Company’s background:
Credit Acceptance Corp (CACC) provide financing services for sub-prime auto purchaser. In simple term, this is how they make money: auto dealers purchase used cars, refurbish them, mark it up at a high margin and sell it to subprime buyers on a loan, and CACC would purchase the loan at a discount price. Since CACC purchase a large amount of loans, they are able to diversified the risk. This business model benefits all parties involved. The dealer benefit through extra revenues from customer who otherwise would not qualify for financing. The car buyer, who given their credit score would not be able to receive financing from other financial institutions, benefit by being able to afford a car. Finally, CACC benefits from interest on these loans.
The company was founded in 1972. The company offers two programs to dealers: Portfolio Program and Purchase Program. The Portfolio Program, which is the more complicated one between the two, will be better explained with an example. Suppose a subprime buyer would like to purchase a car. The dealer would finance the car by giving out a loan to the buyer. Suppose that if the loan is fully repaid, the total cash flow would be 100. Now, given that this is a subprime loan, CACC will forecast that the actual cash flow that comes in would be 70. Then they will pay the dealer 40 dollars in advance, and receive the right to service the loan. When collections come in surpass 40 dollars, any extra amount would go to the dealer, net of certain fees for CACC. Under this program, both the dealer and CACC share the risk of the loan (although CACC assumes the risk of the first 40 dollars). Under the Purchase Program, CACC purchases loans from dealers at a discounted price, and then earns the difference. Under this program, CACC assume the whole risk of the loan.
Qualitative Analysis:
When analysing a financial institution, I placed great emphasis on two qualities. The first one is prudency. Unlike other companies who generates earning through tangible assets, the earnings of financial comes from its equity in the business. Equity allows the company to raise debt, which will be deployed into interest earning assets. As a result, an operating loss is much more devastating to financial institutions. A loss leads to a shrinkage of equity, which means it will not be able to raise as much debt going forward. This will leads to either less interest earning assets, which affect future earnings, or the need to raise additional equity, which will dilute future earnings. Therefore, for a financial institution, it is better to stay prudent, grow gradually over the long-term and avoid losses rather than participating in risky practices to maximize short-term earnings. Slow and steady win the race.
There are signs that lead me to believe in the prudency of the company. Firstly, he company passed through the 2008 Recession with flying colours. That is a rare feat, especially for a financial company. Secondly, in the past three years, the company faced strong competition in the sub-prime lending industry. A lot of companies take advantage of the low interest rate to raise capital and enter the market with laxing lending practices. These companies jack up the price at which they are willing to purchase loans to win over businesses but leaving themselves open for excessive risks. In 2017, many of these companies began to fold, dropping dead like flies . In contrast, during this period of intense competition, CACC has managed to continue to raise revenues and earnings, as well as maintaining a high standard of lending and a high margin. Lastly, in their latest debt financing round, Moody rate all of their debts in the investment categories, which demonstrate the reputation of CACC in the financial industry.
The second quality is integrity of the managers. The complexity of the financial statements of financial institutions allows for a lot of accounting gimmicks and manipulation. If the managers decide to cover up their wrong doing, as an outsider it is extremely difficult for an analyst to spot these shenanigans. Doing so is like playing the managers’ game, on their turf and by their rules – you are most likely going to lose. Therefore, if the integrity of management is in question, then the analyst can not trust the numbers presented to them.
There are signals that lead me to believe in the integrity of the managers. Firstly, the compensations of the executive team are in line with other executives of comparable business. Secondly, management has been extremely open and honest in their earning calls. They spoke openly about the challenges that they are facing, and their plans to tackle these challenges. Lastly, the CEO, Brett Robert, is highly approved by the employees, according to Glassdoor. His “Approval of CEO” rating is much higher than other CEOs of other companies, and there are a lot of good words for him in the comments.
The company also receives an extremely high rating on Glassdoor, especially for a financial company. It also receives multiple awards, including appearance on the Best Workplaces for Millennials by Great Place to Work® and Fortune, #4 Midsize Company on IDGs Computerworld 2018 List of Best Places to Work in IT, appearance in 2018 Best Workplaces in Financial Services & Insurance List by Great Place to Work® and FORTUNE, appearance in Best and Brightest Companies to Work For® in the Nation. This shows that the company takes really good care of its employees.
