PSB Monthly Issue October 2013

It’s been over five years since the heart of the crisis, and the ensuing recession has fallen off in favor of slow growth.  Nevertheless, many credit service companies remain ultra-conservative.  And, several types of loans are still mostly unavailable to the masses.

It’s especially true for those who traditionally are considered higher risk credit customers.  That is, people with low credit scores, low income, or past credit problems.

But, so many people fall into these categories because of the effects of the financial crisis, it has resulted in far fewer loans or credit deals of all flavors.

Clearly there’s still a huge market for somewhat riskier credit services.  After all, people are still going to want to buy houses and cars, among other major purchases.

Here’s the thing…

It’s good for everyone if more credit is available to consumers – assuming appropriate risk measures are taken.  An increase in major purchases means more spending.  And more spending is without a doubt key to economic recovery.

Still, big financial companies haven’t been able to increase their lending availability all that much.  Shareholders and executive managers are still gun shy from the crisis.

Fortunately, smaller companies are stepping in and filling the void left by big financial institutions.  These more nimble players are able to step in and offer credit to those consumers who may not otherwise qualifies for loans.

One such company is Consumer Portfolio Services (NASDAQ: CPSS).

THE AUTOMOBILE FINANCE BUSINESS

CPSS is a specialty finance company which provides purchasing and servicing of retail automobile contracts.  These contracts are originated by automobile dealers from the sales of new and used cars, truck, and vans.

Through purchasing automobile contracts, the company is providing indirect financing to customers with limited credit history, low incomes, or past credit problems.  Basically, CPSS serves as an alternative source for financing for dealers, which helps sell automobiles to those who may not normally be able to obtain financing.

CPSS makes an excellent investment opportunity for a variety of reasons.

First off, as I mentioned earlier, there’s massive demand for credit.  It’s particularly a need for consumers who have less than an ideal credit situation.

And, because major financial institutions are shying away from this space, there’s a ton of opportunity for companies to step in and grab market share.  Judging by revenue and profit growth numbers (which I’ll talk about in a minute), CPSS is doing just that.

And that’s not all…

As the recession slowly fades away into history, and economic growth continues, the alternative lending business is only going to get stronger.  Not only will more and more people qualify for loans, but the entire industry will be safer as consumers have more money to spend.

One way we know the industry is improving is CPSS was just able to close a $205 million round of asset-backed securitization (ABS). Basically, the company packages its loans into ABS products and sells them to prospective yield seekers.

These types of investments are considered riskier since the financial crisis.  So, CPSS being able to close such a big deal is definitely a positive sign for the industry.

Finally, CPSS represents one of the few pure play automobile lenders out there.  Most other auto lending is done through a bigger entity.  Not to mention, there are very few competitors period working with higher risk auto loans.

CPSS is in excellent position in its industry because it’s small and nimble and able to focus on areas bigger players can’t really touch.  As you’re about to see, the results speak for themselves.

THE NUMBERS

Besides providing an intriguing service, CPSS also sports fantastic financials.

In the most recent quarter, the company pulled in $70.5 million in revenues.  That’s an impressive 60% climb over the same quarter last year.  Meanwhile, net income came in at $4.8 million, or $0.15 per share.  It’s a significant boost from the $1.3 million, or $0.05 per share last year.

Both revenues and earnings are a result of an improvement in the industry as the economy distances itself from the recession.  Essentially, credit is normalizing after years of being extremely tight.

On the balance sheet side of things, CPSS is holding $18.6 million in cash compared to roughly $1.1 billion debt.  But, it’s nowhere near as bad as it sounds.  The company has to report its asset backed securities as debt before they sell portions of it off to third parties.  And, despite the high “debt” line item, the company’s current assets are a whopping 9.4x current liabilities.

Essentially, as long as the industry functions as it normally should – and CPSS can continue to sell off its ABS exposure – there’s no concern about default risk.

INVESTMENT RISKS

As with any investment, CPSS does have a few risks.

An unexpected slowdown in the economy could reduce demand for automobile loans in general and slow the company’s revenue growth.

New competitors could enter the field and make securing new and existing customers more difficult.

Finally, if interest rates go up, it could increase debt servicing costs and lower the company’s profits.

POTENTIAL RETURN OF 100% OR MORE

CPSS has a lot going for it.  The company is rapidly growing both revenues and profits.  And, the economy is improving to the point where the automobile loan industry should begin to thrive.

Nevertheless, investors are ignoring CPSS shares.  In fact, the shares are trading at just 2.4x earnings and 5.7x projected earnings.  Those ratios are low for any industry, but are especially glaring with CPSS’ closest competitors trading at 11x earnings or higher.

That implies if CPSS just trades up to the industry average price to earnings ratio, it could easily double.

Based on our analysis, we see CPSS climbing to $12.25 a share or more.  Buy the shares now for potential gains of 100% or higher!

ACTION RECOMMENDATION

BUY Consumer Portfolio Services (NASDAQ: CPSS) up to $6.75 per share.

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