CACC - Credit Acceptance Corp

[wknecht]

Brett Roberts' annual letter was released today. They had a strong fourth quarter (strong loan and loans per dealer growth), probably driven by oil.

http://www.ir.creditacceptance.com/reports.cfm

 

Separately CACC filed an 8-K stating the FTC inquiry was closed without incident.  Given the fines others are getting, it's doubtful the other outstanding matters will resolve so nicely.

http://www.sec.gov/Archives/edgar/data/885550/000088555015000025/cacc_8k20150317.htm

[wknecht]

After trimming my position some time ago, I re-added at $192 recently. They continue to kill it operationally.

[AccentricInv]

Are you concerned that they're willing to take on lower returns in exchange for deploying more capital?  I estimate that they used to earn ~17% on their 2007 vintage loans, and are now take on new loans ~12%.  Also any thoughts on how big their total addressable market actually is?  They're not fully penetrated, but with ~30k used dealers in the country, does that mean they've already roughly tapped 20% of their market? 

 

They're still earning a great return and the management is very forthcoming, but would love to bounce these thoughts off you.

[wknecht]

The trend in returns on capital is certainly unfavorable, but I'm not particularly concerned at this point. The main reason is that they have a track record of being disciplined through the cycle. For example, they have shown a willingness to reduce volumes by maintaining price discipline rather than pushing sales.

 

Here's an interesting comment from Brett Roberts on a recent call: "I think as I said last quarter when I started with the company the longest term we would write is 24 months and I think we probably prefer that if we could get away with that in the marketplace but the marketplace has changed. The customer expects to get a newer nicer vehicle. In order to accommodate that you have to be willing to write a longer-term. So over the course of many many years we've gradually lengthened that term out and the way we’ve done has been I think very methodical, we lengthened 24 to 30 months and we made sure we could price that, we felt comfortable we could forecast the collection rates and we knew how that business would perform and then we moved up to 36 months. So we just continued that trend. In the latter part of last year we extended the term out again, I think again all things being equal if we could get away with writing a short-term in the marketplace we would but ultimately the way we make those decisions is what is going to provide the best combination of volume and profit per unit and we are comfortable that we made decision on that basis."

 

The addressable market isn't super clear to me, but there seems to be plenty of room for growth left. Where do you see the 30k dealership number?

 

In the 10-K they say "Our target market is approximately 55,000 independent and franchised automobile dealers in the United States." And on a call Brett Roberts said "I think that we have a lot of runway in front of us in terms of being able to grow the business. Others in the industry have had much larger numbers of active dealers than that. So I think that there is ample opportunity for a long time to continue to increase the active dealer base."

 

I can't find that 55k number either, but the attached report says 37k independent used-car dealers. That excludes used franchise dealers (also a very large segment) which could get us up to the 55k.

UCIR_2014_email_version.pdf

[AccentricInv]

Agreed.  But since you're currently buying at a premium to the value of the "loan book value" at ~1.4x (?), that 12% return that they're earning on the underlying loan is effectively ~8.6% to the investor at today's stock price right?

 

The 30k was a very rough estimate, I think i remember from either the Experian state of the automotive market reports or perhaps even the NIADA.  I'm operating under the assumption that the majority of their dealers are non-franchised, used car dealers, which places it between 30-40K.  Perhaps there's still plenty of room to penetrate the number of loans per dealer though, especially as they've become more disciplined in the last few years due to the tough environment.

 

Still a great stock (I've owned it since the low 100's), but these are just a couple concerns that have been bothering me.

[wknecht]

Could you elaborate on your math slightly? We're most likely looking at it differently but I think we're paying more than 1.4x.

 

21mm shares at $205 is $4.3b equity at market. Debt and the other small adjustments they mention are $2b. So we're paying $6.3b (4.3+2) for $2.8b of "adjusted capital" supporting the loans, which is 2.25x assuming the book value of debt is close to market.

 

That $2.8b of capital currently earns 12.7% and costs 5% (weighted after tax, per their Q2 PR), which implies 2.65% for the debt after tax. If you assume they don't grow or shrink and just dividend out that 12.7% in perpetuity, that leaves $14.4  per share for the equity ([12.7% *$2.8b - 2.65% * $2b] /21mm shares) for a yield of 7% at $205 a share.