Quantitative analysis:
Below are the historic numbers of the company for the past 20 years.
Income Statement
Revenue:
CACC’s revenue has been increasing every year since 2000. The source of this growth is from attracting more dealers into their program. CACC has been growing with little spending on CAPEX, as they leverage technology to reach more customers instead of expanding through opening new offices. At the end of 2017, the company has 11,500 active dealers. In the US, there is approximately 60,000 dealers – ample room for CACC to continue growing.
Earning before Income Tax (due to the recent change in tax, I only presented the before tax earnings figure):
Over the past 20 years, CACC had always been generating income, except for 1999. Ever since 2000, the company has been earning profit at a very high margin.
Net Income (new tax rate):
Over the course of the company’s history, ROE and ROA has always been extremely high. YOY growth has slowed down in the past few years due to intense competition. However, as interest rate is raising, a lot of competitors are being forced out of business, which would leave a large playing field for CACC in the future.
Financial Position:
CACC has a much larger equity to assets ratio than other sub-prime lender such as Santander Consumer (16%). This will provide a sizable cushion for the company to survive if there is going to be an economic downturn in the near future. This large equity to assets ratio will also allows the company to get more favourable terms when raising debt.
Interest Coverage:
Both earnings before interest and tax covers interest expenses almost 6 times, which is more than sufficient. Historically, in the past 10 years EBT covers interest expense in the range between 8.81 and 3.38.
To provide more assurance, the company has revolving lines of credit with amounts available for borrowing up to 1,161 (warehouse facilities and revolving secured line of credit). When these interest expenses come due, there is without a single doubt that the company will be able to pay them.
Concerns:
As I research the company, I came across some concerns brought up by analysts. Below, I will discuss each of them and explain why I think these concerns are overblown.
Firstly, forecasted collection % fell from the high of 79% in 2009 to 67% in 2016, showing that the company is taking on more risky loans. However, as forecasted collection decrease, the company also decrease the price at which they are buying these loans. As a result, the spread, although did shrunk in recent years, has been maintained at a reasonable level.
Secondly, there has been a shift toward more Portfolio Program compares to Purchased Program. Under the Purchased Program, CACC assumes the whole risk of the loan, and therefore it is considered more risky compares to the Portfolio Program. However, this is a trend that tends to happen whenever the industry is facing intense competition. During 2008, a similar shift took place. When the competition ease, there will be a reverse shift toward more Portfolio Program. Furthermore, despite the shift taking place, the Portfolio Program still take up the majority of the total loans (72.5%). Therefore, I believe there is little reason to worry over this shift.
Thirdly, many analysts are concerned with the fact that recently there has been a lot of companies going bankrupt within the sub-prime lending industry. I believe that this fear is overblown. A lot of the company that went bankrupt are newer companies that entered the market after the recession to take advantage of the low interest rate environment. CACC on the other hand is a strong company that has shown a long history amazing profitability and resiliency during tough times. Analysis of the company’s financial statements shows that the company is in a healthy financial position. The company also recently has been able to refinance its debt and receive high rating from Moody. Therefore, I believe that it's financial position is very sound.
Summary and conclusion:
CACC is an outstanding company selling at a reasonable price. At the moment, the stock is trading at 13.93 PE ratio, which is very reasonable for a financial institution. As a financial companies, it possess both prudency and integrity. The company takes care of its employees, which will allow it to attract and retain talents. Over the past 20 years the company has demonstrated strong revenue growth with above average profitability, and the company recently has announced plan to expand its sales force. The company is in a healthy financial position and should be able to meet its obligation in the near future. With interest rising, many sub-prime lender will be forced out of business, which promises a less competitive environment for the company in the future. The company’s fundamental business is not one that can be replaced in the foreseeable future (there will continues to be poor people, and there will continues to be a need for car ownership). For the above reasons, I recommend a buy for CACC.
