Hello everybody, Bit of background, I have been viewing...

Hello everybody,

Bit of background, I have been viewing HotCopper for a little while now but have never really contributed. Looking to change that by mimicking some of the write-ups that can be found on the US website Value Investors Club (https://www.valueinvestorsclub.com/). I find the process of putting my thoughts on paper keeps me accountable and the opportunity to share it here ensures that I am producing decent work and not missing anything. I hope you like it.

Cash ConvertersInternational Ltd (ASX:CCV)

Business Summary

CCV operates across 4 different segments:

1.Franchiseoperations (FY18: $19.6m revenue, $12.3m EBIT); collects royalties and licence fees from 15 countries with franchised Cash Converters operations as well as from Cash Converters UK, a wholly owned subsidiary that operates as master franchisor to 196 UK franchisee owned stores. Also receives fees from 84 franchisee owned stores in Australia and any upside from its 25% equity stake in the NZ CCV Master Franchisor.

2.Storeoperations (FY18: $118.6m revenue, $12.5m EBIT); retails new and second-hand goods both in-store and online and earns interest from pawn broking loans and cash advance short-term loans. Also receive commission and share of income for any CCV personal loans processed in store

3.Personalfinance (FY18: $109.4m revenue, $46.5m EBIT); combines Mon-E Pty Ltd, which provides the software platform and administration services for the CCV store network, collecting commissions on any cash advance loans, and CCPF which provides both small amount credit contract (SACC) and medium amount credit contract (MACC) unsecured loans

4.Vehiclefinance (FY18: $12m revenue, $2m EBIT); Green Light Auto (GLA) Financing is a vehicle financing business offering a range of secured automotive loans through a network of brokers, dealerships, CCV stores and online

Summary Financials

1		Mkt cap ($m)	.3m	5Yr Avg. EBIT multiple	5.6x
2	Net debt ($m)	$88.3m	FY19 EBIT multiple	2.2x
3	EV ($m)	$174.6m	FY19 normalised NPAT multiple	4.3x
4	Revenue (3yr CAGR)	-3% p.a.	FY20 broker* EBIT multiple	2.0x
5	EBIT (3yr CAGR)	0% p.a.	FY20 broker* NPAT multiple	3.0x

* Patersons ResearchNote dated 18/9/18

Thesis

CCV present an opportunity to purchase a free cash flow generative business with the capacity to grow earnings at ~10%+ p.a. over the next three years at a compelling valuation of 3x NTM broker earnings or 0.5x tangible book value. This opportunity arises because the market has been shaken by the seemingly never-ending adjustments caused by regulatory overhaul, restructuring and class actions. Consequently, the market is failing to note the earnings potential of its new products and the resilience of its store and franchise earnings

1.The combination of CCV’s entry into the MACC market (loans from $2-$4k for 4-24 months) in FY17 and the restructuring of Green Light Auto to pursue a traditional secured vehicle financing model reflects a desire to lower the risk profile of the loan book and improve its quality

a.MACC and GLA are estimated to comprise ~70% of the loan portfolio as of FY19. By FY22, they are conservatively estimated to make up ~80%

b.Bad debts as a % of personal loan book receivables are likely to have peaked at 35.5% in FY17 following the launch of a new applicant assessment platform that automates analysis of customer bank statements. Arbitrary benchmarks are no longer relied upon. Bad debts as a % of the personal loan book are estimated to be ~27% in FY19 and continue to fall as a % of receivables

c.Further evidence of transformation is the appointment of a new CEO in December 2018. Brendan White previously served as Group Executive of the BoQ