 

This all ignores growth (or shrinkage, eg, from a hit to capital by regulators), changes to rates, and changes to returns on capital. They're willing to write down to an economic profit of 0. I haven't done it yet, but using their assumptions one can back into what that would mean for shareholders at current prices.

 

At these prices, modest growth is part of the thesis,  so I haven't added in a really big way yet. I'll add in phases on the way down assuming no other major changes to the situation.

 

Curious your thoughts. 

[valuefinder0525]

http://www.bloomberg.com/news/articles/2016-02-11/some-hedge-funds-want-to-make-subprime-auto-loans-next-big-short

[wknecht]

http://www.bloomberg.com/news/articles/2016-02-11/some-hedge-funds-want-to-make-subprime-auto-loans-next-big-short

I don't think this is a concern.  I think, and have mentioned before, that a blowup in the market would likely be good for CACC because they're disciplined, have liquidity, and capital would leave the market. I doubt that will happen though - which I thought before oil dropped off a cliff.

 

The usual regulatory matters they discuss continue to be a concern and worth monitoring closely. To date, fines received by others (and larger players) are manageable for CACC.

[AccentricInv]

Does anyone have access to the Janney Montgomery Scott report from this morning?  Anything interesting in there?

[johnhuber]

I have never looked at this company but just read the annual report today. Some quick random comments I'll make: I think it's a well-run business, but they have some tough headwinds currently. This is widely acknowledged, but competition is brutal currently. I've looked at CRMT and NICK (much smaller players in subprime auto finance) and loose terms and excess inflows of capital to this business is really affecting their profitability. I've talked to CRMT management, and you almost feel bad for them. They feel like there are new competitors entering their turf on an almost weekly basis, and you get the feeling that they aren't in control of their own destiny at all. It's much easier for people who used to be great CRMT/CACC/NICK customers (subprime, but at the top of the subprime "tranche") to now go to one of the OEM finance arms and get a 72 or even 84 month loan, which allows them to buy a nicer car that's twice as expensive for the same bi-weekly payment

 

But what has impressed me on CACC is their ability to offset declines in volume per dealer (due to heavy competition) with consistent growth in the dealerships that they do business with. They've roughly doubled their dealer count since 2011, which has more than offset around 26% declines in per-dealer volume. Despite losing market share on a per-dealer basis, they've added dealers and improved overall share and volumes, and earning power has doubled.

 

That said, they've gone from 900 dealers in 2003 (the beginning of the previous cycle) to around 9,000 now. And volume per dealer has gone from around 62 loans to 32 loans. So it took a monumental increase (10x) in dealers to offset 50% productivity declines at the dealership level.

 

To sum it up: They've done an impressive job of growing through the cycle by willingly ceding market share to preserve profits at the dealership level during competitive markets and offsetting this with new dealers. Now that they have 9k dealers, it's impossible to achieve the same level of growth going forward, and so the high returns on equity will be much more dependent on level of profitability they can get with each loan, which will likely require some help from the competitive landscape (CACC likely does fine going forward by the way, it's just they won't see anywhere near the rate of compounding I don't think).

 

Just as aside, it's interesting how much higher CACC is valued than smaller (weaker) competitors like NICK. For $4b (equity value of CACC), you get around $3.3b in receivables and $1b of equity. NICK is roughly 10% of that size ($311m receivables and $102m equity), but cost only ~$80m. In other words, NICK is 0.8 P/B and CACC is 4.0, or five times as expensive. Both have similar debt levels relative to equity, but obviously CACC gets much better returns on its equity than NICK, and so its valuation relative to earning power is only twice that of NICK's (14 P/E at CACC vs 7 P/E at NICK)

 

I wonder how much of that is warranted. CACC is obviously a much better business, and I think probably much better positioned to do well if/when the downturn next comes. It has a ton of dry powder via its credit facility and some cash, whereas NICK is mostly tapped out. So CACC will be able to capitalize by writing loans at attractive terms if capital begins to leave the industry.

