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Nicholas Financial NICK
December 09, 2006 - 4:37pm EST by
valuearb856
2006 2007
Price: 11.60 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 116 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

How much would you pay for a company that’s grown same quarter revenues and earnings for 65 out of it’s last 66 quarters? That’s grown EPS from 12 cents per share to $1.08 per share over the last ten years (23.6% annualized).  A quality company with solid financials built solely through organic growth, (no rollup), with at least another decade of strong growth ahead in the U.S. market along. I understand, you’re a bargain type guy, and you don’t like to overpay for anything, even your wife’s engagement present. So how about if Mr. Market puts this hot little number on sale, just for a short time, at a little less than 11 times reported TTM earnings? Not interesting enough? What if earnings may be substantially understated?

Nicholas Financial (NICK) has been already subject to two excellent writeups. The first was by david101 at a split adjusted $3.06 per share in May of 2003 (46% annualized even at todays low price). Then engrm842 added another writeup a year later at a split adjusted $5.38 (36% annualized) when a secondary offering depressed NICK’s price. Kudos to both, their recommendations looked even better a few months ago with NICK near $14.50.

I recommend reading both writeups if you have the chance. What I’m going to do here is quickly layout NICK’s business model, why it’s grown so consistently, and the sustainable competitive advantage I think makes NICK a good long time hold. Then I’m going to tell you why Mr. Market recently put NICK on sale.

Nicholas Financial (NICK) is in the sub-prime automobile financing business. It has carved itself out a specialty niche, by being a very disciplined underwriter of such loans and by taking a different approach to credit verification of its customers than is customary throughout the industry.

Business Summary:
Nicholas Financial exists in the toughest part of the sub-prime auto lending business, and has a unique “hands on” approach that is responsible for high profitability and low loss rates with very low credit score clients.
Nicholas is based in Clearwater, Florida, and its core business offers auto financing through 45 branch offices in ten states, Florida, North and South Carolina, Virgina, Michigan, Ohio, Georgia, Kentucky, Indiana and Maryland.  What makes NICK special is a branch office driven approach. As opposed to other (mostly larger) lenders that centrally automate their approval and collection systems with a focus on maximizing loan productivity, Nicholas handles all clients through local branch offices, in order to get to know them more closely. This means the Nicholas office is close by when clients need to make payments, new applications, and most importantly, when collections are necessary.
Competitors use credit scoring as the main determinant of credit risk, allowing their central offices to process high volumes of loan applications and approvals to keep costs low. Nicholas feels credit scoring alone is in’t the most accurate gauge of individual client risk. Two clients with identical credit ratings can offer much different risk levels. Nicholas administers phone interviews with each client. This allows Nicholas to primarily measure risk through factors other than raw credit scores, such as income level, stability, “life” trend, type of vehicle and previous credit history. Credit scores only supplement those interviews. This allows NICK to “cherry pick” clients who have lower risk than credit scores alone would indicate. Even then, Nicholas turns down 85% of potential clients.
While each branch manager is responsible for purchasing loans, every contract purchased has to meet specific company guidelines. Nicholas’s typical auto loan is $9,100 with an APR of 23.82%, for a four year old car.  Typically NICK buys the loan from the dealer at a discount of 1-15% (average 8.32%), and the buyer pays 5-20% down. NICK generally will not loan more than wholesale value, and this along with the discounts provides it with a strong margin of safety on each loan. In addition, the company takes an additional reserve (typically 4%) on each loan when it’s placed on the books, and requires collision coverage with NICK as the payee on each loan.
And after the loan is approved, Nicholas branch managers and collectors will follow up relentlessly at any sign the account is slipping out of current status. During the interview, contact information was collected for friends, employers and relatives of the applicant to help with any necessary collection efforts. In the first 120 days Nicholas immediately contact the client the first day they are past due. Nicholas starts repossession proceedings at 30 days past due unless the client evidences a strong commitment to fix their delinquency. Nicholas is aggressive about pursuing legal remedies and repossession, much more so than the competition. It’s this high effort approach that allows Nicholas to have default rates similar to competitors, despite having clients who appear to be “riskier” due to lower credit scores.
Management creates static pools of loans, one per quarter per branch, to track branch office performance on a monthly basis. Each branch office is regularly audited by a company audit team to ensure loans and collateral are to company standards. Lastly, Nicholas doesn’t securitize their loans. Because they retain ownership, this provides strong incentive to only write quality loans, since NICK is stuck with them until payoff.
Key Financial Issues:
One of the most attractive qualities of Nicholas is that they do not securitize their loans. This makes their balance sheet clean and easy to understand, and contributes to their quality of earnings. By not securitizing, they actually take long term ownership of their loans. This provides a strong incentive to underwrite conservatively. Because of this, accounting is also conservative, loan discounts are kept as loss reserves and aren’t recognized until the pool is liquidated or the pool is determined to have excess reserves.
Loans are carried as “Finance Receivables, net”, reserved for as follows.
 
