Cash Store Financial is Canada's largest operator of retail loan branches, providing payday and cheque cashing as well as money transfer, private label credit cards, and CDIC insured bank accounts. The company has been in high growth phase since 2005, growing organically as well as consolidating the payday loan industry through economic turmoil. I believe that this high growth company with big insider ownership has been unfairly punished due to its Q1 EPS miss and negative sentiment surrounding rate caps, underperforming metrics at new branches, legal costs and its plans to ease its break neck expansion.
Moral issues aside, short term personal lending at near-usury rates is as old as money itself. The earliest documented solicitation of personal loans in the United States came from the November 1869 Chicago Tribune, touting "Money to Loan in Small Sums on Short Time". Early loans were secured by household goods, effectively making them a pawn brokered loan. In the late 1800's and early 1900's these businesses flourished. With little capital outlay, some of these loan shops earned 46% on invested capital. Big banks like First National, City, and J.P. Morgan were busy making loans to large commercial borrowers, not individual citizens. From the Provident Loan Society to Arthur Morris's Fidelity Savings and Trust Co., consumer finance branched out from under the negative stigma.
As prevalent and enduring as the short term loan business is, it is still relatively underpenetrated in Canada. In the United States there is a 10,000 to 1 ratio of people to cash advance locations, in Canada the ratio is closer to 25,000 to 1. In the United Kingdom, where Cash Store recently opened 4 locations and plans to expand to 200, the ratio is even higher at 50,000 to 1. The regulatory environment in Canada has been clarified so store expansion is lower risk. To open a new location there is $65k in Capex combined with $65k in working capital injection over the first 10 months. Stores have historically reached break even within the first 10 months. This is perhaps why the financials look so poor for Q1, Cash Store opened 101 new locations over the past 12 months and have yet to reach profitability.
Competition however is fierce. Dollar Financial is the largest competitor in Canada and relies on balance sheet lending, not brokered loans. This gives them a lower cost structure and the ability to be more aggressive on pricing. Dollar Financial acquired 19 franchise stores in Alberta and Quebec in the most recent quarter and has made aggressive pushes into TV advertising and product offerings similar to Cash Store's ancillary offerings. Dollar Financial is also expanding into web based consumer lending.
Nonetheless, if you look at Cash Store's existing store base and assume that the new locations will not be an indefinite drag on earnings, you are getting the existing store base for cheap plus the option of continued expansion. If the newly opened existing stores reach same store sales metrics of those open one or two years ago, and assuming operating margins reach the worst levels ever witnessed (35%) at ALL locations, you are buying the business at around 10x normalized after tax earnings with a 3.5% dividend yield.
If management expands like they way they will (and have done in the past) and you reach 700 locations in the next few years, with same store sales and margins in the middle of the pack of those realized historically, you could see $2.50 in earnings. Applying a modest 10x multiple could yield $25/share or nearly a double. This does not incorporate the addition of higher margin products, the transition to on balance sheet lending (therefore higher margins), aggressive expansion into the UK, or strong results in its Australian loan store holdings.
Insiders own 27% of the stock, with the CEO being the largest holder. The company has been able to realize 4% same branch sales increases, 58% EPS CAGR, and greater than 21% return on invested capital in the past 3 years. Management has used this growth to increase the dividend at a 41% rate. While they have been able to show that they can grow, I think the current price is reflecting a pretty conservative valuation on the existing branch network, and that earnings will increase regardless of continued break neck expansion. Competition may be an issue and it is definitely worth keeping a close eye on to see if management faces these challenges head on and if margins deteriorate.
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