 

I'm not sure I really like either business. Subprime auto lending is so tough, and likely to get tougher. And short of another credit crisis, I'm not sure capital leaves as quickly as it did the last downturn.

 

Open to comments on the industry or any one of these firms specifically...

[PatientCheetah]

It is a stock that I would love to own when the next auto replacement cycle starts, just not now or in the near future.

[wknecht]

I have never looked at this company but just read the annual report today. Some quick random comments I'll make: I think it's a well-run business, but they have some tough headwinds currently. This is widely acknowledged, but competition is brutal currently. I've looked at CRMT and NICK (much smaller players in subprime auto finance) and loose terms and excess inflows of capital to this business is really affecting their profitability. I've talked to CRMT management, and you almost feel bad for them. They feel like there are new competitors entering their turf on an almost weekly basis, and you get the feeling that they aren't in control of their own destiny at all. It's much easier for people who used to be great CRMT/CACC/NICK customers (subprime, but at the top of the subprime "tranche") to now go to one of the OEM finance arms and get a 72 or even 84 month loan, which allows them to buy a nicer car that's twice as expensive for the same bi-weekly payment

 

But what has impressed me on CACC is their ability to offset declines in volume per dealer (due to heavy competition) with consistent growth in the dealerships that they do business with. They've roughly doubled their dealer count since 2011, which has more than offset around 26% declines in per-dealer volume. Despite losing market share on a per-dealer basis, they've added dealers and improved overall share and volumes, and earning power has doubled.

 

That said, they've gone from 900 dealers in 2003 (the beginning of the previous cycle) to around 9,000 now. And volume per dealer has gone from around 62 loans to 32 loans. So it took a monumental increase (10x) in dealers to offset 50% productivity declines at the dealership level.

 

To sum it up: They've done an impressive job of growing through the cycle by willingly ceding market share to preserve profits at the dealership level during competitive markets and offsetting this with new dealers. Now that they have 9k dealers, it's impossible to achieve the same level of growth going forward, and so the high returns on equity will be much more dependent on level of profitability they can get with each loan, which will likely require some help from the competitive landscape (CACC likely does fine going forward by the way, it's just they won't see anywhere near the rate of compounding I don't think).

 

Just as aside, it's interesting how much higher CACC is valued than smaller (weaker) competitors like NICK. For $4b (equity value of CACC), you get around $3.3b in receivables and $1b of equity. NICK is roughly 10% of that size ($311m receivables and $102m equity), but cost only ~$80m. In other words, NICK is 0.8 P/B and CACC is 4.0, or five times as expensive. Both have similar debt levels relative to equity, but obviously CACC gets much better returns on its equity than NICK, and so its valuation relative to earning power is only twice that of NICK's (14 P/E at CACC vs 7 P/E at NICK)

 

I wonder how much of that is warranted. CACC is obviously a much better business, and I think probably much better positioned to do well if/when the downturn next comes. It has a ton of dry powder via its credit facility and some cash, whereas NICK is mostly tapped out. So CACC will be able to capitalize by writing loans at attractive terms if capital begins to leave the industry.

 

I'm not sure I really like either business. Subprime auto lending is so tough, and likely to get tougher. And short of another credit crisis, I'm not sure capital leaves as quickly as it did the last downturn.

 

Open to comments on the industry or any one of these firms specifically...

A lot of good stuff to chew on. A couple of comments.

 

Agreed that the level of dealer growth isn't sustainable over a long period of time, and that they need some help from the competitive environment for total long term growth. Management (who I think you must have confidence in to own the stock) seems to think a good runway remains though, and has provided data on the point. I think at these levels we're paying for some growth, though not historical growth levels.

 

When comparing valuation, in addition to the items you noted, I think CACC's earnings stream is higher quality because of how they structure their portfolio program (most of their business). By that I mean the dealers have skin in the game, so (a) incentives are more aligned, and (b) CACC is in a more senior position compared to those using a direct discount purchase model. Regarding (b), up to CACC's advance, the dealer is in the first loss position and beyond that, 80% of the losses (variance below forecasted collections) are born by the dealer through reduced dealer holdback. So their earnings should be less risky and volatile on the downside, and so deserving a higher multiple (though clearly their earnings are quite cyclical and credit risky).

