Run your eye over the top listings on the GuruFocus Undervalued Predictable screener - somewhere there you’ll see WRLD, World Acceptance Corporation. On Friday, September 19, 2014, it sat atop the list, by virtue of the fact its price is a whopping 88% below its Discount Cash Flow value.
Had you taken a look at the same screener a few months ago, you might have seen WRLD in the same area. And, that prompts us to ask, if it’s selling at such a discount, how come investors haven’t begun accumulating it and consequently pulling up its price and moving it down or off the Undervalued Predictable screener?
Every chart tells a story, we’re told, and here’s the story from the World Acceptance chart:
Note how the earnings line, the EPS, has risen dramatically since 1999. If you’re wondering why it has risen like that, take a look at the red line, which shows the number of shares outstanding. This is a company that has used its cash flow and/or retained earnings to buy back shares; no dividends for WRLD, just buybacks.
Note, too, how the share price, the green line, followed the earnings line until early 2007. Like some other financial companies, its price took a beating in the financial crisis while the earnings continued to grow. The price did begin to increase in March 2009, along with much of the rest of the financial sector. However, the price line has not been able to close in on the earnings line again. Take a look at the following chart of short interest, which began growing back in 2006, and has kept on growing ever since:
When, or if, the price line catches up with the earnings line, investors could earn a sizable capital gain. That’s the promise of WRLD, the lure of the undervalued stock, but investors have to account for two other elements of this story: first, a belief in the linkage between earnings and price, and second, taking a stand against political correctness. We’ll have more on this later, after we take a closer look at the company itself, including its history, management, ownership, financial assessments and value assessments.
About World Acceptance
The company opened its doors in 1962 and began making small consumer loans in South Carolina. It has widened its geographical scope since then but continues its focus on small, unsecured consumer loans, or as it’s sometimes called, the payday loan, business. Other operations include income tax preparation services, insurance, and a software system designed to help itself and other companies in its sector handle loan applications (based on information provided in its 2014 Annual Report - unless otherwise noted, company information comes from the 2014 Annual Report or 10-K Report, linked below).
The other operations have little material effect on the company’s financial results. As it notes in the 10-K report, "The Company has one reportable segment, which is the consumer finance company. The other revenue generating activities of the Company, including the sale of insurance products, income tax preparation, buying club and the automobile club, are done in the existing branch network in conjunction with or as a complement to the lending operation. There is no discrete financial information available for these activities and they do not meet the criteria under FASB ASC Topic 280 to be reported separately."
The company reports in its 10-K that the consumer small-loan segment is highly fragmented and very competitive. Most of its competitors are deemed independent operators with fewer than 100 locations; credit unions and community banks don’t factor into the competitive environment because most do not make loans of less than $5,000. The market served by WRLD and its peers is often referred to as the Unbanked and Underbanked. In other words, low-income consumers without accounts at banks or credit unions.
Since most players charge rates at the high end of the spectrum allowed by regulatory agencies, the company believes that customer connections, rather than pricing, determines consumer preferences. For that reason, it emphasizes customer service and customer relationships (fiscal 2014 10-K).
In fiscal 2014 (ended March 31st), WRLD brought in almost $618-million of revenue, and from that generated $107-million of net income. That worked out to $9.36 per share (basic) and $9.08 per share (diluted).
It operated 1,271 offices altogether, 133 of them in Mexico, the rest in 14 American states. Fiscal 2014 produced loans that averaged $1,330 and had an average duration of 13 months. It began operating in Mexico in 2005 and has slowly grown its network; revenues from Mexico accounted for just over 8% of revenue in fiscal 2014. Mexican operations have not yet grown enough to make foreign exchange a material issue.
And about those controversial rates that get so much negative attention, World Acceptance says in its 10-K, "As of March 31, 2014, the annual percentage rates on loans offered by the Company, which include interest, fees and other charges as calculated for the purposes of the requirements of the federal Truth in Lending Act, ranged from 21% to 199% depending on the loan size, maturity and the state in which the loan is made."