September 30, 2005
Finance receivables, gross contract
 $237,193,476
Unearned interest
-$65,217,551
Finance receivables, net of unearned interest
 $171,975,925
Dealer discounts
 -$11,559,119
Allowance for credit losses
 -$9,872,513
Finance receivables, net
 $150,544,293
 
At the end of Q2 the carrying value of all loans was $150M vs. a face value of $172M, a nearly 13% discount. There is also a 37% discount to gross contract value, i.e. face value plus unearned interest. Over the last two fiscal years $6.3M has been reserved for credit losses. Taxable income is actually higher than GAAP income since the IRS defers recognition of credit losses until incurred, this has created $3.9M in deferred tax assets. Netting out these two factors provided $8M in excess cash flow over reported income over the two years (80 cents per share). As long as Nicholas continues to grow profitably and over-reserve, excess FCF should continue for most years.
Nicholas funds all of it’s loans through a large revolving credit line with Bank of America (and three other participating banks), held since 1993. The revolver currently carries a rate of Libor plus 175 bp.
Leverage is very low in relation to its competition (1.35-1 Debt to Equity). Historically the ratio has been higher but a secondary offering in 2004 substantially increased equity. So the risk in the balance sheet revolves around the quality of loan reserves, and the fact it is borrowing short-term, to loan longer term. Since we think the reserves are strong, and the balance sheet is so lightly leveraged, we see both risks as limited or manageable. Part of the equity raised was no doubt raised to more aggressively expand the branch network. In the past 10 years, the company has doubled its branch network every 5 years. We expect this to continue, although it’s reasonable to expect at a lower rate.
The lower leverage since 2004 has had the effect of lowering ROE, which has declined into the 17% range since the secondary. From a conversation in early 2006, management expects the debt to equity ratio to increase as they grow and add more loans, but to stay under 2.5-1 for the next three years. They feel comfortable with any ratio of 3.5-1 or below.
One last interesting financial observation is that Nicholas does not appear to be trading much higher than a simple liquidation value calculation. Using current gross contracts (which includes all future interest) of $237M, and taking a 10% write-off rate leaves $213M. A 10% write-off should be conservative, since it’s not only well above today’s rate of 7.65%, but also above their historical high mark of 9.3% from the 2003 recession. Adding back cash of $1.7M and a 50% haircut to the remaining assets brings total assets to $219M. Deducting $10M for liquidation expenses (one year of salary expense) and $96M in balance sheet liabilities leaves $113M. This corresponds to a $11.30 per share liquidation value. Discounting (6% per year) for a four year liquidation process, gives a present day value of around $9.84..
Of the comparables we found, NICK has the highest ROE, the lowest debt to equity ratio, and the lowest PE ratio. Its loss ratio appears to be the lowest as well, though there is some apples to oranges variations in how different companies calculate that. Its price to book is essentially similar, despite the higher quality of its earnings. Its the only company we found that does not securitize its loans. NICK offers to investors a captive high yield portfolio, while other companies unload this risk and opportunity to third parties at significant discounts. Nicholas charges almost twice the interest rate (28%, while most competitors charge between 11-16%). This is due to the lower credit quality of Nicholas’s clientele (and older vehicles on average than the competition). Competitors growth rates are difficult to compare, because they have all shown losses and lumpy results, while Nicholas’ earnings are more steady because lack of securitization activities and high recurring interest income.
Nicholas’s branch based model, and the company’s historical proprietary database, provide an interesting proprietary aspect, or at a minimum seem to define its unique strategy. Competitors would need to radically change the way they do business, invest heavily to open local branch offices and train staff, while building up their own proprietary database of “high touch” interview factors to discern good clients from bad, and successfully compete for these loans. One comment that management made on a recent interview is that one of their biggest difficulties limiting Nicholas’ growth is finding good branch managers. They are not interested in hiring from some competitors if they believe the competitors employees are too “one dimensional”, lacking the entrepreneurial ability to manage all facets (account i.e. dealer management, loan origination, collection, hiring, etc) of a small business.
Nicholas’ real competitive threat is irrational pricing in the market. The sub prime financial business has gone through irrational pricing periods, until there is a shakeout and some firms go under. This has not happened since 1996-98 when cheap public money flooded the segment. So far, today’s competitors are more rational about pricing. If pricing turns unreasonable, Nicholas has been disciplined enough in the past to give up bad business rather than lose underwriting discipline. Evidence of this is found in 1997, revenues grew only 10% and profits 20% during a period of irrational price competition.
Management:
The two key executives are Peter Vosotas and Ralph Finkenbrink. Mr. Vosotas, age 64, is Chairman of the board, President and CEO. He founded the company in 1985. Mr. Finkenbrink, age 43, is CFO and SVP- Finance. He joined in 1988, and helped start the finance operation, becoming VP Finance starting in 1992.
There is a strong level of insider ownership. The CEO owns 16.4%, the CFO around 1%.  The Mahan family helped fund the Nicholas through a convertible offering in the early 90s, has lowered their ownership to about 11% of the business. Most of this occured during a secondary offering in May, 2004.

