EZCorp,
a fundamental analysis!
April 10, 2019
TICKER: EZPW
ISIN: US3023011063
SHARE PRICE: $10.31
MARKET CAP: $565B
April 10, 2019
SHARE PRICE: $10.31
MARKET CAP: $565B
TICKER: EZPW
ISIN: US3023011063
1. INTRODUCTION
I was scrolling through my list of “to-study” companies and I’ve noticed EZCorp. I am big a fan of the tv show “Pawn Stars” so I’ve decided to take a look at this one. I’m starting by visiting the company’s website.
2. BUSINESS OVERVIEW
2.1. BUSINESS DESCRIPTION
EZCORP’s IPO was in 1901, just two years after it was founded with 16 pawn shops. It now operates 997 stores in the U.S. and Latin America with plans to open between 100 and 200 new stores in 2019.
Everyone that has ever watched “Pawn Stars” on TV already has an understanding of how this business works, but for those who haven’t, it’s quite simple:
The client enters the shop with an item (a watch, a ring, a painting…) that he wants to pawn or sell. If he wants to sell, he will get cash on hand and the store gets an item to sell at a higher price.
If he decides to pawn it, this is where the art and experience of the business comes in. Give the clients to much money and they’ll run off and never come back, give them to little and you’re not maximizing the opportunity.
The company usually lends from 40% to 70% of the item’s retail value at a monthly rate between 12% and 25% (depending on the country), but between 40% and 70% there is a wide difference and knowing which one you should aim to is hard. That’s why the company is investing heavily on a new AI software, but we’ll get to that in a minute.
After the agreed upon period (30 to 90 days) the client must come back to the store and he can do one of two things: he can extend the contract (the most favourable situation for the company) or he can redeem it paying the original amount plus interest. 85% of clients in the US opt for the redemption.
If the client never shows up, the company owns the product and will sell it at one of its stores for a profit (the less desirable situation between the three). So what we’ve got here is both a financial company and a retail company.
2.2. LARGEST SHAREHOLDERS
There are two classes of shares. The Class A has no voting rights and the Class B has all the voting rights. The thing is that these Class B stocks are all in the hands of a single person (like the situation we’ve seen on the Facebook analysis).
This person is Philip Cohen (70), an Australian who has a history of abusing of his position for years through a consultancy agreement with EZCORP that allowed him to take $6M out of the company every year.
Fortunately this agreement has been terminated and it won’t be reinstated. The share price appreciation is now the only way for Phil to increase his wealth….or a sale to a competitor.
Ah, I forgot to mention that the company also owns a 34,75% stake in Cash Converters International (CCV) which currently amounts to $23,6M.
2.3. MANAGEMENT TEAM
From 2000 to 2010 the company had a very good management team led by Joe Rotunda, but when he left everything came crumbling down. The new management tried to pursuit new business segments losing focus of the core business. A couple of years later the company called Joe back again and in 2014 Stuart Grimshaw became the CEO.
Stuart followed the best strategy he could: Close all the underperforming segments (like payday loan business) and refocus on the core pawn business.
One of the reasons Mr. Market is so suspicious about this company is that until recently, the management team had its compensation incentive program tied to the EBITDA which wasn’t a good metric because share dilution wouldn’t affect the management team.
As we will see in a minute this has led to some poor capital allocation decisions, but fortunately the shareholders made some noise and now the incentives are related to the EPS, so both interests are finally aligned.
3. HISTORICAL CONTEXT
3.1. LONG TERM CHART
If we look at the stock performance over the years we can see that shareholder return has been close to zero ever since the IPO.
3.2. MARKET CAP AND SHARES OUTSTANDING
The company’s market cap is around $565M which makes it a small-cap. Fortunately the number of shares outstanding has been kept pretty stable over the years.
But if we dig a little deeper we find out that the company has issued convertible notes in 2017 and 2018 that may dilute the shareholders equity in the future. And that’s why the management compensation is now dependent on the EPS rather than EBITDA.
It’s not good to see management issuing equity at low prices only to buy them at high prices later on and that is one of the reasons why Mr. Market isn’t that fond of this stock.
3.3. SALES - OPERATING INCOME - OPERATING MARGIN
By taking a look at the chart below we can clearly identify the period when Joe Rotunda was at the helm of the company between 2000 and 2010, the subsequent decline in revenue until 2015 when the company lost its focus and the righting of the ship from 2015 onward.
Note: EZCORP’s financial statements are full of restatements, adjustments and GAAP reconciliations. The presented figures may differ from some of the company’s filings.
The company periodically releases great presentations and although I’m not much into copy + paste, I thought that this one would be nice for us to understand that the management is clearly executing as shown by the growth in EBITDA.
3.4. SALES BY GEOGRAPHY
The greatest percentage of the revenue comes from the U.S. and I think it’s safe to say that LATAM will be the main growth driver in future years.
3.5. SALES BY SEGMENT
Merchandise sales are the segment bringing in the most cash…
…but let’s not forget that the “Pawn Service Charges” are net. When we look at net revenue (Marchandise sales – Cost of goods sold) which is the same as saying Gross Profit, we can clearly see that the most money comes from the “Pawn Service Charges.”
It’s also interesting to see that the company has become less and less reliable on Jewelry scrapping sales…
3.6. STORE COUNT
… I would say that the reason for that is the LATAM store expansion, where people are more into pawning TV sets rather than jewelry.
What we can see here is a major shift from a U.S. dominated store mix to a more balanced mix between the two geographical areas.
3.7. COMPARABLE SALES
The Same Store Sales growth in the US (mature market) was 7% while in Latin America (less mature market) was 11%.
If we look at the SSS during the financial crisis we can get a sense of the counter-cyclicality of the business…
…which means this is a good business to hold during a recession.
3.8. NET INCOME, NET MARGIN
Not only did the company’s sales decline between 2013 and 2016 but the net income turned negative due to impairment losses and write offs related to sloppy acquisitions.
With $39M in net income for 2018, it seems that the company is finally on the right track.
3.9. CASH FLOW
If we take a look at the cash flow we can confirm that, although the accounting earnings were negative in recent years, the company has been generating cash all along (green bars).
3.10. SEASONALITY
There is some seasonality to EZCORP revenue, especially due to the different countries in which it operates but to simplify things we can say that the first quarter (October through December) is the strongest one. I would even add that the real seasonality is through the economic cycle.
3.11. DIVIDENDS
The company pays no dividend.
3.12. PROFITABILITY RATIOS
As expected, these ratios don’t help us much given that the company is just now starting to get its act together. Just so we can get a means of comparison, the ROE for First Cash (FCFS), the largest player in this industry, was 11% in 2018.
3.13. FINANCIAL RATIOS
Current ratio at 2,9 and the debt/equity ratio at 0,6 indicates a strong balance sheet.
The Net Debt/EBITDA ratio at 1,4 is also telling us that the company is financially sound, as opposed to what happened in 2014 when this management team came in. Again, a proof that management is executing.
3.14. PRICE RATIOS
Because there have been a lot of write-offs, impairment charges and one time adjustments, I don’t think the PE ratio is the most adequate ratio to look at. Instead, I’m looking at EV/EBITDA.
The forward 2019 EV/EBITDA is 7, not that different from what it was in 2008 when everyone was panicking.
The First Cash (FCFS) EV/EBITDA ratio is at 15,9 showing that Mr. Market is more confident on FCFS than on EZCORP.
4. GAINING PERSPECTIVE
4.1. INDUSTRY AND STRATEGY
There are millions of people living from payday to payday and when the paycheck finally arrives, they have more expenses than that cash can cover.
Close to 19% of U.S. households are unbanked or underbanked. 65% of Mexicans and 45% of the remainder LATAM population don’t have a bank account. Because they have an immediate need for cash with few alternatives or sources to satisfy that need, they turn to pawn shops.
The pawn shop industry is highly fragmented and highly saturated. With thousands of “mom & pop” shops that can’t compete with the big guys when it comes to the adaptation to new regulations, new technologies or marketing expenses, this is an industry prone to acquisitions not only with these smaller players but between big ones as well.
In 2016, the largest player in the industry First Cash Financial Services (FCFS) bought Cash America International. The new FCFS now has more than 2500 stores and a $3,8B Market Cap.
So I think it’s safe to say that we’ll be seeing further acquisitions in future years. For 2019 alone, the company is aiming to open 100 to 200 stores.
But they are also exploring other avenues for growth. The company is experimenting with a digital app in order to fit the needs of the millenials and they are rolling out their new centralized software on 100 stores. On the last conference call, the CEO went on and on explaining how this works and how it will be a game changer.
It seems that this new software helps recognize and instantaneously analyse a client, his history with the company, how many times he pawned something, if he is a good payer, etc etc and that helps the guy at the desk not only to understand who he is talking to but also to better appraise the items, allowing greater accuracy on loan valuing while giving better conditions to better clients. It is called the Automated Lending Grids.
4.2. RISKS AND COMPETITION
The main risks I see for EZCORP are:
- Regulation: Although this is a 3 thousand years old industry and many have tried to end it without success, regulation is a must watch.
- Execution: As we’ve seen in recent years, execution is everything.
- Philip Cohen: This guy still controls all the voting rights but with 70 years of age, the most likely outcome is for him to sell his controlling stake to FCFS.
- Dilution: This is a major risk for shareholders but one that the management team is aware of.
4.3. TYPE OF PLAY
EZCORP is a turnaround play.
5. OVERVIEW AND CONCLUSION
5.1. OVERVIEW
EZCORP is a countercyclical recession proof stock and I’ve been looking to add one of these to my portfolio for some time now. The company’s assets (its stores) become more valuable as the economy slows down.
So, how much are the company’s stores worth? Historically pawn shops have been sold at values between $400.000 and $1,2M depending on location, revenue and other factors.
In 2017 the company bought 112 stores in Guatemala for $550.000 each so let’s be conservative and take $400.000 for the LATAM and Canada stores and $1M for the U.S. stores. The company currently owns 462 stores in Latam, 508 in the U.S. and 27 in Canada.
This leads us to a $703M total store value. If we subtract the net debt, add the $24M Cash Converters stake and a $26M note receivable from Grupo Finmart, we get to a NAV (Net asset value) of $630M, which divided by the current number of shares outstanding leads to an $11,5 share price.
Just so you can get a feeling of how undervalued the company is, it is currently trading at a discount to NAV of 12% while its largest competitor FCFS is trading at 3,5x times its NAV.
If we take a different approach, we can estimate at least $110M in EBITDA for 2019, not even factoring in the 100 to 200 new stores. At the historical multiple of 8, this would lead to a $12,5 share price. And if the management continues to execute, we could easily see the company trading at a 10x multiple (remember that the competition is trading at 16x), which would lead to a $16,7 share price just a year from now.
This is a turnaround play with a great runway for growth in front of it. If one can stand being a shareholder in a company alongside with Mr. Philip Cohen and such a history of shareholder value destruction and believes this management team will keep on executing, this might just be a great growth stock for years to come….. or it might just be acquired by FCFS.
5.2. CONCLUSION
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