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Payday Lending Still Ruled By the Lenders

Larger banks are elbowing in, but with little effect


There is a substantial need for short-term unsecured credit in this country. Until 1990, most people met that need by deliberately writing a check they knew would bounce. It bought them time, but it cost them NSF fees. Over the years, those NSF fees have been augmented by merchant fees for bad checks, so bouncing a single check could cost as much as $60 — even for a tiny transaction. And if a consumer must write several checks, the fees could quickly run into the hundreds of dollars.

The benefit of a payday loan is the consumer can get a loan against his next paycheck for as little as $15 per $100, with all fees and rules completely disclosed by the lender. Contrary to sensationalist nonsense about “cycles of debt,” 94% of all loans are repaid on time and in full.

Banks, realizing what a great deal this was, have been increasingly moving into this area. They are able to undercut payday lenders on fees because they can require a borrower to have their paycheck directly deposited, allowing the bank the ability to get repaid on the loan as soon as the paycheck hits the account. Payday lenders have no such immediate and direct access, so their default rates are higher and consequently must charge more.

Payday loans do not add to a bank’s bad debt pile because of the model, either. The result is an additional revenue stream for the bank.

The question for investors is whether there is opportunity in this unique product, and if you’ve studied the sector for as long as I have, then you know the opportunities are huge — but not for the reasons you might think.

From a bank stock perspective, it’s actually not going to make a meaningful difference. Wells Fargo (NYSE:WFC), U.S. Bancorp (NYSE:USB) and Fifth Third Bank (NASDAQ:FITB) are the primarily players in this space. However, their revenue streams are so diversified, they are so huge and payday loans make up such a small part of their business that the product’s effect on their top line is negligible. Bank of America (NYSE:BAC) and Citigroup (NYSE:C) don’t even have the product on their radar, as far as I know.

The public payday loan companies, however, do reap the benefits. Advance America (NYSE:AEA) is the premier operation and largest in the U.S. It was so good at its job that a Mexican company just bought out the company for $700 million. However, it isn’t the payday product that is driving growth for everyone else these days. The market is saturated in the U.S., so growth is being driven by international expansion, and a push into Mexican pawnshop operations.

DFC Global (NASDAQ:DLLR) is diversified across payday lending, pawnshops, check cashing and Internet lending both domestically and internationally. DLLR isn’t generating great cash flow like it used to thanks to aggressive expansion, but once that growth settles in, I expect that cash flow will go through the roof.

Cash America International (NYSE:CSH) is a massive cash flow machine, generating free cash flow of $375 million in the TTM and growing earnings at 16% annually. It also has diversified across all product lines and has made a big push into Mexican pawn. Because of misplaced concern over Richard Cordray’s impact on the payday lending business — which is not a terribly huge part of Cash America’s revenue — the stock is literally trading at half of what it should be. Its forward P/E is just above 8, and it has a PEG ratio of only 0.6. That is a screaming value play.

However, my two favorite plays in this sector are First Cash Financial Services (NASDAQ:FCFS) and EZCorp (NASDAQ:EZPW).

I know First Cash’s management, and have visited with them often. The company utilizes its capital so intelligently — drawing on credit lines prudently to fund modest growth, then paying the line down as quickly as possible. FCFS buys back stock aggressively and at good prices. It has sold off all domestic payday operations except those in Texas (where it is most profitable), and is the leader in Mexican pawn at this point. First Cash has expanded aggressively down south and is generating incredible same-store sales numbers of over 10% in Mexican pawn, while net income down south is growing at over 30%.

First Cash is growing at 20% annually and will do so for the next several years. Eighty percent of Mexico’s population is potential pawn customers, versus only 20% here in the U.S., and Mexico has no usury cap. First Cash has no debt, $70 million in cash ($2.33 per share) and generated $55 million in FCF last year. FCFS shares trade at just 17 times this year’s earnings estimates and 14 times next year’s. It is as solid and smart a fast-growing company as you can buy, and you can buy it at a huge discount. I am long, and have been accumulating at these prices.

All the same reasons apply when it comes to EZCorp. The company also is expanding aggressively into Mexican pawn, as well as aggressively acquiring domestic pawn chains, while scaling back on non-Texas payday. EZPW also uses capital very efficiently, with only $40 million in debt and $23 million in cash. The company has been on a free cash flow tear the past few years, amping it up from $60 million in 2009 to $120 million in the TTM.

EZPW also is outrageously undervalued, with a 20% increase in net income for this year and 15% in the next several years a slam dunk. Putting a 16x multiple on this year’s earnings of $3.06 yields a $49 fair value, and it currently trades at around $32. I am long, continue to accumulate shares, and it is my largest portfolio position.

As of this writing, Lawrence Meyers was long FCFS and EZPW. He is president of PDL Capital, Inc., which brokers secure high-yield investments to the general public and private equity. You can read his stock market commentary at He also has written two books and blogs about public policy, journalistic integrity, popular culture and world affairs.

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