The Opportunity:

On Nov 2nd, NICK reported disappointing earnings (by it’s standards) in it’s second quarter. Net income only increased 10% year over year, and was actually down over first quarter (27 cents vs 29 cents).  In response, the stock declined to the low $11 range, and only recovered a little bit in the last few days.

A variety of factors are squeezing their results. Borrowing costs are up a half percent, while loan rates are static. Write-offs and charge-offs have increased. NICK has benefited in the past from a rosy economic climate, and it appears that we are in the part of the cycle where things are worsening. Finance receivables have only increased 15% year over year, and operating costs are up slightly proportionately. This leads me to suspect that several recently opened branches aren’t up to speed yet and this may be a drag on quarterly comparisons.

For specific items, increased interest costs are responsible for about a penny per share in lost earnings. They also lost about 5 cents per share due to interest rate swaps they use to hedge against their interest rate exposure, while the 2005 quarter benefited about 4 cents per share.

The question to ask, has anything material damated their business? I don’t think so. Periodically NICK has had to deal with higher default rates, and in the past it managed to always do this while continuing to grow at a strong pace. It's also likely that NICK’s future growth can't keep it's historic pace and this quarter might be the start of that.

The key number for me is that 15% growth in finance receivables. Even 15% per year is still excellent, and justifies a much higher PE ratio than it's currently trading at. And if this quarter was just a blip due to some branch openings, they should be able to do a bit better. They are still far from any real limites to their growth, as they still have many more states to expand into, as well as more markets in existing states. My belief is that we may have to deal with some slower growth in the short run if credit losses are higher, but in the long run earnings will keep up with financial recievables growth. Even if EPS growth over the next ten years slows to 15% per year, NICK should still be worth over $20 (a 20 PE) today. That's a heck of a discount to intrinsic value and a heck of an opportunity.

Catalyst

This has been a tremendous pick twice already without any real catalyst, so I don’t feel I need to offer one, so instead I’ll offer two. One of the reasons I own this stock is a believe in PE expansion. NICK is only a $110M market cap company, which I believe precludes it’s ownership by many institutional investors. I’m betting that NICK will be able to double earnings within four to five years and that larger market cap will put NICK increasingly on the radar of funds hungry for quality growth at a reasonable price. I think they’d find NICK a bargain at any PE below twenty.
The second potential catalyst is a private equity buyout. The CFO has been quoted in an interview this summer as saying they are being approached so regularly by private equity firms that it’s a standard point of discussion at their board meetings. The CEO is getting older and might want to retire. So it’s possible a deal may happen, but if it does I can’t see it happening unless it’s at a premium to the all time stock price high. My guess is at least $16-$17 per share today.
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    Description

    How much would you pay for a company that’s grown same quarter revenues and earnings for 65 out of it’s last 66 quarters? That’s grown EPS from 12 cents per share to $1.08 per share over the last ten years (23.6% annualized).  A quality company with solid financials built solely through organic growth, (no rollup), with at least another decade of strong growth ahead in the U.S. market along. I understand, you’re a bargain type guy, and you don’t like to overpay for anything, even your wife’s engagement present. So how about if Mr. Market puts this hot little number on sale, just for a short time, at a little less than 11 times reported TTM earnings? Not interesting enough? What if earnings may be substantially understated?

    Nicholas Financial (NICK) has been already subject to two excellent writeups. The first was by david101 at a split adjusted $3.06 per share in May of 2003 (46% annualized even at todays low price). Then engrm842 added another writeup a year later at a split adjusted $5.38 (36% annualized) when a secondary offering depressed NICK’s price. Kudos to both, their recommendations looked even better a few months ago with NICK near $14.50.

    I recommend reading both writeups if you have the chance. What I’m going to do here is quickly layout NICK’s business model, why it’s grown so consistently, and the sustainable competitive advantage I think makes NICK a good long time hold. Then I’m going to tell you why Mr. Market recently put NICK on sale.

    Nicholas Financial (NICK) is in the sub-prime automobile financing business. It has carved itself out a specialty niche, by being a very disciplined underwriter of such loans and by taking a different approach to credit verification of its customers than is customary throughout the industry.

