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Saturday, February 16, 2008

Nicholas Financial (NICK) Q3 results

NICK (sec)
I originally bought NICK at the end of July 2003 and sold it in Aug and Sept 2005. Great success! I looked at them briefly here. I have this habit of being correct about things, but then not taking my own advice. With NICK, I've said for a long time that they would remain cheap until after the sub-prime issues all resolved (presumably after some sort of meltdown or crisis). The crisis is well underway and NICK has dropped a lot. I repurchased NICK in Sept 2007 at an average $9.06, some more in Oct 2007 at $9.16, and some more in November and January at $7.49. So with NICK, I've done what I said I should do and I believe it's been the right thing so far. However, the stock is now $6.95.

My reason for owning NICK is that 1) it has always been cheap to some degree, although nothing like July 2003 when I got the idea from ValueInvestorsClub (of which I've never been a member), 2) I believe it's run very conservatively and that bad economic times will actually reveal this to be true.

Let's check the most recent results (I already did back when they came out, but let me write it down now).

10-Q

Period ending Dec 31, 2007 (Q3).
10 million shares outstanding on Jan 31, 2007.
The CEO exercised 50K options on 2/1/08.
The CFO flat out bought 1K shares and exercised 75K shares on 2/7/08.

BALANCE SHEET
92% of the assets are auto loan receivables.
PP&E is miniscule.
They have $100 million in an outstanding line of credit (54% of assets).
42% equity.
Total assets are $185 million.

INCOME STATEMENT
Revenue up 7.7%.
Expenses are mostly salaries, provision for losses, interest expense, and admin costs.
Salaries up 7%. [additional branches opened]
Provision for losses more than doubled, which is not too surprising.
Interest expense up 11%.
Admin costs up 11%.
Operating income down from 38% of revenue to 28% of revenue.
Tax down to $1.3 million from $1.7 million on revenues of roughly twelve million.
Net income down to 17.8% of revenue from 23.6% of revenue.
Diluted income of 22 cents vs 27 cents.

CASH FLOW STATEMENT (9 months)
Net income was $7.6 million but operations generated $11.3 million in cash (differs mostly due to additional provision for losses).
$66 million in customer principal was repaid.
$79 million went back into purchase and origination of loans.
Borrowed about $6 million from the line of credit.

Cash went from $1.5 million to $4.7 million.


CASH FLOW STATEMENT (3 months, using prior 10-Q)
Net income was about $2.2 million while operations generated $2.9 million.
Provision for losses increased by $2.5 million.
AP decreased by about $1.2 million.
prepaid expenses dropped by about $400K.
$22 million in customer principal was repaid.
$24 million went back into purchase and origination of loans.
Borrowed about $2.5 million from line of credit.

Cash went from $2.5 million to $4.7 million.

Looks good.

NOTES

The line of credit is for $115 million (with covenants that can decrease the amount), LIBOR + 1.625 or prime plus 0.375. LOC expires Nov 2010.

Interest rate swaps exist, converting from floating to fixed. $70 million notional amount.
Swaps match the hedged items according to SFAS 133.
$678K loss due to swaps, after tax.
Q3 comprehensive income drops to $1.6 million from $2.2 million.

783K options outstanding. 11 million shares fully diluted. Assume 12 million totally diluted.
So net income for the quarter is 19 cents totally diluted. Comprehensive income is 13.3 cents totally diluted.
If annualize that and slap a P/E of 15 onto it, you get $8.00 a share in value... in the middle of the worst of times.


RATIOS ETC.
comparing with prior year's Q3

Contract interest rate: 24.14% (up from 23.78%)
Cost of borrowed funds: 6.51% (about the same)
Gross portfolio yield: 26.18% (down slightly from 26.84%)
Interest expense / finance receivables: 3.35% (about the same as 3.33%)
Provision for losses / finance receivables: 5.13% (cranked WAY up from 2.74%)
Net portfolio yield: 17.7% (down from 20.77%)

Operating expernses / finance receivables: 10.23% (down slightly from 10.46%)
Net charge-offs / (ave finance receivables - unearned interest): 9.51% (up a lot from 7.38%)
The gross portfolio yield decreased due to reduced accretion of discounts. The decrease was partially offset by a change to reflect interest earned on a contractual basis, as opposed to on the basis of expected yield (see discussion under “Analysis of Credit Losses” below). The net portfolio yield decreased due to the above factors, plus the effect of additional provisions for credit losses required for the change in the recognition of interest and the resulting effect on credit loss provisions, together with additional provisions in response to increased charge-off rates.
Which is what I expected.

