPS growth should accelerate over the next couple of years because the cost of
the plan will come down dramatically. Also, revenue should keep growing but provisions should
come down or become flat as the mix changes.
 
Q: Can EBIT/branch go back to $155,000/branch level?
 
A: Yes, I think it can exceed that level. It is possible and we are approaching it that way. We are
trying to maximize profit per branch by growing accounts per branch and increasing accounts
per employee.
 
Operating leverage comes from increasing accounts per employee. We’re at 270-280 accounts
per employee, the goal is to be at 350.
 
Notes from our call with a sell-side analyst:
 
We had a productive discussion with a sell-side analyst whom we are leaving unnamed. He
came out of the gate very negative in his views on WRLD, but by the end of the discussion he
admitted he understood why we would be long on the stock. He also was not able to disprove
any part of our thesis.
 
Rationale for valuation:
Regional Management (RM) and One Main Financial (OMF) trade at 6.5x and RM at 7x.
So, a low $40’s PT is not out of the question.
 
As the call progressed, we felt we changed his mind for a few reasons:
 
He is comping WLRD to OMF (which is 7x levered vs 1x for WRLD), and RM (which is
more levered and earns half the ROE’s WRLD does).
He stated that WRLD management does not return his calls given the sell rating he has
on the stock; therefore, he is not able to be fully up to date on their thinking and
planning.
He is worried about CECL and the debt covenants, but as per the cash generation in the
recent Q4 results and managements comments, this will not be an issue.
While he has a spike in charge offs in his forecasts, we believe charge offs will either
remain flat or come down.
 
He did not dispute our thesis that the business could easily return to prior profitability levels,
and if that is the case, $25/share is achievable. We agreed on several things:
The company has now underwritten profitably for decades.
WRLD is a countercyclical business, which is something great to own if you are worried
about a recession.
The business has not fundamentally changed, which means it should be able to return to
historical margins.
WRLD’s regulatory issues should stay contained to a state by state basis, and that WRLD
primarily operates in Republican states, and therefore should not have significant
regulatory issues unless a Democrat wins in office and the Senate, which most observers
believe has a low probability of occurring.
 
Reversion To Mean Levels Of Profitability & ROE, Combined With Share Buybacks, Will Drive
A Rebound In Earnings:
As illustrated in the following table, WRLD is a company with a 20+ year proven business model
as well as a track record of growth and delivering strong earnings, cash flow and financial
returns. During the 10-year thru-the-cycle period between FY05-FY15 WRLD recorded a
revenue CAGR of 11.2%, EPS growth of 21.2%, FCF growth of 19.1% and a 13.4% growth in book
value/share. A critical part of our investment thesis on the stock is that WRLD’s business has
not significantly changed from a structural perspective relative to the past, and that following a
period of a couple of years where the company has dealt with a number of temporary issues,
the financial model will mean revert back to prior historical levels.
 
 
As discussed, the recent increase in charge-offs is mostly tied to the growth in new customers,
which we believe will continue and help drive revenue growth in the 6%-8% range over the next
few years. Revenue growth should be split between 2-3% branch growth and 4-5% SSS growth
per branch. As recent vintages of new customers acquired over the last few years begin to
season and help offset new customer growth, we believe overall charge-offs will peak during
the current fiscal year. Thus, profitability and ROE should begin to mean revert closer to more
normalized levels in the next 18-24 months. The improvement in margins combined with
continued aggressive share repurchases should result in a ~$25+ EPS CAGR in GAAP earnings
over roughly the next 5 years. Again, this estimate is directional in nature and not meant
to be specific in the time period.
 
Once the mix normalizes, 0-6 month & 0-12 month customers will become a smaller portion of
the portfolio and loss rates and delinquencies will drop dramatically resulting in higher
revenues and less provisioning. When that turn happens, EPS will grow rapidly.
 
The below analysis highlights the major assumptions to achieve management’s target of
$25/share in EPS in 5 years. As illustrated, they do not make any heroic assumptions, and are
even below historic levels.
 