    Business Summary:
    Nicholas Financial exists in the toughest part of the sub-prime auto lending business, and has a unique “hands on” approach that is responsible for high profitability and low loss rates with very low credit score clients.
    Nicholas is based in Clearwater, Florida, and its core business offers auto financing through 45 branch offices in ten states, Florida, North and South Carolina, Virgina, Michigan, Ohio, Georgia, Kentucky, Indiana and Maryland.  What makes NICK special is a branch office driven approach. As opposed to other (mostly larger) lenders that centrally automate their approval and collection systems with a focus on maximizing loan productivity, Nicholas handles all clients through local branch offices, in order to get to know them more closely. This means the Nicholas office is close by when clients need to make payments, new applications, and most importantly, when collections are necessary.
    Competitors use credit scoring as the main determinant of credit risk, allowing their central offices to process high volumes of loan applications and approvals to keep costs low. Nicholas feels credit scoring alone is in’t the most accurate gauge of individual client risk. Two clients with identical credit ratings can offer much different risk levels. Nicholas administers phone interviews with each client. This allows Nicholas to primarily measure risk through factors other than raw credit scores, such as income level, stability, “life” trend, type of vehicle and previous credit history. Credit scores only supplement those interviews. This allows NICK to “cherry pick” clients who have lower risk than credit scores alone would indicate. Even then, Nicholas turns down 85% of potential clients.
    While each branch manager is responsible for purchasing loans, every contract purchased has to meet specific company guidelines. Nicholas’s typical auto loan is $9,100 with an APR of 23.82%, for a four year old car.  Typically NICK buys the loan from the dealer at a discount of 1-15% (average 8.32%), and the buyer pays 5-20% down. NICK generally will not loan more than wholesale value, and this along with the discounts provides it with a strong margin of safety on each loan. In addition, the company takes an additional reserve (typically 4%) on each loan when it’s placed on the books, and requires collision coverage with NICK as the payee on each loan.
    And after the loan is approved, Nicholas branch managers and collectors will follow up relentlessly at any sign the account is slipping out of current status. During the interview, contact information was collected for friends, employers and relatives of the applicant to help with any necessary collection efforts. In the first 120 days Nicholas immediately contact the client the first day they are past due. Nicholas starts repossession proceedings at 30 days past due unless the client evidences a strong commitment to fix their delinquency. Nicholas is aggressive about pursuing legal remedies and repossession, much more so than the competition. It’s this high effort approach that allows Nicholas to have default rates similar to competitors, despite having clients who appear to be “riskier” due to lower credit scores.
    Management creates static pools of loans, one per quarter per branch, to track branch office performance on a monthly basis. Each branch office is regularly audited by a company audit team to ensure loans and collateral are to company standards. Lastly, Nicholas doesn’t securitize their loans. Because they retain ownership, this provides strong incentive to only write quality loans, since NICK is stuck with them until payoff.
    Key Financial Issues:
    One of the most attractive qualities of Nicholas is that they do not securitize their loans. This makes their balance sheet clean and easy to understand, and contributes to their quality of earnings. By not securitizing, they actually take long term ownership of their loans. This provides a strong incentive to underwrite conservatively. Because of this, accounting is also conservative, loan discounts are kept as loss reserves and aren’t recognized until the pool is liquidated or the pool is determined to have excess reserves.
    Loans are carried as “Finance Receivables, net”, reserved for as follows.
     
    September 30, 2005
    Finance receivables, gross contract
     $237,193,476
    Unearned interest
    -$65,217,551
    Finance receivables, net of unearned interest
     $171,975,925
    Dealer discounts
     -$11,559,119
    Allowance for credit losses
     -$9,872,513
    Finance receivables, net
     $150,544,293
     
