This is the 5th in a series of articles that attempt to identify relative value discrepancies between two closely related securities. So far, the first four have been modestly successful in aggregate, though it's a little early to be drawing conclusions:
- 3/14: Buy Met-Pro (MPR), Sell Nalco Holding (NLC)
- 4/18: Buy Johnson & Johnson (JNJ), Sell Allergan (AGN)
- 5/3: Buy Columbia Sportswear (COLM), Sell UnderArmour (UA)
- 5/10: Buy C.R. Bard (BCR), Sell Intuitive Surgical (ISRG)
In this trade, I am looking at two companies that deal with credit-impaired or low-income consumers generally. In the case of Aaron's (AAN), which just changed its ticker from RNT, the company "leases" appliances, televisions, computers, etc. to anyone without doing a credit check. Not surprisingly, its sales have been strong lately. My thesis is that it's easy to sell to someone with bad credit, but harder to collect when the economy is struggling. It's not a bad business in a strong economy, but it's very risky in a weak one.
EZCORP (EZPW), on the other hand, is a pawn shop and payday lender, though it is moving into other areas such as auto titles. When it sells used merchandise, it is a final sale, unlike AAN, which may have to repossess if the "buyer" doesn't keep up his payments. While the payday lending is at risk, the low valuation of EZPW tells me that investors are paying very little for that business. According to management (twice publicly to me on their conference call), the exit costs are minimal should the business become uneconomic. Here's the tape:
EZPW is much cheaper on a PE basis, and it has a very strong balance sheet. AAN has a high EBITDA margin, but its D&A is huge. AAN has also been boosting its sales by buying in franchises. I don't know management at AAN as well, but I can say that EZPW management is very strong. I believe that EZPW will trade towards 18 this year as the strength of its pawn business supports earnings growth, while AAN is likely to pull back towards 24.
Disclosure: Long EZPW