 

Also, you're right that it's a tough business. It's not one of Buffett's businesses that is "so good an idiot could run." But I think if it were easy it would be a very bad business - totally comoditized. And they strike as having the philosophy, management, and discipline to do well. Not dissimilar to an investment business, insurance company, or bank, which are also not easy, but can be quite good if run in a rational and disciplined manner. A bit of a leap of faith with management is required.

[kab60]

Anyone interested in CACC should read RV Capitals letters (also if you're not interested in CACC I recommend them).

[glorysk87]

Anyone interested in CACC should read RV Capitals letters (also if you're not interested in CACC I recommend them).

 

Mind posting a link to the letters here? Or attaching if you have pdfs?

[AccentricInv]

Anyone interested in CACC should read RV Capitals letters (also if you're not interested in CACC I recommend them).

 

Mind posting a link to the letters here? Or attaching if you have pdfs?

 

The letters are posted on the RV Capital site.  You just need to register.

 

http://www.rvcapital.ch/news/

[johnhuber]

I have never looked at this company but just read the annual report today. Some quick random comments I'll make: I think it's a well-run business, but they have some tough headwinds currently. This is widely acknowledged, but competition is brutal currently. I've looked at CRMT and NICK (much smaller players in subprime auto finance) and loose terms and excess inflows of capital to this business is really affecting their profitability. I've talked to CRMT management, and you almost feel bad for them. They feel like there are new competitors entering their turf on an almost weekly basis, and you get the feeling that they aren't in control of their own destiny at all. It's much easier for people who used to be great CRMT/CACC/NICK customers (subprime, but at the top of the subprime "tranche") to now go to one of the OEM finance arms and get a 72 or even 84 month loan, which allows them to buy a nicer car that's twice as expensive for the same bi-weekly payment

 

But what has impressed me on CACC is their ability to offset declines in volume per dealer (due to heavy competition) with consistent growth in the dealerships that they do business with. They've roughly doubled their dealer count since 2011, which has more than offset around 26% declines in per-dealer volume. Despite losing market share on a per-dealer basis, they've added dealers and improved overall share and volumes, and earning power has doubled.

 

That said, they've gone from 900 dealers in 2003 (the beginning of the previous cycle) to around 9,000 now. And volume per dealer has gone from around 62 loans to 32 loans. So it took a monumental increase (10x) in dealers to offset 50% productivity declines at the dealership level.

 

To sum it up: They've done an impressive job of growing through the cycle by willingly ceding market share to preserve profits at the dealership level during competitive markets and offsetting this with new dealers. Now that they have 9k dealers, it's impossible to achieve the same level of growth going forward, and so the high returns on equity will be much more dependent on level of profitability they can get with each loan, which will likely require some help from the competitive landscape (CACC likely does fine going forward by the way, it's just they won't see anywhere near the rate of compounding I don't think).

 

Just as aside, it's interesting how much higher CACC is valued than smaller (weaker) competitors like NICK. For $4b (equity value of CACC), you get around $3.3b in receivables and $1b of equity. NICK is roughly 10% of that size ($311m receivables and $102m equity), but cost only ~$80m. In other words, NICK is 0.8 P/B and CACC is 4.0, or five times as expensive. Both have similar debt levels relative to equity, but obviously CACC gets much better returns on its equity than NICK, and so its valuation relative to earning power is only twice that of NICK's (14 P/E at CACC vs 7 P/E at NICK)

 

I wonder how much of that is warranted. CACC is obviously a much better business, and I think probably much better positioned to do well if/when the downturn next comes. It has a ton of dry powder via its credit facility and some cash, whereas NICK is mostly tapped out. So CACC will be able to capitalize by writing loans at attractive terms if capital begins to leave the industry.

 

I'm not sure I really like either business. Subprime auto lending is so tough, and likely to get tougher. And short of another credit crisis, I'm not sure capital leaves as quickly as it did the last downturn.

 

Open to comments on the industry or any one of these firms specifically...

A lot of good stuff to chew on. A couple of comments.