Looking at the contract procurement vs states, South Carolina and Virginia dropped somewhat. Alabama increased: new branch opening(s).

Averate loan size of new contract purchases was $9,316 and 48 months. Down from $9,100 and up from 46 months.

Loans originated were typically for $3,09 (down from $3,269) and 26 months (down from 30).

Originated loans are only about 10% of the purchased loans. They tend to do better (not surprising).


ANALYSIS OF CREDIT LOSSES

They have 831 static pools. I really like static pools based on location and date of loan origination. I really like static pools since they can show trends that might be hidden by the consolidated numbers. The average static pools has 67 contracts, $612K.

Before April 2005, the static pools were run differently, but they've changed the method to match industry standards for comparability with other similar companies. The new method boosts both provisions for losses and interest income, but not net income.

THE STUFF BELOW IS FOR PURCHASED LOANS

The allowance for credit losses has been dropping somewhat from $21.1 million in Sept 2006 to $19.9 million in Sept 2007 to $19.3 million in Dec 2007.

Discounts in purchasing new loans gets dumped into the allowance for credit losses.
Q3 07: $2.1 million added due to discounts
Q3 06: $2.4 million added due to discounts

Losses absorbed:
Q3 07: $5.0 million
Q3 06: $3.6 million

Provision added to the allowance in the quarter:
Q3 07: $2.3 million
Q3 06: $1.1 million

So they added about $4.4 million to the allowance account while absorbing $5.0 million from it. The entire allowance is over $19 million.

The allowance on direct loans has actually been increasing and even this quarter, the provision exceeded the losses, without even considering recoveries.
The Company has seen deterioration in the performance of its Contract portfolio, more specifically, static pools originated since June 30, 2006 have seen an increase in the default rate when compared to the preceding year pool performance during their same liquidation cycle. The Company attributes this increase to weakness in the consumer credit cycle and weakness in employment and believes this trend will continue for the remainder of its fiscal year.
...i.e. for at least three more months, which doesn't tell us much.
The average dealer discount associated with new volume for the three months ended December 31, 2007 and 2006 were 8.34% and 8.53%, respectively.... The Company believes the average dealer discount may continue to decrease as the result of competition in the markets the Company is currently operating in.
If the liquidity/credit cycle causes much of a shake-out, then I would expect this trend to stop or even reverse.
The longer term outlook for portfolio performance will depend on the overall economic conditions, the unemployment rate and the Company’s ability to monitor, manage and implement its underwriting philosophy in additional geographic areas as it strives to continue its expansion. The Company does not believe there have been any significant changes in loan concentrations, terms or quality of Contracts purchased during the three or nine months ended December 31, 2007 that would have contributed to the increase in losses.
Recoveries as a percentage of charge-offs decreased to 10% from 13%. They see this continuing as the expansion further away will make it more difficult to recover cars. Repo man!
The Company believes there is a correlation between the unemployment rate and future portfolio performance. The Company believes the down turn in the housing sector is affecting its customer’s employment status and does not foresee any recovery during the current fiscal year. The number of bankruptcy filings by customers during the nine months ended December 31, 2007 has increased when compared to the nine months ended December 31, 2006.
I'm going to reprint the entire delinquencies table:

