EZCORP, INC. (EZPW): “Old School” Convert Looks Attractive at Current Levels

In Monday’s Hybrid Vigor, we highlighted EZPW new management as a team capable of turning the company around by instilling new discipline into operations. EZCORP released first quarter fiscal 2015 earnings Tuesday night which missed analyst estimates on the top and bottom lines by a wide margin. While market headwinds may be stronger than we anticipated, the results also indicate that management has begun to reintroduce operational discipline to the business.

Earnings Scorecard:

 

Revenue in $ millions

The common stock reacted negatively to the release, dropped an additional $1.20 this morning to $10.42 after falling $0.63 in the regular session yesterday.

Quarter Highlights

Headwinds in the quarter included a drop in consumer loan demand as a result of lower gas prices and an improving employment situation.  That scenario was confirmed earlier yesterday morning when competitor First Cash Financial Services (FCFS) posted total revenue of $202.8 million, missing estimates by about $10 million.  FCFS stock dropped by over 8.5% during the trading day to $50.81.

Beyond economic factors, other company specific factors played a role in reduced revenues and earnings.

-Increasing government regulatory restrictions on auto loans combined with the aforementioned drop in consumer demand led to a decrease in revenue from consumer loan fees and interest. Revenue for that business line fell $8 million compared to last year’s quarter. Of particular note, loan balances dropped 41% in Texas markets with increased regulatory restrictions. Regulatory markets also experienced a jump in bad debt expense. It is expected that regulatory restrictions will continue to have a negative effect on consumer lending revenue.

-Jewelry scrap volumes decreased $9.2 million year-over-year to $18.5 million during the quarter as consumers reduced the amount of gold they sold and posted for collateral. Somewhat ominously, CEO Mark Kuchenrither said it was too early to determine when bottom would be reached for this business.

-EZPW focused on selling older inventories in order to boost inventory turns, resulting in a reduction in gross margins on merchandise sales and a $9 million drop in merchandise sales operating income compared to fiscal Q1 2014. While this is a hit to quarterly profit, we do believe it points to management’s effort to return to a disciplined business approach over the long-term.

-The reductions in revenue described above were offset by a $10 million reduction in administrative expenses during the quarter. Again pointing to management improving operating efficiencies.

-The Company’s Mexico operations continued to grow with consumer lending up 28% and pawn service charges up 12%. Merchandise sales also increased 17%. The gains were moderated by a stronger dollar.

It will take the full year for the main headwinds to work their way through the EZPW net income statement.  These headwinds include:

·       An unfavorable regulatory environment

·       Reduced gold scrap sales

·       Lower margins on merchandise sales as inventory turns are increased

·       Stronger US dollar

·       Lower gas prices/strengthening US economy

As such, we look for the current run rate to last through fiscal 2015. Beyond that point we expect management’s disciplined growth to begin to improve earnings, returning the company to its former growth of organic store build-outs and bolt-on acquisitions. Management has already begun that process.  During the first quarter, EZCORP opened 5 new stores and completed the acquisition of 12 new stores.

Bottom Line: The stock is down 16%, giving up the last six weeks of gains. That offers opportunity, but the convertible bond seems an even better way to invest in the company.  The convertible is quoted this morning at 88 ¼ to yield 5.16% and a premium of 35%.  These “old style” numbers offer the investor a solid return as management works through the current headwinds. HOCS scores remain a solid 61 overall/66 growth/51 safety. We think patient investors will be rewarded over the life of the bond as management returns to a disciplined approach to growth albeit in a more restrictive regulatory environment.