 

Agreed that the level of dealer growth isn't sustainable over a long period of time, and that they need some help from the competitive environment for total long term growth. Management (who I think you must have confidence in to own the stock) seems to think a good runway remains though, and has provided data on the point. I think at these levels we're paying for some growth, though not historical growth levels.

 

When comparing valuation, in addition to the items you noted, I think CACC's earnings stream is higher quality because of how they structure their portfolio program (most of their business). By that I mean the dealers have skin in the game, so (a) incentives are more aligned, and (b) CACC is in a more senior position compared to those using a direct discount purchase model. Regarding (b), up to CACC's advance, the dealer is in the first loss position and beyond that, 80% of the losses (variance below forecasted collections) are born by the dealer through reduced dealer holdback. So their earnings should be less risky and volatile on the downside, and so deserving a higher multiple (though clearly their earnings are quite cyclical and credit risky).

 

Also, you're right that it's a tough business. It's not one of Buffett's businesses that is "so good an idiot could run." But I think if it were easy it would be a very bad business - totally comoditized. And they strike as having the philosophy, management, and discipline to do well. Not dissimilar to an investment business, insurance company, or bank, which are also not easy, but can be quite good if run in a rational and disciplined manner. A bit of a leap of faith with management is required.

 

The other thing that makes me nervous about these subprime companies is that its very difficult to get a good feel for the true performance of these loans. CACC discloses the "spread" all through their filings: i.e. the amount of the total loan value (p&i) that they collect compared to the amount that they advance to the dealers up front. This spread has always been positive, and as you pointed out, this creates in effect a seniority position in the loan. That said, when only 65-70% of the loan value is getting collected, the default rates are very high. Somewhere around 50% of the loans are getting repaid in full.

 

This isn't surprising, as other subprime lenders have very high default rates as well. But CACC's disclosure is much more complicated than the other subprime lenders that basically just state their credit metrics in more traditional form. For CACC, it seems the only way that this model has been so successful is that the dealers are jacking up the price of the car above the fair market value so that a) it can get an advance from CACC (combined with the downpayment from the car buyer) that is close to what the dealer would get from a cash buyer or traditional subprime lender and b) CACC gets enough interest to recoup its advance and make a profit before the buyer quits paying.

 

It's like a race against the clock. CRMT is in a similar position, where it needs around 10 or 11 months of payments to breakeven, and soon after the buyer typically quits paying. NICK and CACC need more time since their loan terms are longer, but same concept. The difference is NICK and CRMT (and others) are currently provisioning more than 25% of their revenue for credit losses, and CACC is in the single digits.

 

I know this is due to the differences in their model, but I fear that dealers have more of an incentive to artificially inflate the cost of the car on a CACC loan since they don't get as much up front as they do from another subprime lender that does a more traditional loan purchase.

 

Thoughts?

[ItsAValueTrap]

With CACC and Westlake, it's more of a partnership where the car dealership will have skin in the game.  There are also upfront costs... so the dealer does not make a lot of money unless they exceed certain volumes.  If the dealership only does a few loans through CACC, then the dealership basically eats all of the risks and makes no profit.

 

NICK on the other hand retains all of the credit risk.  They don't split credit risk with the dealership.  NICK is kind of a bottom feeder because it tries to intelligently pick off the best loans.

 

Santander and some of the new entrants are some of the dumb money in this sector.  Highly leveraged guys chasing higher volume are the ones I would personally stay away from.  The smart guys are shrinking their volumes.

[AccentricInv]

A lot of good stuff to chew on. A couple of comments.

 

Agreed that the level of dealer growth isn't sustainable over a long period of time, and that they need some help from the competitive environment for total long term growth. Management (who I think you must have confidence in to own the stock) seems to think a good runway remains though, and has provided data on the point. I think at these levels we're paying for some growth, though not historical growth levels.

 

When comparing valuation, in addition to the items you noted, I think CACC's earnings stream is higher quality because of how they structure their portfolio program (most of their business). By that I mean the dealers have skin in the game, so (a) incentives are more aligned, and (b) CACC is in a more senior position compared to those using a direct discount purchase model. Regarding (b), up to CACC's advance, the dealer is in the first loss position and beyond that, 80% of the losses (variance below forecasted collections) are born by the dealer through reduced dealer holdback. So their earnings should be less risky and volatile on the downside, and so deserving a higher multiple (though clearly their earnings are quite cyclical and credit risky).