It may have been those rates that prompted the U.S. Consumer Financial Protection Bureau (CFPB) to launch an investigation of WRLD and its peers in March of this year. That announcement prompted investors to whack almost 20% off the stock price on March 13. Management said it was cooperating with investigators, and that it "believes its marketing and lending practices are lawful." A news report from February said the CFPB planned to give a lot of attention to payday and other small-loan providers in 2014.
The company stock also experienced another severe decline after announcing that KPMG L.L.C. would not continue as its registered accounting firm. In its 8-K notice on September 5, 2014, WRLD says KPMG’s audits for fiscal 2013 and fiscal 2014, " did not contain any adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles." On September 17th, the company reported in an 8-K filing it had appointed a new firm, McGladrey LLP.
And, several class-action law firms are trying to recruit investors who would like to sue the company. For example, Faruqi & Faruqi, LLP says in a June 18, 2014 news release, "Defendants made false and/or misleading statements and/or failed to disclose that: (i) World Acceptance's loan practices have not abided by the Consumer Financial Protection Act and/or the Truth in Lending Act; and (ii) the Company did not exercise adequate internal and financial controls."
Takeaways: World Acceptance operates successfully, and has done so for more than 50 years. Given its strong margins and growth on key metrics, it should be an easy investment choice. But, while operations have been successful, they have been significantly overshadowed by external issues, making this a more difficult choice for value investors.
Growth Strategy
In an investor presentation on its website, the company indicates it plans to do more of the same, growing sales at its existing offices and expanding into new markets.
It sets 50 offices in the U.S. and 20 offices in Mexico as its target for fiscal 2015. Expansion will include potential acquisitions and entry into states with ‘favorable regulations’.
Takeaways: As noted, the business model has worked well for 52 years and doing more of the same in new places naturally follows.
Management
A. Alexander McLean, III aged 62 holds the positions of Chairman (since 2007) and CEO (since 2006). He had previously served as the CFO and a senior vice-president at WRLD
John L. Calmes aged 34 has served as Vice President and Chief Financial officer since December 2013; previously he had worked at the Bank of Tokyo-Mitsubishi and PricewaterhouseCoopers
Janet Lewis Matricciani aged 46 is the Chief Operating Officer, taking up the position in January 2014 after serving as a senior officer at techology companies.
The board of directors is made up of CEO McLean and five independent directors, one of whom is also a director of Credit Acceptance Corporation (based on information from the Wall Street Journal - World Acceptance provides little information about its officers and directors on its website).
The ISS Governance QuickScore Summary rates WRLD at 6 out of 10, with 1 representing less governance risk and 10 more governance risk. It receives red flags for Board Practices, Voting Issues, Use of Equity, and Audit & Accounting Controversies.
Takeaways: Two key, senior executives are recent arrivals and have limited history with the company, and seemingly with the small-loans business. Given the scrutiny this company faces from regulators and the media, this may concern potential investors, and particularly if the succession plan is weak.
Ownership
Only three gurus followed by GuruFocus hold WRLD stock, but one of them has a major commitment. Columbia Wanger (Trades, Portfolio) Asset Management owned more than 1.1-million shares. That gives it an 11.1% stake in the company, and makes it the second largest owner. Paul Tudor Jones (Trades, Portfolio) owned 3,500 and Jim Simons (Trades, Portfolio) held 10,900 shares (all holdings as of closing, June 30, 2014)
Yahoo! Finance shows institutional ownership at 130%, indicating that many institutions are also short on the company.
Shorts are out in droves for this company, at almost 95% of outstanding shares, and account for the one Severe Warning signal issued by GuruFocus. As the following chart shows, short interest actually has grown since 2005:
Insiders seem to take the short interest in stride, they own 14% of the company, a relatively high proportion. In the 2014 Annual Report, Chairman McLean notes that many of the company’s 4,700 employees are also owners. The next GuruFocus chart shows how they’ve increased their stake since 2006:
Among insiders, CEO Alexander McLean had the largest holding, 165,000 shares according to the latest filing. Former President and COO Mark Roland held 100,000 shares, while Kelly Malson, a former senior VP and CFO held 74,000 (based on information provided at Yahoo! Finance).
