Value Meets Momentum: EZCorp Run Has Just Begun (NASDAQ:EZPW)

EZCORP (NASDAQ:EZPW) appears to be undervalued by almost any metric. As growth and momentum continue building, I believe the stock has potential to unlock value and perform a great run in 2024 and 2025, with ~50% upside to the current price by my calculations.

The Company

Founded in 1989 with a small cluster of 16 stores, EZCORP has since grown to become one of the leading companies in the pawn shop business. They currently operate 1,237 stores across the United States, Mexico, Guatemala, Honduras and El Salvador.

A pawn shop is an old-fashioned business and makes its money primarily in two ways: from loans using goods as collateral, which is classified as “pawn service charges”, or proceeds from the sales of goods it bought at a discount from the public, classified as “merchandise sales”. Sales of goods taken as collateral on defaulted loans fall under this category as well. A minor revenue stream, “jewelry scrapping sales”, is classified differently because some of the jewelry acquired gets scrapped first if it has little to no value in selling directly to the public in its current state.

The company has a healthy gross margin between 55%-60%. No surprises here-the main cost comes from the purchased goods.

Besides merchandise costs, the second biggest expense is the cost of running the stores. G&A (general and administrative) and D&A (depreciation and amortization) expenses come next but are dwarfed by the former two.

Some of the EBIT gets spent as interest expenses but not much-taxes are a bigger weight. Net profit margin is usually ~7%, a healthy level for the business. On the chart below, the obvious impact on 2Q23 catches the eye; equity in unconsolidated affiliates (usually positive) was a huge draw down on that quarter.

That impact was from a previously announced, one-time, non-cash goodwill impairment recognized from Cash Converters International. It occurred because, in December 2022, the Australian government passed the Financial sector Reform Bill 2022, which limited small amount credit contracts-precisely the pawn business. Since becoming effective in June 2023, the bill impacted Cash Converters, creating a $32.5 million impairment charge in 2Q23 because EZCORP owns a portion of Cash Converters. It’s non-cash impact can be verified by looking at the cash flow statement of that period, as the expense gets added back to the operational cash flow.

When we compare the company’s US GAAP EPS with its adjusted one, the main difference is the removal of non-cash, goodwill impairments and the movement of currency fluctuations.

Such EPS has been constantly beating consensus by a healthy margin in the past few years. I believe that its mainly because the company is under followed by Wall Street’s analyst, being a small cap (~600 mm as of the time of this article).

Here’s what the current forecast consensus look like when we compare them recent earnings.

Such projections are likely to continue being wrong simply because the company is under followed. The consensus is based on two analysts only.

As momentum builds and the company starts attracting attention, I believe that is likely to change. Currently, Seeking Alpha’s Quant grade for the company is a STRONG BUY, with A grades on momentum and revisions. On its chart, the company broke through the last trend on 1Q24’s earnings, showing powerful momentum.

Under the Hood

There are a few reasons for the out performance of EZCORP. To understand it, we have to look at a few, business-specific metrics.

The first one is PLO-Pawn Loans Outstanding. This metric is the main one I like to look at, as I view it as the true asset of the company; it’s those loans outstanding that will either return as pawn service revenue (a.k.a, interest plus principal on the loans) or become a future sale of a merchandise (because the loan was defaulted on and the goods taken as collateral), being booked when sold as merchandise sales.

The second most important metric is PSC-Pawn Service Charges. This is, essentially, the company’s main business “price”; at least, the best way for us to gauge it.

I like to divide PSC/PLO, because PSC is measured in USD and therefore naturally increases with the PLO base; dividing one by the other allows me to get a sense of how much the company is charging across quarters on a relative basis.

Those two are the most important metrics to keep track of, and they are on a positive uptrend. As long as this continues, I expect EZCORP’s performance to continue to surprise positively. The company is expanding in both the US and Central America, and I believe they are working on consolidating a particular niche that still has lots of pulverized, small business to be acquired.

Cash Flow & Balance Sheet

When analyzing EZCORP’s cash flow statement, the main thing one needs to be aware of is that new loans being made (or being paid) impact the Cash From Investing Activities. For instance, if the company is growing healthily, one would expect the CFI (Cash From Investing) to be severely negative as money is flowing out in the form of new loans. In the opposite, consider that if the company was losing market share and making less loans, CFI would be very positive because more cash would be coming in from loans being paid than going out in new loans being made. Because of that, I like to remove the effect from new loans/loans paid from the CFI to try and get a better sense of how the company is performing.

Here’s what happens when I remove those impacts to try to estimate the company’s Free Cash Flow to the Firm. I also remove the line above (in the image)-Invest. In Marketable Securities, because that’s simply the company managing its cash.

As you can see above, the Free Cash Flow to the Firm has grown tremendously in the past few quarters, reaching very healthy levels. The negative FCFF in the 1Q23 comes from a US$ 15 mm investment into Founders. From the 1Q23’s earnings call:

We also invested an additional $15 million in preferred equity and $15 million in debt into Founders, which purchased additional ownership in SMG. This capital was used by SMG to complete the 100% acquisition of La Familia Paw, which operates 53 stores in Florida and Puerto Rico, where it is the market leader.

When it comes to debt and leverage, current net debt is US$ 142.01 mm and TTM EBITDA US$ 138.1, which means a 1.03x leverage, a healthy level and strong balance sheet.

The Road Ahead

The company has been reaping benefits from inflation, which I expect to continue in the short-to-medium term. From their 1Q24 earnings call:

… The macroeconomic environment continues to be a challenge for our customer base, with inflationary pressure increasing the demand for pawn as consumers seek cash to satisfy their short-term needs. In addition, consumers seek value by purchasing preowned merchandise and jewelry, which also represents a more environmentally responsible way to shop…

Management is excited with its investment in Founders, and this could be another source of surprising upside.

… Founders is a high-performing business. It’s now the third largest pawn broking chain in the North American region. So it’s very, very quickly become quite a force, which is what we’d hoped. So we’re very happy with that investment. It’s producing even better returns than we expected. They have bought stores this quarter in Central America, which is exciting.

So they’re now at 97 stores. The way we think about it long term is that we are very happy with the structure that we’ve obviously already spoken to investors about. But it’s a potential acquisition going forward and could be a source of really high growth for our shareholders. So we’re really happy with the team, with their performance…

They are also very active with buybacks, considering their own stock to be very cheap in the market.

On the share buyback side, obviously, we’re trying to balance our own growth with share buybacks. We listen to shareholders, obviously, and we assess this, every quarter, but we continue to buy back stock. We’ve done that very consistently across every quarter, and we see it as another good return on investment.

We believe that our stock is very, very cheap. And so we are balancing buying that back with the really significant growth opportunities that we think we have just even in the regions in which we operate. So we’re trying to strike a balance between growth and scaling up our cash flows and our store base with what we see as a good return on investment in buying back stock.

Based on that and their recent, strong performance, I believe that EZCORP is setting up to have an outstanding year in 2024.

Valuation

EZCORP closest peer is FirstCash Financial Services (FCFS), and the difference in their forward PE ratio is currently very steep.

The gap has been narrower in the past and I expect it to narrow further in 2024 and 2025. EZCORP’s growth and performance is, in my opinion, too strong for it to remain trading at 10x earnings for too long. As momentum gathers, I think it’s only a matter of time before the market slowly starts to take notice of the stock.

I’ve showed above that the stock has been constantly beating earnings estimates by large numbers. For my own forecast, I assume that such trend will continue. I think the earnings projections are still at least 20% below what should be a reasonable range.

As you can see in the simple exercise above, if you assume a 20% earnings surprise (the past few years have been strongly above that) and a 13,59 multiple (halfway between EZCORP and FCFS current forward PE gap), you reach a price target of roughly $16. At current prices, that’s at least a ~50% discount, which is why I believe this is a good investment with a reasonable margin of safety.

Risks

Growth always comes with internal pain, and EZCORP has been rapidly expanding through new stores and acquisitions. That creates a serious execution risk as management has to take care of many new operations and integrate it to the current ones.

EZCORP has been a value trap for a very long time. It’s been cheap forever, and as value traps often do, it could continue being cheap for a long time. I’ve had my eye on the stock for a while in my screeners, and it’s one of the cases where I prefer to wait for momentum to build up a little before jumping in. It seems to be the case, but it could also be a bull trap. Another positive aspect is that management is buying back shares aggressively, which helps… But EZCORP has a history of disappointing bulls.

Executive chairman Philip Cohen controls 100% of the Class B voting shares, which means he de-facto controls all the important decisions. This is a governance issue that has always plagued the stock and a source of its discount. There has been controversy here in the past and claims that Philip overpays himself and his close colleagues, essentially running the company for himself. I believe this is the main issue causing a cheap valuation, and investors should be aware of this as it is definitely a skeleton in the closet.

Conclusion

EZCORP seems extremely undervalued to me. When it comes to such cases, one must be very careful not to fall for a value trap. As growth and momentum continues, I think that it’s possible that we’re witnessing a positive run for EZCORP, and I believe the stock has a good margin of safety at current levels.