 

Also, you're right that it's a tough business. It's not one of Buffett's businesses that is "so good an idiot could run." But I think if it were easy it would be a very bad business - totally comoditized. And they strike as having the philosophy, management, and discipline to do well. Not dissimilar to an investment business, insurance company, or bank, which are also not easy, but can be quite good if run in a rational and disciplined manner. A bit of a leap of faith with management is required.

 

The other thing that makes me nervous about these subprime companies is that its very difficult to get a good feel for the true performance of these loans. CACC discloses the "spread" all through their filings: i.e. the amount of the total loan value (p&i) that they collect compared to the amount that they advance to the dealers up front. This spread has always been positive, and as you pointed out, this creates in effect a seniority position in the loan. That said, when only 65-70% of the loan value is getting collected, the default rates are very high. Somewhere around 50% of the loans are getting repaid in full.

 

This isn't surprising, as other subprime lenders have very high default rates as well. But CACC's disclosure is much more complicated than the other subprime lenders that basically just state their credit metrics in more traditional form. For CACC, it seems the only way that this model has been so successful is that the dealers are jacking up the price of the car above the fair market value so that a) it can get an advance from CACC (combined with the downpayment from the car buyer) that is close to what the dealer would get from a cash buyer or traditional subprime lender and b) CACC gets enough interest to recoup its advance and make a profit before the buyer quits paying.

 

It's like a race against the clock. CRMT is in a similar position, where it needs around 10 or 11 months of payments to breakeven, and soon after the buyer typically quits paying. NICK and CACC need more time since their loan terms are longer, but same concept. The difference is NICK and CRMT (and others) are currently provisioning more than 25% of their revenue for credit losses, and CACC is in the single digits.

 

I know this is due to the differences in their model, but I fear that dealers have more of an incentive to artificially inflate the cost of the car on a CACC loan since they don't get as much up front as they do from another subprime lender that does a more traditional loan purchase.

 

Thoughts?

 

Hey John, I appreciated your post on CACC today.  It's probably one of the better summaries of CACC's business model out there.  I agree with everything you've said, but I guess what tilts me (and I'm sure a few other bulls) into the buy camp is the competitive environment that you've hit on.  The dealer TAM becoming saturated is indeed an issue, and I'm not sure they'll be able to meaningfully grow past another cycle or two (unless they go international, which they failed in the UK 15 years ago, and seems a stretch now).  However, most of my work and scuttlebutt research has been focused on where we are in the cycle, and signs indicate that we're about to enter a better competitive environment over the next year.  So I'm skewing my thesis towards that side of the story, but know that this won't be able to compound at the same rates for another 20 years (maybe another 5-10).  I'm expecting them to be able to increase the dealer-level market share, while growing dealer count modestly.  But certainly not at 2007-11 levels.

 

Anyways, just wanted to share a couple thoughts.  I really enjoyed your write-up, and think it did a good job of conveying both sides.  Always happy to chat offline as well.

[grym02]

A lot of good stuff to chew on. A couple of comments.

 

Agreed that the level of dealer growth isn't sustainable over a long period of time, and that they need some help from the competitive environment for total long term growth. Management (who I think you must have confidence in to own the stock) seems to think a good runway remains though, and has provided data on the point. I think at these levels we're paying for some growth, though not historical growth levels.

 

When comparing valuation, in addition to the items you noted, I think CACC's earnings stream is higher quality because of how they structure their portfolio program (most of their business). By that I mean the dealers have skin in the game, so (a) incentives are more aligned, and (b) CACC is in a more senior position compared to those using a direct discount purchase model. Regarding (b), up to CACC's advance, the dealer is in the first loss position and beyond that, 80% of the losses (variance below forecasted collections) are born by the dealer through reduced dealer holdback. So their earnings should be less risky and volatile on the downside, and so deserving a higher multiple (though clearly their earnings are quite cyclical and credit risky).

