Advance America, Cash Advance: Small-cap lending for small-cap borrowers
Everyone needs love, and everyone needs credit. On the former, even the most dinged and damaged among us can find it, if they just look. And on the latter, the dinged and damaged can find it if they just saunter into one of Spartanburg, S.C.-based Advance America, Cash Advance's (NYSE: AEA) many retail centers.
Advance America is the country's leading provider of payday loans. Here's how it transacts business: a borrower completes an application, presents identification (a pay-stub or other evidence of income and a bank statement) and writes a personal check for the loan amount plus a fee (typically $15 for a $100 advance). Two weeks later (typically) the loan is repaid and the personal check is reclaimed. No probing credit checks or embarrassing questions asked.
Estimates vary on the size of the payday economy, but the Center for Responsible Lending estimates payday loan volume at $28 billion while Stephens Inc. estimates it around $40 billion. Either way, growth has been impressive, considering estimates for loan volume ranged from $8 billion to $14 billion in 2000. Depending on how the numbers are coupled that produces an average annual growth rate of anywhere from 12.2% to 30.8%.
Advance America's haul of the payday-loan take has been impressive too. From 2002 through 2006, total revenues grew at an average annual clip of 13% to $672 million, with net income growth tagging along at an average annual clip of 7% to $70 million.
Contemporary growth, though, has been slightly more subdued. For the nine months ended Sept. 30, total revenue increased 8.1% to $525.9 million, compared with $486.6 million for the same period in 2006. EPS, meanwhile, posted at $0.54, compared with $0.63 in 2006. The EPS shortfall was due to a poor third-quarter showing, where Advance America posted EPS of $0.07, a number stifled by write-downs related to the closure of 31 centers in Pennsylvania, 45 in Oregon and 27 in various other states.
The Pennsylvania and Oregon closures are of particular concern; regulation was the reason. Adverse legislation has already forced Advance America to abandon Georgia and North Carolina. Moreover, growing populism in the wake of the recent smackdown in subprime mortgage lending is likely to increase pressure for new consumer-protection legislation.
Regulatory worries and third-quarter write-downs have pressured (and that's putting it politely) Advance America's stock over the past four months. Shares, trading at $18 back in July, closed Friday at $8.66, not far from the $8.48 52-week low established the day before. The 52-week high of $19.05 was established July 6.
The bearish sentiment appears excessive, for Advance America continues growing despite the aforementioned closures, having added 164 new centers in the first nine months of 2007. The network of centers totals 2,849 and is spread across 36 states and the United Kingdom, giving it a footprint nearly twice as large as its nearest competitor.
This extensive network mitigates the risk of unfavorable changes in state legislation or regional economies. It also provides ample opportunities to cross-sell additional products and services. On that front, Advance America recently expanded into prepaid debit cards and plans to offer money transfer services. These sources of incremental revenue should come at little cost and add desirable diversification to the payday-lending business.
Another advantage of the centers is that they are user friendly, unlike those of many of its competitors. Advance America targets suburban shopping centers, so there is no need for armaments or continual over-the-shoulder scanning. In fact, the centers are designed to resemble bank branches. The location and design allow Advance America to effectively market to its working-class clientele, whose median annual income approaches $41,000 and averages a not-so-callow age of 39.
On the equity side of the ledger, management has been historically shareholder friendly. Since going public in December 2004, Advance America has returned approximately $189 million to shareholders through share repurchases and quarterly dividends. During the most recently reported quarter, the company repurchased approximately 2.1 million shares for $27 million while continuing to fund its quarterly dividend of $0.125 per share (the annual yield is around 5.4%).
Both buybacks and dividends are likely to continue into the relevant future thanks to a conservatively financed balance sheet (debt to equity is less than 40%) and growing earnings. Consensus estimates are for EPS to recover to $0.30 for the fourth quarter and to $1.09 for 2008, producing a forward Dodd-and-Graham-like P/E of 8.5.
But the pros remain cautious nonetheless. Ferris Baker Watts' Henry Coffey has a “neutral” rating on Advance America's stock. Morningstar's Jim Sinegal calculates fair value at $15 per share based on a 12% cost of equity, 9% average revenue growth over the next five years and SG&A expenses holding around 40% of revenue. His enthusiasm is tempered with the following note: “We believe the risk of further legislative changes is high in the wake of the subprime mortgage fiasco, and we recommend extreme caution when contemplating an investment in the shares of this company.”
Ironically, victims of the “subprime mortgage fiasco” could provide Advance America with additional business. Banks generally forgo lending to bankrupt and foreclosed customers, but that doesn't squelch demand. People will find credit from other legitimate sources like Advance America (AEA). And if they can't find it there, more of them will find it in illegitimate source like with the ham-fisted “financier” who sports a crooked nose and intimidating demeanor.
With a little more lobbying, the payday-loan industry just might convince a few more legislative-happy politicians of that unpleasant fact.
