“Value investing is at its core the marriage of a contrarian streak and a calculator.” – Seth Klarman
When pausing to think about what the absolute most hated things in the world are, things such as disease, corruption, and taxes are some of the items that may immediately come to mind. But down on this same list is also usually debt or usury of one form or another.
Given this stigma, payday lenders have almost always been reviled to a lesser or greater extent throughout their official history going back to the early 1980’s Depository Institutions Deregulation and Monetary Control Act which effectively overrode all existing state and local usury laws, giving way to the elimination of interest rate limits.
Thus it should come as little or no surprise that a small, Kansas City based payday lending company – QC Holdings Inc. (OTC: QCCO) was valued at a whopping 75% discount to its discounted net asset value as late as last month. While this gap has significantly closed recently, a buying opportunity still persists as shown if one reads on.
Before going into what QC may approximately be worth today, the reasons for undervaluation are numerous, obvious, and real:
– QC has experienced declining financial results in the past three years, which have resulted in the failure of the company to meet various financial covenants in their outstanding credit agreements.
– Proposed new Consumer Financial Protection Bureau (CFPB) rules would adversely effect business and financial condition. Other state, county or municipal laws affecting the payday loan industry may also have an adverse effect on the company over the long-term.
– Company’s current revolving credit facility ($9 million USD) expires on July 23, 2016.
– Voluntary Nasdaq de-listing in Q1 of this year forced indiscriminate selling on the part of institutional investors from which the share price has still not fully recovered.
Another thing that can only be categorized as both odd and strange is the fact that as a condition to entering into its prior credit agreement, its lenders required that it issue $3.0 million of senior subordinated notes. Which were then issued on September 30, 2011, $2.5 million initial principal amount of senior subordinated notes were issued to its Chairman of the Board Don Early. The remaining $500,000 principal amount of subordinated notes was issued to another major stockholder of the company, who is not an officer or director of the company.
These subordinated notes bear interest at the rate of 16% per annum, payable quarterly, 75% of which is payable in cash and 25% of which is payable-in-kind (PIK) through the issuance of additional senior subordinated PIK notes. Subsequently, as a condition to entering into the amendment of the credit agreement on July 23, 2014, the lenders then required that the maturity date of the subordinated notes be extended.
Such an amended agreement was entered into an with the holders of the subordinated notes to extend the maturity of the outstanding notes to September 30, 2016. Needless to say, it appears one truly does learn something new with every company, as I have personally never seen something like this in my near decade of investing experience.
QC holds up in other respects, as the only arrangement that can be considered to be off-balance sheet arises solely due to an accounting technicality since the company acts as a CSO in Texas with liabilities from this ongoing activity limited to an immaterial $260K USD as of Sept. 2015.
The company does additionally have some exposure to Canadian consumer loans via its limited online lending platform, but this operating segment currently makes up a mere 4.7% of their total revenue.
Now for the good, yes good bits and parts do exist! QC’s runs a fairly diversified, traditional operation, owning over 329 short-term brick and mortar lending branches across the country, with branches located in its home state of Missouri and California representing approximately 22% and 14% of total revenues for the nine months ended September 30, 2015. The short-term lending branches located in the states of Missouri and California likewise represent approximately 32% and 12%, respectively, of total gross profit for the nine months ended September 30, 2015.
As for potential catalysts, the company has re-purchased over 6 million common shares worth over $56.6 million in the open market to date and has $3.4 million still eligible to dedicate to re-purchases until June 30, 2017 at its discretion. QC also currently owns one commercial building which is leased out to a third-party tenant and is classified as held for sale with a divestiture expected sometime in the next 12 months.
Overall, single-pay loan fees make up approximately 65.5% of the company’s total revenue.
The average single-pay loan (including fee) totaled $383 during the first nine months of 2015 versus $386 in comparable 2014. Average fees received from customers per loan were $59 during first nine months of 2015 and $59 during first nine months of 2014. This displaying that the often touted industry line that its lenders only make their margins on continually recurring business actually has some truth in it.
QC’s all-important loan/loss ratio was 28.7% during the first nine months of 2014 versus 28.9% during the first nine months of 2015, while stratospheric-ally high by traditional lending standards it is not untypical for the payday loan industry. In addition, it also received cash of approximately $623,000 from the sale of certain single-pay loans receivable during nine months ended September 30, 2015 that had previously been written off compared to $560,000 during the same period in 2014, with such secondary market sales becoming more and more recurring for the company.
Capital expenditures for the nine months up to Sept. 30, 2015 were a relatively lean $928K USD.
Finally, $25.25 million USD is QC Holding’s adjusted net current asset value after deducting all liabilities and assuming a 30% loan/loss ratio. The company’s current market value stands at $19.07 Mil. USD as of 6/10/16, implying a 34.5% discount still persists.
– $17.38 Mil. Current Assets less deferred income taxes and prepaid expenses
– $39.01 Mil. Loans receivable – discounted by 30%
Disclaimer: Author or author’s company currently owns a minority stake in the security mentioned above. All information contained herein is “as is” and the author expressly disclaims making any express or implied warranties with respect to the fitness of the information contained herein for any particular usage, application or purpose.