 

Also, you're right that it's a tough business. It's not one of Buffett's businesses that is "so good an idiot could run." But I think if it were easy it would be a very bad business - totally comoditized. And they strike as having the philosophy, management, and discipline to do well. Not dissimilar to an investment business, insurance company, or bank, which are also not easy, but can be quite good if run in a rational and disciplined manner. A bit of a leap of faith with management is required.

 

The other thing that makes me nervous about these subprime companies is that its very difficult to get a good feel for the true performance of these loans. CACC discloses the "spread" all through their filings: i.e. the amount of the total loan value (p&i) that they collect compared to the amount that they advance to the dealers up front. This spread has always been positive, and as you pointed out, this creates in effect a seniority position in the loan. That said, when only 65-70% of the loan value is getting collected, the default rates are very high. Somewhere around 50% of the loans are getting repaid in full.

 

This isn't surprising, as other subprime lenders have very high default rates as well. But CACC's disclosure is much more complicated than the other subprime lenders that basically just state their credit metrics in more traditional form. For CACC, it seems the only way that this model has been so successful is that the dealers are jacking up the price of the car above the fair market value so that a) it can get an advance from CACC (combined with the downpayment from the car buyer) that is close to what the dealer would get from a cash buyer or traditional subprime lender and b) CACC gets enough interest to recoup its advance and make a profit before the buyer quits paying.

 

It's like a race against the clock. CRMT is in a similar position, where it needs around 10 or 11 months of payments to breakeven, and soon after the buyer typically quits paying. NICK and CACC need more time since their loan terms are longer, but same concept. The difference is NICK and CRMT (and others) are currently provisioning more than 25% of their revenue for credit losses, and CACC is in the single digits.

 

I know this is due to the differences in their model, but I fear that dealers have more of an incentive to artificially inflate the cost of the car on a CACC loan since they don't get as much up front as they do from another subprime lender that does a more traditional loan purchase.

 

Thoughts?

 

Hey John, I appreciated your post on CACC today.  It's probably one of the better summaries of CACC's business model out there.  I agree with everything you've said, but I guess what tilts me (and I'm sure a few other bulls) into the buy camp is the competitive environment that you've hit on.  The dealer TAM becoming saturated is indeed an issue, and I'm not sure they'll be able to meaningfully grow past another cycle or two (unless they go international, which they failed in the UK 15 years ago, and seems a stretch now).  However, most of my work and scuttlebutt research has been focused on where we are in the cycle, and signs indicate that we're about to enter a better competitive environment over the next year.  So I'm skewing my thesis towards that side of the story, but know that this won't be able to compound at the same rates for another 20 years (maybe another 5-10).  I'm expecting them to be able to increase the dealer-level market share, while growing dealer count modestly.  But certainly not at 2007-11 levels.

 

Anyways, just wanted to share a couple thoughts.  I really enjoyed your write-up, and think it did a good job of conveying both sides.  Always happy to chat offline as well.

 

Can you share more of your scuttlebutt and why you think we are entering a better competitive environment in the next year? Very interested in anecdotes and your analysis of the market.

[wknecht]

The other thing that makes me nervous about these subprime companies is that its very difficult to get a good feel for the true performance of these loans. CACC discloses the "spread" all through their filings: i.e. the amount of the total loan value (p&i) that they collect compared to the amount that they advance to the dealers up front. This spread has always been positive, and as you pointed out, this creates in effect a seniority position in the loan. That said, when only 65-70% of the loan value is getting collected, the default rates are very high. Somewhere around 50% of the loans are getting repaid in full.

 

This isn't surprising, as other subprime lenders have very high default rates as well. But CACC's disclosure is much more complicated than the other subprime lenders that basically just state their credit metrics in more traditional form. For CACC, it seems the only way that this model has been so successful is that the dealers are jacking up the price of the car above the fair market value so that a) it can get an advance from CACC (combined with the downpayment from the car buyer) that is close to what the dealer would get from a cash buyer or traditional subprime lender and b) CACC gets enough interest to recoup its advance and make a profit before the buyer quits paying.

 

It's like a race against the clock. CRMT is in a similar position, where it needs around 10 or 11 months of payments to breakeven, and soon after the buyer typically quits paying. NICK and CACC need more time since their loan terms are longer, but same concept. The difference is NICK and CRMT (and others) are currently provisioning more than 25% of their revenue for credit losses, and CACC is in the single digits.