    At the end of Q2 the carrying value of all loans was $150M vs. a face value of $172M, a nearly 13% discount. There is also a 37% discount to gross contract value, i.e. face value plus unearned interest. Over the last two fiscal years $6.3M has been reserved for credit losses. Taxable income is actually higher than GAAP income since the IRS defers recognition of credit losses until incurred, this has created $3.9M in deferred tax assets. Netting out these two factors provided $8M in excess cash flow over reported income over the two years (80 cents per share). As long as Nicholas continues to grow profitably and over-reserve, excess FCF should continue for most years.
    Nicholas funds all of it’s loans through a large revolving credit line with Bank of America (and three other participating banks), held since 1993. The revolver currently carries a rate of Libor plus 175 bp.
    Leverage is very low in relation to its competition (1.35-1 Debt to Equity). Historically the ratio has been higher but a secondary offering in 2004 substantially increased equity. So the risk in the balance sheet revolves around the quality of loan reserves, and the fact it is borrowing short-term, to loan longer term. Since we think the reserves are strong, and the balance sheet is so lightly leveraged, we see both risks as limited or manageable. Part of the equity raised was no doubt raised to more aggressively expand the branch network. In the past 10 years, the company has doubled its branch network every 5 years. We expect this to continue, although it’s reasonable to expect at a lower rate.
    The lower leverage since 2004 has had the effect of lowering ROE, which has declined into the 17% range since the secondary. From a conversation in early 2006, management expects the debt to equity ratio to increase as they grow and add more loans, but to stay under 2.5-1 for the next three years. They feel comfortable with any ratio of 3.5-1 or below.
    One last interesting financial observation is that Nicholas does not appear to be trading much higher than a simple liquidation value calculation. Using current gross contracts (which includes all future interest) of $237M, and taking a 10% write-off rate leaves $213M. A 10% write-off should be conservative, since it’s not only well above today’s rate of 7.65%, but also above their historical high mark of 9.3% from the 2003 recession. Adding back cash of $1.7M and a 50% haircut to the remaining assets brings total assets to $219M. Deducting $10M for liquidation expenses (one year of salary expense) and $96M in balance sheet liabilities leaves $113M. This corresponds to a $11.30 per share liquidation value. Discounting (6% per year) for a four year liquidation process, gives a present day value of around $9.84..
    Of the comparables we found, NICK has the highest ROE, the lowest debt to equity ratio, and the lowest PE ratio. Its loss ratio appears to be the lowest as well, though there is some apples to oranges variations in how different companies calculate that. Its price to book is essentially similar, despite the higher quality of its earnings. Its the only company we found that does not securitize its loans. NICK offers to investors a captive high yield portfolio, while other companies unload this risk and opportunity to third parties at significant discounts. Nicholas charges almost twice the interest rate (28%, while most competitors charge between 11-16%). This is due to the lower credit quality of Nicholas’s clientele (and older vehicles on average than the competition). Competitors growth rates are difficult to compare, because they have all shown losses and lumpy results, while Nicholas’ earnings are more steady because lack of securitization activities and high recurring interest income.
    Nicholas’s branch based model, and the company’s historical proprietary database, provide an interesting proprietary aspect, or at a minimum seem to define its unique strategy. Competitors would need to radically change the way they do business, invest heavily to open local branch offices and train staff, while building up their own proprietary database of “high touch” interview factors to discern good clients from bad, and successfully compete for these loans. One comment that management made on a recent interview is that one of their biggest difficulties limiting Nicholas’ growth is finding good branch managers. They are not interested in hiring from some competitors if they believe the competitors employees are too “one dimensional”, lacking the entrepreneurial ability to manage all facets (account i.e. dealer management, loan origination, collection, hiring, etc) of a small business.
    Nicholas’ real competitive threat is irrational pricing in the market. The sub prime financial business has gone through irrational pricing periods, until there is a shakeout and some firms go under. This has not happened since 1996-98 when cheap public money flooded the segment. So far, today’s competitors are more rational about pricing. If pricing turns unreasonable, Nicholas has been disciplined enough in the past to give up bad business rather than lose underwriting discipline. Evidence of this is found in 1997, revenues grew only 10% and profits 20% during a period of irrational price competition.
    Management:
    The two key executives are Peter Vosotas and Ralph Finkenbrink. Mr. Vosotas, age 64, is Chairman of the board, President and CEO. He founded the company in 1985. Mr. Finkenbrink, age 43, is CFO and SVP- Finance. He joined in 1988, and helped start the finance operation, becoming VP Finance starting in 1992.
    There is a strong level of insider ownership. The CEO owns 16.4%, the CFO around 1%.  The Mahan family helped fund the Nicholas through a convertible offering in the early 90s, has lowered their ownership to about 11% of the business. Most of this occured during a secondary offering in May, 2004.

    The Opportunity:

    On Nov 2nd, NICK reported disappointing earnings (by it’s standards) in it’s second quarter. Net income only increased 10% year over year, and was actually down over first quarter (27 cents vs 29 cents).  In response, the stock declined to the low $11 range, and only recovered a little bit in the last few days.

    A variety of factors are squeezing their results. Borrowing costs are up a half percent, while loan rates are static. Write-offs and charge-offs have increased. NICK has benefited in the past from a rosy economic climate, and it appears that we are in the part of the cycle where things are worsening. Finance receivables have only increased 15% year over year, and operating costs are up slightly proportionately. This leads me to suspect that several recently opened branches aren’t up to speed yet and this may be a drag on quarterly comparisons.

    For specific items, increased interest costs are responsible for about a penny per share in lost earnings. They also lost about 5 cents per share due to interest rate swaps they use to hedge against their interest rate exposure, while the 2005 quarter benefited about 4 cents per share.

    The question to ask, has anything material damated their business? I don’t think so. Periodically NICK has had to deal with higher default rates, and in the past it managed to always do this while continuing to grow at a strong pace. It's also likely that NICK’s future growth can't keep it's historic pace and this quarter might be the start of that.

    The key number for me is that 15% growth in finance receivables. Even 15% per year is still excellent, and justifies a much higher PE ratio than it's currently trading at. And if this quarter was just a blip due to some branch openings, they should be able to do a bit better. They are still far from any real limites to their growth, as they still have many more states to expand into, as well as more markets in existing states. My belief is that we may have to deal with some slower growth in the short run if credit losses are higher, but in the long run earnings will keep up with financial recievables growth. Even if EPS growth over the next ten years slows to 15% per year, NICK should still be worth over $20 (a 20 PE) today. That's a heck of a discount to intrinsic value and a heck of an opportunity.

    Catalyst

    This has been a tremendous pick twice already without any real catalyst, so I don’t feel I need to offer one, so instead I’ll offer two. One of the reasons I own this stock is a believe in PE expansion. NICK is only a $110M market cap company, which I believe precludes it’s ownership by many institutional investors. I’m betting that NICK will be able to double earnings within four to five years and that larger market cap will put NICK increasingly on the radar of funds hungry for quality growth at a reasonable price. I think they’d find NICK a bargain at any PE below twenty.
    The second potential catalyst is a private equity buyout. The CFO has been quoted in an interview this summer as saying they are being approached so regularly by private equity firms that it’s a standard point of discussion at their board meetings. The CEO is getting older and might want to retire. So it’s possible a deal may happen, but if it does I can’t see it happening unless it’s at a premium to the all time stock price high. My guess is at least $16-$17 per share today.