Article written by Cole Le
Credit Acceptance Corp (CACC) provide financing services for sub-prime auto purchaser. In simple term, this is how they make money: auto dealers purchase used cars, refurbish them, mark it up at a high margin and sell it to subprime buyers on a loan, and CACC would purchase the loan at a discount price. Since CACC purchase a large amount of loans, they are able to diversified the risk. This business model benefits all parties involved. The dealer benefit through extra revenues from customer who otherwise would not qualify for financing. The car buyer, who given their credit score would not be able to receive financing from other financial institutions, benefit by being able to afford a car. Finally, CACC benefits from interest on these loans.
The company was founded in 1972. The company offers two programs to dealers: Portfolio Program and Purchase Program. The Portfolio Program, which is the more complicated one between the two, will be better explained with an example. Suppose a subprime buyer would like to purchase a car. The dealer would finance the car by giving out a loan to the buyer. Suppose that if the loan is fully repaid, the total cash flow would be 100. Now, given that this is a subprime loan, CACC will forecast that the actual cash flow that comes in would be 70. Then they will pay the dealer 40 dollars in advance, and receive the right to service the loan. When collections come in surpass 40 dollars, any extra amount would go to the dealer, net of certain fees for CACC. Under this program, both the dealer and CACC share the risk of the loan (although CACC assumes the risk of the first 40 dollars). Under the Purchase Program, CACC purchases loans from dealers at a discounted price, and then earns the difference. Under this program, CACC assume the whole risk of the loan.
Qualitative Analysis:
When analysing a financial institution, I placed great emphasis on two qualities. The first one is prudency. Unlike other companies who generates earning through tangible assets, the earnings of financial comes from its equity in the business. Equity allows the company to raise debt, which will be deployed into interest earning assets. As a result, an operating loss is much more devastating to financial institutions. A loss leads to a shrinkage of equity, which means it will not be able to raise as much debt going forward. This will leads to either less interest earning assets, which affect future earnings, or the need to raise additional equity, which will dilute future earnings. Therefore, for a financial institution, it is better to stay prudent, grow gradually over the long-term and avoid losses rather than participating in risky practices to maximize short-term earnings. Slow and steady win the race.
There are signs that lead me to believe in the prudency of the company. Firstly, he company passed through the 2008 Recession with flying colours. That is a rare feat, especially for a financial company. Secondly, in the past three years, the company faced strong competition in the sub-prime lending industry. A lot of companies take advantage of the low interest rate to raise capital and enter the market with laxing lending practices. These companies jack up the price at which they are willing to purchase loans to win over businesses but leaving themselves open for excessive risks. In 2017, many of these companies began to fold, dropping dead like flies . In contrast, during this period of intense competition, CACC has managed to continue to raise revenues and earnings, as well as maintaining a high standard of lending and a high margin. Lastly, in their latest debt financing round, Moody rate all of their debts in the investment categories, which demonstrate the reputation of CACC in the financial industry.
The second quality is integrity of the managers. The complexity of the financial statements of financial institutions allows for a lot of accounting gimmicks and manipulation. If the managers decide to cover up their wrong doing, as an outsider it is extremely difficult for an analyst to spot these shenanigans. Doing so is like playing the managers’ game, on their turf and by their rules – you are most likely going to lose. Therefore, if the integrity of management is in question, then the analyst can not trust the numbers presented to them.
There are signals that lead me to believe in the integrity of the managers. Firstly, the compensations of the executive team are in line with other executives of comparable business. Secondly, management has been extremely open and honest in their earning calls. They spoke openly about the challenges that they are facing, and their plans to tackle these challenges. Lastly, the CEO, Brett Robert, is highly approved by the employees, according to Glassdoor. His “Approval of CEO” rating is much higher than other CEOs of other companies, and there are a lot of good words for him in the comments.
The company also receives an extremely high rating on Glassdoor, especially for a financial company. It also receives multiple awards, including appearance on the Best Workplaces for Millennials by Great Place to Work® and Fortune, #4 Midsize Company on IDGs Computerworld 2018 List of Best Places to Work in IT, appearance in 2018 Best Workplaces in Financial Services & Insurance List by Great Place to Work® and FORTUNE, appearance in Best and Brightest Companies to Work For® in the Nation. This shows that the company takes really good care of its employees.