 

I know this is due to the differences in their model, but I fear that dealers have more of an incentive to artificially inflate the cost of the car on a CACC loan since they don't get as much up front as they do from another subprime lender that does a more traditional loan purchase.

 

Thoughts?

Their disclosure is different, but I think arguably simpler and in my view a lot more transparent. I think it's key to determine how accurately they underwrite through time, and they keep and succinctly disclose their score on that at point over 10-year rolling periods, hitting different points in past cycles.

 

There are only so many levers to pull, so you're probably right that dealers raise the car price (indirectly, the cost of credit)  more than others. But I feel that gets a lot of deals done that wouldn't otherwise get done (rather than sweetening a deal that was already going to get done), so which is the worse outcome for everyone? If you think - morally, philosophically, regulatory, whatever - that those deals shouldn't get done for the consumers sake, or it should be cheaper, then that may well be a reason to not own the stock.

[ping19920218]

Anybody cares enough to comment on CACC at today's price?

[DTEJD1997]

Anybody cares enough to comment on CACC at today's price?

CACC is without question a well run company.

 

Years ago, I used to invest in some of their competitors.

 

I still think CACC is too high to be investing in (for me). 

 

In the GFC, some of these types of companies sold for "silly" valuations.  Valuations WAY below book, and single digit P/E's even when earnings started to go down.

 

CACC is still printing/quoted at likely peak earnings.  Wait 2-3 quarters and I would guess their earnings get cut in half at a minimum.  So go from $35 EPS to $15.  Put a 6 P/E on that and you are at $80/share?

 

Of course, CACC is better than their competition, so perhaps valuations won't quite go this extreme example, but I don't doubt that there is still room for earnings/valuation compression if things continue to get worse.

 

Finally, this crisis is going to be VERY different than the GFC.  Back then, it was people's own greed/stupidity that got them in trouble.  Today, it is a virus that is costing people their jobs.  CACC customers are going to get hit harder than the average person.  There is going to be TREMENDOUS pressure on lenders to try and work things out with their borrowers.  I don't think CACC is going to be able to repo cars like they did back 09?

 

Definitely a company to watch though.  I'd be tempted at lower levels.

[abitofvalue]

in a 'normal' environment, their default rate is like 50%. what's it going to be in this backdrop... who knows.  CECL accounting could also matter here.

 

Overall, they should do better than other auto lenders given their better cash-flow model and the ridiculous (imo) rates they charge (+ ruthlessness in repo / wage garnishment + regulatory capture in Mi).  but valuation has been an issue for a long time.  I think i saw some insider buying though..

 

 

[Guest roark33]

They started a new 3m share repurchase program like a week ago.  That's like 20% of their outstanding shares.

[Cigarbutt]

in a 'normal' environment, their default rate is like 50%. what's it going to be in this backdrop... who knows.  CECL accounting could also matter here.

 

Overall, they should do better than other auto lenders given their better cash-flow model and the ridiculous (imo) rates they charge (+ ruthlessness in repo / wage garnishment + regulatory capture in Mi).  but valuation has been an issue for a long time.  I think i saw some insider buying though..

You may remember a thread that was initiated 2 years and four days ago about leap puts on subprime auto lenders. (You had participated)

Shorting is hard. Shorting CACC at the start of the thread would have resulted in a compound annual return of 11.5% (as of today) but one would have endured a rise of interim market value of 50% and the recent fall is not exactly classic end of cycle reversal.

I would say CACC can adapt (I will spend time on various scenarios) and critical variables will be 1-the speed and extent of consumer (that segment) duress and 2-the availability and cost of funds.

I've spent some time on the potential effect of CECL on CACC and such and come to the conclusion that it will affect the bottom line but not the cash flows. Anyways, voices are heard to postpone the application of CECL across the board. I remember that, in early March 2009, accounting rule changes did seem to help for sentiment reversal in terms of the way banks could recognize losses although it did not make a difference in the end. Predicting the future is hard and a way to get around this may be to jump on the train when it looks like it will stop (margin of safety sort of thing).