    Messages

    Subjectre: management
    Entry12/09/2006 11:20 PM
    Membervaluearb856
    Last year Ralph told me that wouldn't sell except at a decent premium to the trading price, which was around $12 if I remember correctly. So at that time I thought $14 was the floor for a sale, and bumped my estimate in the writeup due to the new highs the stock has made. How long ago did they estimate the fair value at $12? That's pretty disturbing if it's recent.

    I believe in economies of scale as they grow, so I tend to dismiss any negative trends as hiccups. After all, they should be able to manage a larger company with the same, or less overhead. But they have to execute and it appears they are having a bit of a learning curve lately.

    As far as Vsosotas's selling, that supports your contention that mgmt is undervaluing the company.
    SubjectRe:Management
    Entry12/10/2006 03:30 PM
    Membervaluearb856
    I'm disappointed to hear that Ralph might be leaving. I've actually never spoken to Peter, and hadn't spoken to Ralph in a little while. I posted this on a weekend and thought about holding it until I could reconnect with mgmt, but I have I've been busy and decided to just post it. Essentially I was lazy.

    They don't have a deep bench as far as I can tell so this is all very disturbing. I'm not as worried about the subprime market in general, as I'm sure it will get cyclically better and worse, but that they've shown they can manage through that. Assuming they still have the same team.

    Thanks for your honest feedback, I will call both on Monday and post what I hear.
    Subjectthoughts
    Entry12/11/2006 02:03 PM
    Memberskyhawk887
    Thistle, Grant, thanks for the quality commentary.

    I like these guys and think they are easily the best-in-class operator with the least amount of leverage. (Finkenbrink, by the way, is a superb name for a CFO in the subprime space.) I have owned them in the past, but not recently. While I'm bullish on the economy, I think the lowest rung will continued to get squeezed disproportionately by high oil prices and wouldn't be surprised to sees NICK's losses creep up a bit. Will investors buy if this key metric is going in the worng direction? You can definitely see this affect in the subprime mortgage space vs. the prime and near-prime mortgage space.

    And hearing that two huge players are moving down into their market is clearly a negative. Their eventual losses will likely cause them to exit the market, but how long will this take? One quarter? Two? Six?

    Ralph's departure would also be a huge blow to the company. As I understand the situation, Peter isn't in the office all that often anymore and already leads a semi-retired life. Ralph is THE operational heart of the company. Vosotas would be a fool to let him go. With the depressed stock price, now would be an excellent time to grant him and a couple of other key players some substantial restricted stock ownership.

    By the way, I don't think Vosotas selling 90K shares at $14 in June is anything to worry about. It is entirely understandable given the $2 stock price that existed just a few years ago. He still has a lot of skin in the game.
    SubjectSG&A
    Entry12/11/2006 02:17 PM
    Membervaluearb856
    Thistle, can you go into more detail on your concerns over growing SG&A? I looked at the last two years and year over year from this quarter, and it looks like all expenses are growing at a similar pace to sales, with the exception of interest costs in the latest quarter. What am I missing?
    SubjectComments
    Entry12/11/2006 04:21 PM
    Memberdavid101
    Valuearb,

    Thanks for write-up. I have been kicking the tires lately, so I'll add some comments. First, NICK is extremely well run. There is no doubt about that. See my comments that I posted this morning on the CRMT thread to get a different perspective in the subprime auto sector.

    That said, NICK is a cyclical company, and it is in the downside of the credit quality cycle. To give an idea, here are the quarterly numbers for accreted reserves:

    06-30-04 $0.9 million
    09-30-04 $1.1 million
    12-31-04 $1.6 million
    03-31-05 $1.9 million
    06-30-05 $1.6 million
    09-30-05 $1.9 million
    12-31-05 $2.1 million
    03-31-06 $2.7 million
    06-30-06 $1.2 million
    09-30-06 $1.1 million

    What is interesting is that the downturn in accretion has occurred despite rosy employment figures (Florida's unemployment rate was 3.1% as of October 2006). This is a little bit unusual environment and there is some near-term turbulence. Is this the bottom? I have no idea.

    Long-term, they should continue to grow branches 12-15% per annum, and earnings in a like manner. It will be lumpy, though.

    On thistle's SG&A comments, I looked at the figures and the last two years look to be inline with receivables growth. There was a jump between the quarter ended 3/31/04 and 6/30/04, but seems to be a one-off. The proxy shows that the CEO and CFO saw their bonuses nearly double between FY04 and FY06, and would imagine that the branch managers saw similar bonuses.

    One thing that has been interesting since the 2004 recap is the line of credit (LOC) to equity ratio. NICK went from 2.5X to 1.4X, so they have delevered the balance sheet. Amongst it peers, only CRMT is less levered than NICK. They are bettered positioned than in 2002.

    David
    Subjectrating
    Entry12/17/2006 01:39 PM
    Memberskyhawk887
    I gave the rating a 1. In hindsight it was too harsh, and I apologize. 3-4 would have been more appropriate, but here are my reasons for a low rating:

    1) You yourself claim you were lazy. For better or worse, I take the VIC idea submission process seriously. Obviously, typos and grammatical errors are going to happen, but failing in some basic due dilligence is something that should be penalized. For small companies like this, where management is very accessible and a source of great information, talking to management is probably a good idea.

    And since NICK has been written up twice before on VIC, relatively recently, I'm looking for a little something extra rather than just "Yes, results have deteriorated a bit, but the stock is 25% cheaper and they get calls from investment bankers and private equity funds."

    The second submission of GROW was a terrific example of this.
    Subjectsubprime mortgage impact?
    Entry02/21/2007 09:21 PM
    Membergb48
    it's been a couple of months since you posted the idea but wondering if you have any thoughts on if and how the recent shakeout in subprime mortgage lending could potentially impact NICK's business?
    SubjectI'll jump in
    Entry02/22/2007 08:38 AM
    Membergrant387
    I addressed NICK in another forum regarding this general comment - below is a shortened/edited version of what I posted there. Also - interesting to note that in the past 10 days there have been THREE 5% ownership disclosures on NICK.
    . . . . . . . . . . . . . . . . .

    Reply,

    The fundamental differences between NICK's business and an overstretching home lender (whose likely corporate history goes wayyyyy baaaackkkkkk to 2004) are too numerous to list.

    OK - I'll list one. Some of the names in the space I wouldn't even classify as a "lender" - if you define lender as one who loans money with the expectation of being repaid based on an analysis of the underlying asset value and credit-worthiness of the borrower. Some of these companies are just plainly speculative financing vehicles.

    That doesn't mean NICK's stock price won't feel the pain (it has - it is a wide brush the market paints with quite frequently) or that its business may not look that good for a while - but if you want to own for a very long time its just about impossible to justify an exit (pay taxes) and time the perfect re-entry.

    All the articles about the blowups makes for interesting reading - but for comparison purposes to NICK. Not that relevant. Their separate pool approach by location is the polar opposite of a no-doc, interest only, fraudulent FICO, overleveraged, volume only boiler room.
    SubjectRE:sub prime market
    Entry02/22/2007 09:04 AM
    Membervaluearb856
    I think Grant covers it well. I don't expect NICK to have poorly underwritten it's loans, it's got a 15 year history of doing this right. So I don't think there is much direct connection to the sub prime market's problems, which appear to be caused by a gradual loosening of underwriting standards.

    But I believe there is a direct connection to the housing market's problems. My guess is that the downturn in home building has directly hurt one of their prime customer segments, construction workers and day laborers. I think that's what we are seeing, and as we see housing starts in FL recover I'll bet NICK's loss rates recover as well. Our only problem would be a recession piling on to our problems here.

    Otherwise I see the story as the same. Growth has temporarily slowed due to these problems, eventually they'll pull out and keep chugging along as before.
    SubjectValuearb - 5% positions
    Entry02/22/2007 09:29 AM
    Membergrant387
    Any insight? Pretty tight window where these have been filed. At first look none of the filings had an "activist" position - though it appears that taking activist stance is part of Southpoint's dna.
    SubjectRe: Subprime
    Entry02/22/2007 10:27 AM
    Memberdavid101
    I'll add a few comments. First is that NICK's loan losses are roughly back to the normal range. Does not mean they can't or won't go higher, just that credit quality the past few years was unusually good, in large part due to the kindness of the Fed.

    Second point is that the biggest impact will be to growth. I would expect NICK's growth to slow. The flat yield curve is causing lenders to move up the risk curve to higher yielding lending. Seeing that to a degree with BOFI and UWBK, but I am sure the slow down in auto sales is increasing the number of lenders competiting in the subprime auto space. That might send investors to the exits but I see it as a positive. Underwriting discipline means walking away from loan deals that do not meet your IRR instead of maintaining volume.

    I would not link subprime mortgages to subprime auto loans but I see parallels in their cycles. There will probably be some auto lenders licking their wounds by the end of this year, but NICK will not be one of them.

    David
    Subject5% positions
    Entry02/22/2007 11:02 AM
    Membervaluearb856
    No insight, all filings appeared passive to me.
    Subjectany update?
    Entry07/31/2007 10:13 PM
    Membergb48
    any new thoughts here given the most recent market dislocation?
    SubjectStill holding
    Entry08/04/2007 11:36 AM
    Membervaluearb856
    I'm not sure that anything has changed in my thesis, except that clearly NICK was at the top of a cycle a year or so ago, and is now rapidly hitting the bottom. Financing costs are up. Losses are up, probably partially due to the bad housing market in Florida. Most disappointing, they wrote fewer contracts (though for more revenue) this quarter, year over year. Also they are tweaking their business model some to deal with the growth.

    But after all that is said, it's trading at an 8 PE. Even if you think this demonstrates that future EPS growth rates are going to slow to the 10% range, that still seems like a great deal to me.

    Obviously if I had seen this coming I'd recommend buying now instead of then. I'm fully allocated, so I just have to take it like a man, a man who whimpers when he sees his portfolio nowadays. NICK's not my only holding to go bad over the last three weeks.
    SubjectGrowth wasn't the problem, reg
    Entry11/19/2007 11:21 PM
    Membervaluearb856
    My theory is that they were too concentrated in florida with a clientele that was concentrated in home construction, and that's what bit them. It looks also like we just were at the peak of their cycle, with abnormally low losses.

    It's a legitimate question whether they can continue to scale up, or whether they need to modify their management structure to handle being in so many states. But they only have 46 offices, and only open a couple every few months, so I have to think the mgmt team can handle the growth challenges.
    SubjectRecent Q
    Entry11/20/2007 11:03 AM
    Memberbroncos727
    There was a fairly big uptick in Assets Owned for Resale, which I assume is similar to OREO for a bank, but in this case repo'd cars. On the plus side I was struck by a large increase in provision for credit losses. It nearly doubled from the year ago qtr. This provision to me seems highly subjective, but given the gloom and doom credit situation it seems logical. I was encouraged to see such a conservative number, even though it dented eps. I dont think growth was ever really priced into the stock anyways, as the excellent write up pointed out.
    Subjectworst case
    Entry11/20/2007 11:48 AM
    Memberthistle933
    What do you all think a worst case is for the company?
    Subjectworst case
    Entry11/20/2007 12:26 PM
    Memberbroncos727
    Given the carnage in levered sub prime plays lately, it would probably be foolish of me to try and estimate a worst case scenario other than a stock price of zero. So I would gladly pass this question off to someone else brave enough or smart enough to estimate a more realistic worse case scenario. I think that people dont buy used cars as an "investment" the way condo flippers or second home buyers do. The ordinary guy or girl finances a car so they can get to and from work and run errands. And as long as they are buying a car, they may as well stretch on price a little for the sake of conspicuous consumption. But essentially people need their cars. So to envision a worst case scenario of massive defaults would suggest a U.S. economy that is really really really hurting. In which case you wouldnt want to own any U.S. stocks, subprime or otherwise. Nick just refinanced with BofA at what appears to be favorable terms. So I dont see any sort of looming liquidity issues. I have been buying NICK, but as usual not betting the ranch. 8 pe trading close to book value with insider buying, seemingly conservative provisions for credit losses, and a good track record: sure why not. Buy low then sell high, right...??
    Subjectre: worst case
    Entry11/20/2007 01:38 PM
    Membergrant387
    lots of thoughts here. I'll just blast away without editing.

    I think NICK's financials are a thing of beauty. All the info is laid out to really dissect the underlying performance.

    Lets start with some basics. The portfolio at any moment in time has the following characteristics (approximately) - 20% of loans go to term. About 20% - 22% of loans have a discharge event (typically within 6 months) and the balance are paid off around 18 months. Looking at historical losses and reserving you can get an estimate that the hit NICK takes on a specific loan if it is discharged is about 30% or so.

    Now NICK is only levered 2:1 and just recently renewed financing. So I can't see how this is a $0 (from a liquidity point of view). But lets look at worst case.....the portfolio goes POOF! Well first off you don't need the reserve for losses (you'll be taking them!) so receivable is $192 mil. But the note is actually 8% higher (the dealer discount factor) and loss rates historically are based on that number. Thus the "receivable" to recover is roughly $205 mil. Then with historical 30% losses lets just use a 35% loss. That leaves you with $135 mil. Add in other assets of about $5 mil puts you at $140 mil less all debt of $107 leaves $33 to equity or roughly $3.25 per share. To me that would be worst case absent a complete destruction of the US economy and way of life.

    Now obviously - given the above portfolio stats - if NICK winds down over 18 months they are going to collect a much higher percent. How much? Doing some rough calculations and using the same loss rates I can get to $160 for the receivable over 18 months. Now, there would be some expense drag etc, but I think that net asset number in this scenario is north of $5.50.

    Lastly - how about earnings? Looking at historical pretax yields (on receivable) can give us some clues. A reasonable (pessimistic) range would be 5% - 9%. If NICK stood still at $170 million in receivables the range of earnings would be .55/sh to .90/share. That would be pessimistic and ignoring a turn of the cycle where NICK has done above 10% in pretax yield.

    If they shrunk the receivable to $155 level and had the same range you'd be in the .45/sh range on the low end. This would ignore the strong cash that would be generated as they shrunk the portfolio - so this would be very conservative in my mind. (ie cash could shrink the share base - reduce debt thereby reducing int. exp. etc.)


    My own belief is that NICK's minimum base earnings is somewhere around .85 - .95/sh. Those earnings are capable of growing at 10%-12% per year or better. Sustainable ROE is mid-teens or better.

    Another random point - if NICK re-levered to where they were in the late 90's (when they were a smaller and arguably "riskier" bet) they could borrow $35 million right now. We can all do the financial engineering math that $35 million implies....that would be pretty sweet.


    So I guess, yeah, things can get worse. But how much? Not a lot in my mind without some serious strategic action taken by the Board/management. This is not a cigar butt by any stretch but it is trading like one.
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