World Acceptance Corp. (WRLD) is a current selection of GuruFocus’ Undervalued Predictable Companies screen. While there are concerns regarding future growth and profitability (which we will discuss), the company has posted impressive top and bottom line growth over the past decade. WRLD has been able to compound book value at a >15% CAGR over the same time period.
Predictably, strong long-term financial returns have resulted in the company’s shares outpacing the market by a considerable sum.
This article will analyze the factors which led to WRLD being selected to GuruFocus’ Undervalued Predictable Companies list and ascertain whether previous success can be emulated in the future.
The Business:
WRLD operates as a small-loan consumer finance company through 1,271 branches across 14 states and Mexico. The company primarily offers small loans to consumers ranging in size of $300-$4,000 (average 2014 loan was $1,366) with terms generally between 4-42 months. WRLD targets individuals with limited access to consumer credit from outside sources such as banks and credit unions. They also generate a small portion of revenues from income tax return preparation services offered to its existing customers.
The median income of small consumer loan borrowers was just over $22,400 a year, according to an analysis of roughly 15 million loans by the Consumer Financial Protection Bureau. Nearly 70% of borrowers use the loans to cover basic expenses, with 16% tapping the loans for emergencies according to the Pew Charitable Trust.
As a result of their expansive branch network, WRLD has been able to diversify their loan portfolio across multiple geographies.
As can be expected of a company offering loans to consumers shut out by typical credit institutions however, WRLD has experienced a large yet consistent level of loan write-offs (bad debts).
Despite this, WRLD has been able to achieve an excellent margin profile and returns on capital primarily by charging incredibly high interest rates. Regulatory actions threaten to limit their ability to do this, depressing the company’s current valuation and potentially future returns (more on this later).
Competition:
The small-loan consumer finance industry is highly fragmented, with numerous competitors. The majority of WRLD’s competitors are independent operators with generally less than 100 offices. Competition from community banks and credit unions is limited because they typically do not make loans of less than $5,000. With >1,200 offices, WRLD is a dominant industry player.
How Have Historical Returns Been So Attractive?
Most states regulate the financial terms of consumer finance loans that companies like WRLD offer. Because their customers typically have few other financing options, WRLD is generally able to charge at or close to the maximum rates allowable under applicable state laws. This means that even with ~15% charge-off rates, the company earns a very attractive return on its capital.
APR’s of WRLD’s loan portfolio:
Major Risk is Regulatory Action:
As mentioned, most states regulate the financial terms of consumer finance loans. It is also no coincidence that WRLD has experienced their strongest period of outperformance coinciding with the 2008 recession, as the supply of credit-needy consumers ballooned. In response, consumer finance companies are seeing increased regulation on both State and Federal levels.
The Consumer Financial Protection Bureau, created after the 2008 financial crisis, will soon release the first draft of federal regulations that will govern a wide range of short-term loans. The most damaging potential new rule for WRLD is a requirement that lenders assess whether borrowers can repay loans at the end of a two-week period by examining their income, other debts and their payment history.
The Consumer Financial Protection Bureau found that during a 12-month period, borrowers took out a median of 10 loans. These borrowers paid median fees of $458 while the median amount borrowed was a mere $350. Additionally, a number of states are either implementing or considering harsher caps on loan APR’s.
These measures will effectively limit WRLD’s potential customer base and lower interest rate levels (aka earnings).
Valuation:
Understandably so, WRLD’s valuation has suffered in response to pending regulatory actions. The company is trading near the lows on almost every valuation metric.
Using GuruFocus’ Reverse DCF tool, we can estimate that investors are currently pricing in negative EPS growth for the company over the long-term. This is despite WRLD growing earnings by ~20% annually over the past five and ten year periods. Potentially game-changing regulations have created a rare valuation for such a consistent compounder of value.
Growth Opportunities:
To mitigate the negative impacts of future U.S. regulations, the company has been expanding aggressively into Mexico where the regulatory environment is much friendlier. Over the past eight years, WRLD has grown their Mexico business from practically nothing to comprising ~10% of current branches. They plan on opening an additional 20 branches in 2015. Still, at a majority of revenues, these branches will do little to save the company from potentially crushing U.S. regulations.
Conclusion:
An investment in WRLD is currently a bet on either future regulations being tabled or, at the minimum, less detrimental than is currently priced into the stock. While the valuation is seemingly very attractive, this may be one to put into Charlie Munger (Trades, Portfolio)’s proverbial “Too Hard” pile.