 
Absolute & Relative Valuation Disparity With Significant Upside Share Potential:
Today, WRLD is trading around $54/share, or 5.1x normalized EPS. While there are few real
comparable companies to compare WRLD, we think Credit Acceptance (CACC) - a sub-prime
auto lender is the best comp. Prescott’s Scott Vasaluzzo is on the board of both companies, and
we believe he intends to advise both companies similarly. CACC has averaged ~14.5x earnings
over the past 5 years. Using CACC as a comp leads us to a price target of $150/share today on
normalized EPS. If management hits its 5-year target of $25/share, WRLD should be valued in
the $250-$300 range in 5 years. However, to be more conservative, we looked back historically
as to the multiple that WRLD traded at in the 15-year period prior to when the company began
to experience some of its recent issues beginning in FY16. As illustrated below, during this
period WRLD’s forward P/E multiple averaged 10-12x.
 
 
Using the midpoint of this historical multiple suggests the shares should be valued at
~$120/share on normalized EPS. Moreover, looking out to the future, should management
deliver on its 5-year $25/share EPS target (which could be delayed somewhat due to COVID-19),
the shares could trade in the $250-$300/share range compared with the current ~$54/share
stock price. As per our 5-year financial model, this price target is not intended to imply
precision, but to directional illustrate what we believe is the significant upside potential as
well as the margin of safety in the shares due to the current mis-pricing associated with
investor misunderstanding of charge-off’s and the company’s growth potential. The point we
are trying to illustrate is that if management comes anywhere close to delivering on its 5-year
earning target the shares could be up many multiples of the current stock price.
 
COVID-19; A Temporary Pause Similar To Others, But Structurally Nothing Has Changed:
Commenting on the impact of COVID-19 on its business during the March investor call WRLDS
management noted the following:
originations were healthy, growing +5-10% until about March13th when they began to
see the COVID-19 impact on their business,
thereafter management proactively halted marketing and tightened underwriting
criteria,
the company saw a decline of about 50%-60% in their business in the second half of
March and in April saw the business drop ~80% from new customers and ~50% in
refinancing activity,
the company has seen very few charge-offs related to COVID, with most related to the
growth in new customers over the prior 12 months,
to date WRLD has not seen a dramatic shift in the quality of applicants coming in,
management stated that there is a lot of headroom on their debt covenants.
 
Thus, there appears to have been a temporary pause in the business due to COVID-19, but
structurally nothing appears to have changed. The company appear ready to reaccelerate its
growth when states begin to re-open and the crisis begins to abate. Thus, the next two quarters
will likely be temporarily depressed from a growth/earnings perspective due to the virus, but
we believe WRLD will be back on its growth path to achieving its long-term EPS goal later in the
year.
 
Helpful to WRLD’s recovery is the fact that many of the states in which the company has its
largest concentration of branches have or will shortly lift stay-in-place restrictions. The map
below illustrates the states which have lifted stay-in-place restrictions. The four states in which
WRLD has the largest number of branches (Texas, Georgia, Tennessee and South Carolina),
which combined account for about 50% of all branches, are open as of May 12
th. In total about 75% of WRLD’s branches are in states who have already lifted these restrictions as of this date.
 
WRLD Has A Heavy Concentration Of Branches in States
      That Have Lifted Stay-In-Place Restrictions
 
  
 
We believe the impact of COVID-19 on its business will be about consistent with that of other
sub-prime lenders. In general, comments from other sub-prime lenders suggest that the impact
of the virus began in the second half of March and somewhat temporarily froze the market for
a period relative to new originations. In response to the crisis and early sign of an increase in
delinquencies, most sub-prime lenders significantly tightened lending standards. The result of
these two actions has led to a significant drop in new originations. However, indications are
that initially delinquency rates rose modestly but importantly, despite the sharp increase in
unemployment levels, have leveled off. Also, with the passing of the CARES Act and the payroll
protection program, it appears that many sub-prime customers who missed payments have
begun to now make some payments. Noteworthy in this regard are the April 28
the comments from Enova’s CEO David Fisher: