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Relative Value Of Leading Pawn Shop Stocks

 January 16, 2013 03:10 PM

Tough economic times drive demand for unconventional financial services.  Pawn shops cater to desperate borrowers who have low credit scores, troubled financial histories, and other problems that make them unsuitable risks for mainstream banks.  Opportunists can open their own pawn shops or invest in existing ones, including some that trade publicly.

Cash America International (CSH) is trading at about the mid-point of its 52-week range.  Its long term debt is almost five times its net income (far above the 2x level I prefer) and fluctuates wildly from quarter to quarter.  It has positive FCF but that fluctuates too, and I wonder why their capex is non-negligible if their business model is based on franchising (i.e., the franchisee should be paying the upfront store costs).  Its 5yr EPS growth and 5yr ROE are respectable but they're not beating their sector average.  That's too bad, because Cash America offers other non-storefront service like tax filing and insurance that can appeal to low income "non-banked" clientele.

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EZCORP (EZPW) is trading toward the low end of its 52-week range but has a P/E of just over 7; that's bad news for trend followers but good news for value investors.  Its net income has shown a distinct upward trend for three years and its balance sheet has a manageable level of long term debt.  FCF is strongly positive.  Their product lines are very simple, focused on various types of loans for goods with no other services.  EZCORP's recent purchase of online lender GoCash reflects this loan focus.  Their 5yr EPS growth and 5yr ROE are remarkably high, beating the sector average.  I must admit, I'm impressed.

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First Cash Financial Services (FCFS) trades at a P/E of 20 and is near its 52-week high; my gut tells me it's probably overpriced on those metrics alone.  Their net income has risen dramatically in the last three years.  They did an excellent job reducing their long term debt to zero in 2011 only to allow it to balloon again this year.  That debt is still manageable (less than 2x annual net income at present) but erratic changes like that are worrisome.  FCF is positive and their 5yr EPS and ROE figures are strongly outperforming the sector.  One strategic disadvantage of First Cash is its brand confusion.  They have five different brands but their services are so similar that such a brand family complicates their marketing message.

The three companies above taken together have a combined market share that does not come close to sector dominance, so none of them have strong pricing power.  Gaining pricing power in a sector like this is nearly impossible because product inventory is so unpredictable in quality and turnover time.  Winning in a sector that emphasizes discount goods means reliance on brand strength (i.e., whichever has the best word of mouth in low-income demographics) and physical location (i.e., near HUB zones, Section 8 housing, and other areas with low costs of living).  The whole sector is highly fragmented and localized, so despite some opportunity for consolidation through acquisition these national chains have little incentive to do so.  Economies of scale in financial services come from consolidating back-office functions, and pawn brokerage is mostly a front office affair.

I suspect that peer-to-peer lending will soon pose a major competitive threat to pawn broking.  It won't undermine the high-end segment where large loans are collateralized with luxury goods but it will affect smaller loans.  P2P lending is cheaper for the borrower and more transparent for the lender.  It is more of a threat to smaller pawn shops that lend small amounts (under $5000) and do have other complementary business lines.

Pawn brokers aren't the only financial players who can profit from the pain of distressed borrowers.  Investors can make some bucks from this growing sector.

Full disclosure:  No position in any stocks mentioned at this time.



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