Quantitative analysis:
Below are the historic numbers of the company for the past 20 years.
Income Statement
Revenue:
CACC’s revenue has been increasing every year since 2000. The source of this growth is from attracting more dealers into their program. CACC has been growing with little spending on CAPEX, as they leverage technology to reach more customers instead of expanding through opening new offices. At the end of 2017, the company has 11,500 active dealers. In the US, there is approximately 60,000 dealers – ample room for CACC to continue growing.
Earning before Income Tax (due to the recent change in tax, I only presented the before tax earnings figure):
Over the past 20 years, CACC had always been generating income, except for 1999. Ever since 2000, the company has been earning profit at a very high margin.
Net Income (new tax rate):
Over the course of the company’s history, ROE and ROA has always been extremely high. YOY growth has slowed down in the past few years due to intense competition. However, as interest rate is raising, a lot of competitors are being forced out of business, which would leave a large playing field for CACC in the future.
Financial Position:
CACC has a much larger equity to assets ratio than other sub-prime lender such as Santander Consumer (16%). This will provide a sizable cushion for the company to survive if there is going to be an economic downturn in the near future. This large equity to assets ratio will also allows the company to get more favourable terms when raising debt.
Interest Coverage:
Both earnings before interest and tax covers interest expenses almost 6 times, which is more than sufficient. Historically, in the past 10 years EBT covers interest expense in the range between 8.81 and 3.38.
To provide more assurance, the company has revolving lines of credit with amounts available for borrowing up to 1,161 (warehouse facilities and revolving secured line of credit). When these interest expenses come due, there is without a single doubt that the company will be able to pay them.
Concerns:
As I research the company, I came across some concerns brought up by analysts. Below, I will discuss each of them and explain why I think these concerns are overblown.
Firstly, forecasted collection % fell from the high of 79% in 2009 to 67% in 2016, showing that the company is taking on more risky loans. However, as forecasted collection decrease, the company also decrease the price at which they are buying these loans. As a result, the spread, although did shrunk in recent years, has been maintained at a reasonable level.
Secondly, there has been a shift toward more Portfolio Program compares to Purchased Program. Under the Purchased Program, CACC assumes the whole risk of the loan, and therefore it is considered more risky compares to the Portfolio Program. However, this is a trend that tends to happen whenever the industry is facing intense competition. During 2008, a similar shift took place. When the competition ease, there will be a reverse shift toward more Portfolio Program. Furthermore, despite the shift taking place, the Portfolio Program still take up the majority of the total loans (72.5%). Therefore, I believe there is little reason to worry over this shift.
Thirdly, many analysts are concerned with the fact that recently there has been a lot of companies going bankrupt within the sub-prime lending industry. I believe that this fear is overblown. A lot of the company that went bankrupt are newer companies that entered the market after the recession to take advantage of the low interest rate environment. CACC on the other hand is a strong company that has shown a long history amazing profitability and resiliency during tough times. Analysis of the company’s financial statements shows that the company is in a healthy financial position. The company also recently has been able to refinance its debt and receive high rating from Moody. Therefore, I believe that it's financial position is very sound.
Summary and conclusion:
CACC is an outstanding company selling at a reasonable price. At the moment, the stock is trading at 13.93 PE ratio, which is very reasonable for a financial institution. As a financial companies, it possess both prudency and integrity. The company takes care of its employees, which will allow it to attract and retain talents. Over the past 20 years the company has demonstrated strong revenue growth with above average profitability, and the company recently has announced plan to expand its sales force. The company is in a healthy financial position and should be able to meet its obligation in the near future. With interest rising, many sub-prime lender will be forced out of business, which promises a less competitive environment for the company in the future. The company’s fundamental business is not one that can be replaced in the foreseeable future (there will continues to be poor people, and there will continues to be a need for car ownership). For the above reasons, I recommend a buy for CACC.
Article written by Cole Le
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