World Acceptance ("WRLD") is an installment lending business serving low-income customers, mostly in red states. WRLD has a multi-decade track record of strong returns on capital across the business cycle, but, for the last several years, revenues and earnings have declined as the company dealt with two significant problems: (i) a Consumer Financial Protection Bureau (“CFPB”) regulatory investigation and (ii) lack of new customers which pressured financial performance. As detailed below, the regulatory problems have been resolved, the company has returned to growth, and, aided by tax reform, the company's earnings should grow significantly. Further, WRLD is extremely over-capitalized and with its regulatory problems behind it, we believe it is likely to aggressively repurchase shares in order to lever up to its conservative target of 2x debt-to-equity (vs 0.8x today). Our base case target price is $175/share based on mid–teens P/E applied to $13-15/share EPS in FY2020 discounted back. We believe that continued business momentum, aggressive share repurchase, and short covering (thesis broken, but still 1.2 million shares short out of a float of 4.7 million!) will aid convergence.
The company has been written up in the past on VIC so we have skimped on background and focused on what has changed.
CFPB no longer a problem
WRLD makes installment loans to mostly lower income subprime customers. Given WRLD’s large size and the interest rates in the installment lending industry, the company has always been a target of consumer advocates. In 2013, ProPublica ran a lengthy expose painting WRLD's business practices in a bad light, particularly its selling optional insurance to borrowers, encouraging frequent loan renewals, and aggressively collecting debts. The article did not allege that any of WRLD's business practices were illegal, just that they were predatory and, in some cases, employees weren't following the rules. In March of 2014, the CFPB launched an investigation that we believe was motivated by the ProPublica piece. While the CFPB never made public accusations about WRLD, it did issue WRLD a Notice and Opportunity to Respond and Advise (“NORA”) in August of 2015, which indicated that the agency was preparing to sue the company. The threat of the CFPB attacking WRLD's business practices caused WRLD's bank group to shut off the company’s ability to repurchase shares - WRLD had historically been an aggressive repurchaser. From 2014 to 2016, the bank group reduced its commitment from $680 million to $370 million, and WRLD was forced to de-lever from roughly $580 million to $380 million (less than 1x equity).
With the November 2017 appointment of Acting Director Mick Mulvaney, the CFPB has taken a new approach to regulation. Whereas the agency had previously "pushed the envelope" and used the Dodd-Frank prohibition on unfair, deceptive, or abusive practices (“UDAAPs”) to bring enforcement actions against companies for well-known practices previously thought to be legal, the agency would now take a more measured approach. Specifically, according to Mulvaney, companies will not be charged with breaking rules unless those rules are clearly articulated. Consistent with that approach, WRLD received notice from the CFPB in January 2018 stating that it would not be bringing an enforcement action against the company or require any changes to its business practices.
We believe that the regulatory philosophy embraced by the next permanent director will be similar to Mulvaney's (see short memo articulating it here: https://www.documentcloud.org/documents/4357880-Mulvaney-Memo.html), and should position WRLD well through at the least summer of 2023. We also believe that, in responding to a difficult regulatory environment, WRLD has benefited from certain business improvements -- such as improving compliance, eliminating small dollar renewals, and ending field calling -- that improve the customer experience and better position the company for the long-run.
Growth engine re-invigorated
In the final years of CEO Sandy Maclean's leadership, WRLD prioritized EPS by focusing on growing balances within the existing customer base. When the new management team led by Janet Matricciani took over in 2015, the new customer funnel was in terrible shape. With a couple years of revamping marketing and IT, the new team has rebuilt the funnel to the point where the company is again growing balances, and doing so through new and returning customers. We expect the recent mid-single digit loan growth to accelerate to the high single digits as initiatives continue to roll through, positioning the company for double digit medium term earnings growth (ex-repurchase).
Broken short thesis
The short thesis on WRLD have been that (i) regulators would blow up the company, (ii) the company hides the inability of its borrowers to pay back by extending and pretending with refis, and (iii) the brick and mortar business model is becoming obsolete. It is clear that the odds of a regulatory blow-up in the next several years are much more remote given the recent actions by the CFPB. The only remaining regulatory issue is their self-reported Mexican FCPA violations, which are not large in relation to the company (see below). To be sure, WRLD's period of customer declines temporarily bolstered the obsolescence thesis. However, even during this period of soft demand, cash generation was strong enough to pay down $200 million of bank debt, refuting the “extend and pretend” thesis. The company's recent growth is demonstrating that the business remains viable with the forward-leaning strategy implemented by the new team.
There is now no good reason to be short the stock.
FCPA hiccup in Mexico
Through a spring / summer 2017 investigation prompted by a whistle blower, WRLD appears to have discovered improprieties in its Mexican operations, which account for 8% of revenues. Our conjecture is that bribes had been paid to Mexican union officials in order to induce the repayment of loans. WRLD launched a thorough independent investigation and turned over the findings to the DOJ and SEC. It has also fired some Mexican employees and is exiting the business line that makes loans through these unions. It is conceivable that it may sustain write-downs as it collects on remaining loan balances from customers during its wind down, but the net receivable balance is currently very small (i.e. less than $20 million) and so there isn’t much left to write down. We believe that WRLD may have to pay fines to the DOJ and SEC at some point, but we believe that the impact of any fines and associated costs will not be material considering the small scope of the business in question.
In January 2018, CEO Janet Matricciani left the company. We believe that Matricciani is a turnaround specialist, and is no longer needed in that capacity. With the operations strong we do not see risk around this management transition; however, we acknowledge its something potential new investors should diligence.
Putting it all together
WRLD trades at 11x forward earnings estimates that we believe to be too low. Recent trends and leading KPIs suggest double digit earnings growth. The company, with a current market cap of $960 million, has the ability and apparent intention of returning large amounts of capital -- we estimate it could be $600 million over 4 years. The float is tight, the holder base concentrated in long-term investors, and ~1/4 of the float is short on a broken thesis.
Risks to our thesis:
-- Capital return could happen slower than we envision: WRLD is currently imposing a black-out of repurchasing due to the investigation into Mexican improprieties, which could linger on. Also, the bank group could make WRLD go slower than we envision.
-- Growth could flatten or decline: we have only seen a few quarters of evidence that the growth strategy is working. We find these quarters, when viewed in the context of the business changes, to be convincing evidence, but we could be wrong.
-- Credit could deteriorate: credit trends ticked down when the company ceased field calling, but have since stabilized at strong levels. The company has a very long track record of good collections across the credit cycle. We'd be surprised to see large problems with credit.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.
We believe that continued business momentum, aggressive share repurchase, and short covering will aid convergence.