Takeaways: A confusing picture, to say the least. But, we do need to take notice of the fact WRLD has attracted an immense amount of short interest. Even though the company’s share price has dipped from its 52-week low of almost $108, to the mid-$70s at the moment, many investors obviously think this company will fall further. Of course, wishes don’t always turn into reality, and shorts have been burned before. Also note that management and employees keep the faith, and hold a significant ownership stake.
Key Statistics for World Acceptance Corporation
Takeaways: First, the P/E ratios, both forward and trailing, catch our attention. Both sit solidly in single digits, while P/S sits just above 1. Return on Equity has risen from its traditional range around 20% to more than 33%. Second, the company (which does not pay a dividend) has aggressively bought back shares, in 2014 that amounted to almost 16% of the shares outstanding at the beginning of the fiscal year (April 1, 2013). And fiscal 2014 marked the third consecutive year buybacks hit double digits.
Financial Strength
GuruFocus sums up its ratings as 6/10 for Financial Strength and 8/10 for Profitability, as shown in the following:
In its annual report for fiscal 2014, the company reported that it ended the year with a 1.6 to 1 debt/equity ratio, a ratio with which it said it was comfortable. It also lays out its overall financial aim this way, "Our current objective is to use free cash flow from operations to continue with our repurchase activities while keeping the debt to equity ratio between 1.5 to 2.5, depending upon quarterly seasonality and upon the availability of shares at prices that make economic sense for our shareholders."
In addition, at the end of fiscal 2014, it had a revolving credit facility of $175-million. Of course, it also could always divert some of its cash flow to debt servicing if necessary; in fiscal 2014 it spent $191-million on share buy backs.
For fiscal 2014, the company describes its ups and downs this way, "...this was the fourth consecutive year of slower year over year loan growth, which resulted in lower revenue growth. We experienced an increase in our net loan charge-offs and delinquencies but retained control over our operating expenses." Overall, net earnings growth grew by 2.4%, compared to 3.4% in fiscal 2013, and double digit percentages in the two previous years. These trends extended to its most recently reported quarter, the first quarter of fiscal 2015.
World Acceptance currently has an Equity to Assets ratio of 0.32, down from 0.66 in March 2011. Here’s how the company’s ratio looks over time:
The downward trend over the past three years reflects WRLD’s ability to increase its revenues and earnings, while simultaneously reducing the number of shares outstanding. At the moment, a ratio of 0.32 puts WRLD in the middle of a pack made up of its peers:
Turning to the quality of its business, the following excerpt from its 2014 Annual Report shows the growing size of past due accounts:
And, the second line of this excerpt shows the quarterly trend of Provision for Loan Losses (please note the years are fiscal years, ending on March 31st). The company said in its 2014 annual report that it set the general reserve at 4.25% of the gross loan portfolio; in its 2012 Annual Report, it noted that the general reserve usually ranges between 4.5% and 5.5%.
Despite the slowing growth and provision for losses, Return on Equity has increased to more than 30%, thanks to its continued repurchases of stock, and the general reserve is reduced by being spread over a larger portfolio.
GuruFocus issues one Severe Warning (noted above in the Ownership section), two Medium Warning signs, and six Good Signs.
The two Medium Warning signals refer to the Altman Z-Score and the issuance of new long-term debt. Generally, the Altman Z-Score (potential of bankruptcy) is not used to assess the viability of financial firms, and the debt issue was addressed in a preceding paragraph in this section.
Two of the Good Signs refer to the expansion of WRLD’s operating margin and consistent growth of its revenue per share.
Takeaways: Although its rate of growth has slowed, and it net earnings have declined, World Acceptance still knows how to make and manage its money. Most importantly, it has continued to grow while decreasing the share count, and consequently pushed up its Return on Earnings.
