FCFS - FirstCash: Pawn Stores Well Positioned To Benefit From Weak Consumer

2023-06-22 16:13:21 ET

Summary

• FirstCash Holdings, the largest operator of pawn shops in the US and a major player in Latin America, is experiencing strong business due to inflationary times.
• The company has seen a 38% gain over the past year and has a manageable debt load, strong shareholder returns, and a solid dividend.
• Both the pawn receivables segment and the merchandise sales segment showed strength in Q1 amid the current inflationary environment.

FirstCash Holdings ( FCFS ) is the largest operator of pawn shops in the United States and a major player in Latin America. Inflationary times have made the business strong, with lower-end consumers turning to pawn stores for short-term cash needs. This trend is not one likely to dissipate anytime soon and could accelerate if job losses appear in the coming 12 months. This counter-cyclical nature makes FCFS a very interesting equity play, with the market agreeing to a 38% gain over the past year. During the great financial crisis and period after 2007-2012, pawn receivables grew 50% in the US and 31% in Latin America. This has made the stock intriguing for those looking at defending recent market gains and achieving growth during a potentially difficult period. FCFS is a well-run business, with a manageable debt load and strong shareholder returns over time. The company pays a solid dividend and has been returning cash to shareholders with buyback programs to supplement growth. Let's look at the most recent numbers and why the stock has strong potential returns going forward.

All three segments show strength

FirstCash has three synergistic segments that contribute to revenue and earnings - pawn receivables, merchandise sales, and American First Finance. Both the pawn receivables segment (loans of pawned items) and the merchandise sales segments showed strength in Q1 due to inflationary pressure. Pawn fee revenue was up 15% across FCFS, showing strong demand amid inflation. Operating income for this segment was up double digits as well. This is because growth outpaced costs. In coming quarters, more income will flow to the bottom line as wage pressures slow, as a large amount of labor cost has impacted margins for FCFS. Gross margins stayed strong in the US, with 42% gross margins for the value priced merchandise continuing to sell well. This merchandise is both bought outright, or kept if someone doesn't pay their pawn fees. Latin America saw a 22% increase in merchandise sold, with margins heading lower but still a solid 34% for that region. Keep in mind that they are solidly profitable in this segment with margins above 30% with it more important that they move inventory quickly. Neither region had stale inventory that was not able to be sold quickly for a profit, showing strong demand from consumers of all regions. Less than 1% of inventory in the US and Latin America was stale, showing pricing is in the sweet spot with people continuing to take advantage of value where they can get it. Total revenue growth was strong in Q1 at 15.6%, which is respectable when you consider the trailing P/E of 16 is at a 5-year low.

Buy-now, pay-later (BNPL) has been a strong theme over the past five years, and America First Finance was bought by FirstCash to take advantage in late 2021. AFF provides BNPL to FCFS customers and lease to own options, making it even easier to sell to customers. 1100 FCFS stores in the United States have the lease to own option now, with Latin America potential in the future. They are now in 9800 overall stores, a 43% growth rate over Q1 2022 with $238 million in revenues from this segment. That is with a solid 14% y/y growth rate with charge-off and delinquency metrics holding steady versus 2022 on credit offered. Originations continue to be strong as well, which will lead to future growth but actually hinders short-term profits as losses have to be set aside. Full year origination growth of 12-18% is very solid and should provide increased profits in subsequent years as they roll AFF out in all US pawn locations over time.

Total debt has come down and is very manageable now at 2.8x EBITDA - which is around average for this kind of business. The company continues to use debt to purchase additional pawn locations over time and fund its own new store openings. They are also paying a reasonable $1.32 dividend and buying back shares when the opportunity strikes. They have repurchased $867m in shares since the start of 2017 albeit at an inconsistent cadence. If cash flow improves, hopefully, they will increase the pace of repurchases and limit acquisitions in the midterm to maximize share returns. Return on equity for the past year is a solid 15% , with a return on assets of 7% improving significantly as well. 21% expected earnings growth in 2024 from the 16x P/E this year would require a significant move-up in the shares to reflect the strong fundamentals. Plus the Mexican peso continues to strengthen against the US dollar which will benefit FCFS with every 1-point improvement worth 9 cents of EPS each year. That trend is showing no signs of stopping with continued improvement in the exchange rate over the past three years from 24.6 to 17.2 pesos per USD.

Buy rated

FirstCash is an interesting equity to buy in this environment for its earnings growth and its strength during periods of economic weakness. Risks to the thesis are that the US or Latin American economies avoid a recession and inflation subsides, reducing pressure on household budgets. However, even if a recession is avoided with moderate inflation, consumers will continue to turn to pawns and value priced merchandise to save money. The lower-end consumer is struggling as noted by companies like Dollar General, and companies like FCFS will benefit. The company is pushing all-time highs in the share price, if it breaks through we should see strong upside without any holders in the loss column. FCFS is a stock that should be given a spot in defensive portfolios for 2023 especially if they have a bearish economic view. I continue to add shares at $85-$95 dollars for a 2-3 year outlook of continued tight employment and high costs for consumers.

For further details see: