PSB Monthly Issue April 2014

For instance, small businesses accounted for more than 75% of all jobs created over the last decade.  Yet, all the talk you hear about job creation is focused on the big companies.

Here’s the thing…

Small businesses are an extremely important part of the US economy, but most small business owners are cash constrained.  In fact, seven of ten small business owners start with less than $20,000.

As such, there is significant need for alternative financing for small businesses.

It’s not like big banks are in a hurry to lend to small companies.  And, it’s vital for these companies to procure the proper equipment for their businesses to run.

You see, eight out of ten companies will lease at least some of their equipment.  And, nine out of ten will lease equipment continually over time (rather than buy at some point).

Check this out…

According to the Equipment Leasing and Finance Association, the overall market for equipment leasing is an estimated $725 billion.  How’s that for a massive market!  And with roughly 50% of US businesses being small companies, there’s clearly immense opportunity for a company specializing in small business leasing.

One such company is MicroFinancial (NASDAQ: MFI).

THE EQUIPMENT LEASE BUSINESS

MFI is a specialized commercial and consumer finance company which provides micro-ticket equipment leasing and other financial services.  The company offers financing alternatives through leases and rents of commercial equipment.

MicroFinancial’s clients range from start-up businesses to established enterprises.  The leased equipment is typically used for vital, daily operations of the various clients.  This includes everything from water filtration systems and fitness equipment to point of sale cash registers and security devices.

Contracts can be as small as $500 or as high as $25,000, with the average contact ranging from $4,000 to $6,000.  The average contract length is a little under four years. Basically, these aren’t the types of loans you’ll see coming from a standard bank.

Besides the lack of significant competition and the huge potential market, MFI has several other things going for it.

The company has paid a dividend since 2005, showing a strong record of consistency and stability.  The current divided is yielding 3.5% after the dividend was increased by a penny in 2013.

Moreover, because of the nature of the business, the company has strong cash receipts.  During 2013, MFI received nearly $131 million in cash from customers, representing $8.86 per diluted share (more than what the stock is trading for at the moment).

Finally, during the fourth quarter of 2013, the company launched a new E-Commerce initiative, which provides its dealer base with additional channel to increase sales efforts.  It also provides customers with a quick and efficient way to finance their equipment needs online.

THE NUMBERS

The strong year MFI just had can be readily seen in 2013’s numbers.

Annual revenues increased by 5.4% to $62.5 million.  The gains were driven by increases in lease revenue, rental income, and income from service contracts.  In other words, the entire business improved year-over-year.

Meanwhile, net income climbed 4.4% to just under $10 million.  It’s no surprise this company is profitable, given its robust operating margin of over 40%.  It’s hard to lose money when a company is working with those kinds of margins.

The company holds just over $2 million in cash compared to roughly $72 million in debt.  However, the high debt to cash ratio is related to the nature of the business. The company relies on its revolving credit line to finance its leases.

With the amount of cash MFI pulls in every year, there’s very little credit risk involved. Not to mention, current assets are a robust 2.2x current liabilities.

INVESTMENT RISKS

As with any small cap investment, MFI does have a few risks.

A slowdown in global economic growth could lower demand for equipment from small businesses and hurt revenues.

An increase in competition or new players in the market could result in a slowdown in revenue growth.

Finally, an increase in interest rates could make the company’s revolving credit line more expensive to maintain and lower profits.

POTENTIAL RETURN OF 100% OR MORE

Analysts project MFI’s profits to grow by 22.5% next year.  That means the shares are current trading at just 9.2x expected profits.  Meanwhile, the industry average price to earnings ratio is a substantially higher 27.3x.

If MFI trades up to the industry average, that would imply a 197% gain in the share price.  While we don’t expect those kinds of gains overnight, a 100% gain is a very realistic medium-term target.

Just for comparison, the company’s shares are also trading at a meager 2.9x sales. The industry average price to sales ratio is 10.6x.  Once again, it’s clear that MFI is very undervalued at the current price.

Based on our analysis, we see MFI climbing to $16.00 a share or more.  Buy the shares now for potential gains of 100% or higher!

ACTION RECOMMENDATION

BUY MicroFinancial (NASDAQ: MFI) up to $8.60 per share.

Don’t forget your position sizing and stop-loss rules.