WRLD Valuations
According to the Undervalued Predictable list using the discount to discounted cash flow and you’ll find World Acceptance at the top (close of trading, September 19, 2014). Based on the formulas GuruFocus uses, WRLD delivers as follows:
- The valuation using the discounted cash flow comes in at a whopping $597, far above the current (closing, September 19, 2014) of $73.18 (please note this calculation differs from the DCF calculation on the menu bar)
- Turning to the discounted earnings column, we see it comes in at $270.
The WRLD Price to Book ratio comes in at 2.57, just above its one year low of 2.46. To put that into context, the P/B hit a high of 4.16 in January 2007, and a low of .91 in March 2009.
World Acceptance receives a GuruFocus 5-Star predictability rating. This rating refers to the steadiness with which a company generates earnings; GuruFocus describes it this way, "We rank the predictability of these companies based on the consistency of their revenue per share and EBITDA (earning before interest, tax, depreciation and amortization) per share over the past ten fiscal years...."
Such consistency also pays off for investors. In backtesting, GuruFocus found that 5-Star companies (the highest ranking) averaged a gain of 12.1% per year over 10 years, and only 3% had negative returns on positions held for 10 years. Only 76 of the many thousands of North American companies evaluated achieved this ranking.
How has World Acceptance been able to do this? Essentially, by using its cash flow and retained earnings to buy back shares. It made a decision a number of years ago to reward investors strictly through share buy backs, rather than dividends, or some combination of dividends and repurchases. If it buys back stock, it divides net income among fewer shares, thus increasing the value per share.
Takeaways: Not only do operations provide consistent earnings, but the company created conditions which allow it manage the level of earnings every quarter. At the same time, we note that a lot of value is locked in by its decision to reward investors with only repurchases (no dividends). This means investors can only be rewarded if the stock price goes up, and as we’ve seen, that can hardly be taken as a given.
Outlook and Risks
From an operational perspective, this would a straightforward buy proposition, with a couple of caveats:
World Acceptance reports in its 10-K that competition for senior management employees is intense; in fiscal 2014 the company lost, and had to replace, both its Chief Financial Officer and Chief Operating Officer.
Among office employees, annual turnover last year was about 31%. Turnover increases costs and presumably dilutes the quality of customer service (which, as we’ve noted, is important in generating new and repeat business).
And, we’ve noted that it has experienced four years of slowing loan growth.
Still, when you look at its projected DCF at just under $600 or its 52-week high near $108, it would appear the price of WRLD stock has lots of room to grow; the Friday, September 19 closing price of $73.18 is 32% below the 52-week high.
But, there’s more to this story than just its operations. The company operates in a politically incorrect industry, and its share price may continue to feel the effects. As the company notes in its 10-K report, federal and state governments, and their regulators, as well as Mexican jurisdictions, impose extensive conditions and limitations on this industry. Compliance is both demanding and costly.
In addition, media and public perception are mostly negative, which could prompt legislators and regulators to impose even more stringent rules, thus compromising the company’s ability to operate profitably.
Still, while critics of the payday loan industry are prolific and loud, none has yet offered a feasible alternative. Left unspoken is the knowledge that the only real alternative may be the friends of TV mobster Tony Soprano, the loansharks. And without a realistic alternative, it seems unlikely legislators or regulators will push the industry to the point of going out of business.
Takeaways: Don’t expect either the payday loan business or World Acceptance to go away anytime soon. The negative criticisms and intense regulatory oversight will no doubt continue, but WRLD should continue to operate profitably and perhaps even see its stock price begin to catch up with earnings growth. Getting there will require faith in the axiom that earnings drive stock prices.
Conclusions
At the beginning of this analysis, I wrote that the chart told a story. Having now looked at the World Acceptance Corporation chart and environment in more detail, let’s now say the chart tells two stories:
First, the story told by the earnings and shares outstanding lines (blue and red, respectively). They combine to tell an optimistic story of growth, income, and return on equity.
Second, the story told by the price line (green), is a pessimistic one, about shorts betting heavily that the price will fall in a big way, and about regulatory and public concern with the small consumer loan business.
Which story foretells the future is, of necessity, a choice for each investor.
　