Contracts

Dec 31, 2007





Dec 31, 2006



Gross balance outstanding


$ 256,278,730



$ 233,992,372







Delinquencies











30 to 59 days


$ 8,908,945
3.48 %
$ 4,942,628
2.11 %

60 to 89 days



2,933,134
1.14 %

1,682,993
0.72 %

90 + days



1,402,143
0.55 %

691,092
0.30 %













Total delinquencies


$ 13,244,222
5.17 %
$ 7,316,713
3.13 %













Direct Loans











Gross balance outstanding


$ 10,989,625



$ 10,052,202







Delinquencies











30 to 59 days


$ 212,084
1.93 %
$ 94,912
0.95 %

60 to 89 days



77,503
0.71 %

55,635
0.55 %

90 + days



91,271
0.83 %

25,482
0.25 %













Total delinquencies


$ 380,858
3.47 %
$ 176,029
1.75 %


Here's the table from the same period in 2005:

Contracts



Dec 2006





Dec 2005



Gross balance outstanding


$ 233,992,372



$ 203,293,741




















Delinquencies













30 to 59 days


$ 4,942,628
2.11 %
$ 3,438,414
1.70 %

60 to 89 days



1,682,993
0.72 %

1,144,851
0.56 %

90 + days



691,092
0.30 %

409,335
0.20 %













Total delinquencies


$ 7,316,713
3.13 %
$ 4,992,600
2.46 %


















Direct Loans













Gross balance outstanding


$ 10,052,202



$ 7,904,426




















Delinquencies













30 to 59 days


$ 94,912
0.95 %
$ 89,224
1.13 %

60 to 89 days



55,635
0.55 %

35,969
0.46 %

90 + days



25,482
0.25 %

28,087
0.35 %













Total delinquencies


$ 176,029
1.75 %
$ 153,280
1.94 %

That's a significant jump in delinquencies, but not as bad as you'd think from all the hype. Remember that this is all subprime with interest rates well above 20%.

NICK currently runs 46 branch offices in 11 states. Each branch can handle up to 1,000 accounts up to $7.5 million in net finance receivables. Only 6 of the branches have hit this level. They expect to open two more branches before March (Indianapolis and Birmingham).

They expect to continue to expand via contract purchase and direct loan. They recently announced a Central Processing Center to underwrite, process, and collect new loans.

They might close under-performing branches.


CONCLUSION

I'll have to wait for the dust to settle from the current economic situation before things become clear about NICK. I suspect the stock is worth about $18. I'm very happy with how they're doing and continue to own the stock. This is one that I believe I should consider holding for a long time period. However, I wisely dumped it and repurchased it at a much lower price.

Comments:
Great write-up. I've owned NICK for nearly a decade and added a little recently at $6.85. Hard to believe it's not a great buy now under BV (@7.50/sh) given that they earn north of 20% on BV in "normal" times with a conservative balance sheet. With LIBOR dropping their NIM will increase. The dealer discount increased sequentially for the first time in many quarters and I think their boilerplate comment about competition may be too pessimistic given that major competitors (eg CPSS) rely on the now crummy market for securitizations for financing. Still, delinquencies are high even compared to the previous downturn and will be interesting to watch over the next few quarters.

--Jay
 
Hi Jay,

I didn't figure the book value per share, but at $7.50, yeah, it's clearly a bargain.

I also think that the competition might get a lot less intense after this whole thing plays out.

I planned to look at some competitors to see what their delingquency rate is but haven't gotten around to it yet.
 
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Let me be straight forward.
I have two questions for you.
1.How did you get a google page rank of 3 ?
and
2.Why aren't any advertisements in your blog?
Please tell me...
regards
Saran.
 
Saran,

1) I get a fair amount of traffic and a lot of people show up after searching for "pink sheets". Nowadays, the traffic is much lower; Sitemeter claims it's 50 visits per day. When I was a lot more active here, I was getting about 100 per day.

2) There are no ads because the gain I might get from it would be very small while I believe it would have slightly negative impact on the target readers. My intent has been to make money by digging up good ideas and acting as a sort of wholesaler of information. But there are a lot of people now digging up these little companies, so I'm not sure if I add any significant value. If so, it would be to provide a second opinion on a given stock.

Another reason for avoiding ads is because it would tend to cause me to do things for the sake of increasing traffic alone rather than my intended purpose (taking notes for my own sake, acting as a wholesaler of information). People respond to incentives and I'd rather not give myself the wrong incentives.
 
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