2.Loan applications have been growing at ~8% p.a. since FY17 illustrating strong demand for CCV’s products. Thecombination of regulatory overhaul forcing many competitors out of the marketand tightening credit conditions across prime lenders as a result of the RoyalCommission has provided a strong tailwind for CCV

a.~45% of loans were originated online in FY18 and this is anticipated to increase to in FY19 to ~50% and should translate into improved operating leverage

b.Established brand-name and shop-fronts gives CCV both legitimacy and exposure

3.Could be a takeover target of EzCorp Inc (Nasdaq:EZPW), an American pawn shop operator with a $450m market capitalisation. It owns a ~34% stake in CCV and is master franchisor of CCV’s franchisee stores in Canada, Mexico and South America. Additionally, EzCorp’s CEO Stuart Grimshaw is Chairman of CCV’s Board of Directors

Comparables

Money3 (ASX:MNY); Mkt cap of $400m and trading at 10x TTM EBIT or 7.8x FY20 consensus EBIT. Exited the SACC market in Feb 2019 via an MBO at 1.6x gross loan receivables citing regulatory complexity. Now solely provides vehicle financing in Aus and NZ. Possesses an Aus loan book of $274m as of FY19 with average loans of $12k with interest rates from 9.95%. MNY targets higher credit quality customers than CCV with GLA averaging $18k loans at 25% interest and an estimated book size of $67m in FY19. MNY’s bad debts are running at 4-5% of receivables and the loan book is growing strongly

Nimble (private); Estimated to be worth $100m with earnings of $15m in FY18 placing it on 6.7x. In FY17 it possessed a loan book of $40m and earnings of $4m (10x TTM loan book). It is in the SACC and MACC markets and operates solely online

Other comparables ofnote; Wallet Wizard – owned by Credit Corp (ASX:CCP), FairGo Finance, Ferratum, Good Shepherd Finance – not for profit, Flexigroup (ASX:FXL) – although provides a diverse range of services from leasing, credit cards, broadband, layby, etc., SocietyOne – P2P online lender

Risks

·In pursuit of loan book growth credit quality may be compromised and bad debts as a % of receivables could remain elevated à following on from this, could the loan book growth be sustained at lower bad debt levels?

·After Westpac pulled its financing facility amid reputational damage from a 4Corners investigation into payday lending, CCV obtained a $150m facility with Fortress Investment Group LLC, based in New York and owned by Softbank Group. It is secured over CCV’s loan books. In the event of a credit crunch, CCV may struggle to find alternative funding with the big 4 no longer funding the payday lending sector

·Outstanding class action: Sean Lynch v Cash Converters Personal Financeà Hearings finished on 9^th Nov 2018. This appears to be the sole class action CCV has declined to settle (see McKenzie v CCV for $16.4m and Julie Gray v CCV for $23.1m) which may be indicative of a worthwhile case. $8.5m in provisions have been set aside

·Additional class actions?

·Further regulatory reform curbing CCV’s pricing power à currently for SACC loans establishment fee limited to 20% of loan amount and interest at 4% per month, or 48% p.a. Additionally, CCV cannot charge more than 200% of the original loan amount. MACC loans are also subject to the legislative cap of 4% per month or 48% p.a. and a $400 establishment fee. There is no cap on the total charge

·Retailing weakness?

·EzCorp sell down

·Valuation-wise a loan book with an average term of ~1year and ~20% bad debts will always struggle to attract premium valuation multiples. Therefore, unless CCV can deliver longer duration MACC loans and grow the GLA book it is unlikely that there will be a significant re-rating of its loan book

·Why aren’t insiders buying significant parcels at these levels?

·Long term, does CCV deserve to exist?

oI can buy and sell my own goods via eBay/GumTree at better prices since you do not have CCV clipping the ticket, but this takes time and if you need money quick it is a convenient way to flip second-hand goods

oCash advances are less and less common given the stringent regulations

oWill millennials use CCV? Why should I obtain an expensive loan that requires 90 days of bank statements when I can Afterpay it for free (provided I pay on time)? Afterpay not available for your utility bill/car repair/etc, but eventually it might be…The sheer number of payday lenders, especially online models, and the continued strength of Credit Corp’s Wallet Wizard suggests that at least in the short-medium term it is not going anywhere…

Summary Forecasts