Car-Mart (CRMT): Like the Company, Hate the Industry
Car-Mart (CRMT) now trades for $35 a share. I picked the stock for my old newsletter, The Avid Hog (you can read all 27 past issues of that newsletter here), when it was trading at $38 a share back in June of 2014. So, it’s now three years later. And the stock is now 8% cheaper. Do I like Car-Mart more today than I did in 2014?
No.
Ideally, a stock should be:
- Cheap
- Good
- Safe
I’m not sure Car-Mart meets all 3 of those criteria. And I am sure it has a harder time meeting those 3 criteria today than it did back in June of 2014. But, let’s start with the criterion that Car-Mart clearly passes.
Receivables Per Share: The Right Way to Value Car-Mart?
Buy and hold investors value a business on its future cash earning power.
So, the correct way to value a business is usually to begin by finding the key determinant – the ultimate source – of a company’s future cash earnings and multiply that number by a second figure. For a timber producer, you’d use the acres of timberland. You might look at a company owning 500,000 acres of timberland and see that buyers normally pay $600 an acre for such land. Based on that, you’d say the business is worth $300 million. If this corporation currently had $120 million in debt on its books, you’d then say all the common stock combined was only worth $180 million. If there were 9 million shares outstanding, you’d say each share of stock was worth $20 a share. In this way, you’ve done an entire calculation for a single share of stock based on something that is:
- Constant
- Calculable
- and consequential
The amount of timberland a company owns varies much less from year-to-year than reported earnings. It’s a “constant” figure. It’s also a very easily “calculable” number. The company states the number of acres it owns in the 10-K each year. Finally, the quality and quantity of acres of timberland owned is clearly the most “consequential” number there is for such a business. Different owners, different managers, different ways of running the business could squeeze a little more profit or a little less profit from the business from year-to-year. But, how much land the company owns and where it owns that land can’t be changed. Clearly, the quality and quantity of acres of timberland owned is the key determinant – the ultimate source – of this company’s future cash earnings.
What is the ultimate source of Car-Mart’s future cash earnings?
What one number can we find that is: 1) constant, 2) calculable, and 3) consequential? We need to find the “essential earnings engine” for Car-Mart.
It’s receivables per share.
Here’s how I explained the right way to value Car-Mart, back in 2014:
“Car-Mart’s value over time should mirror its per share loan balance. This loan balance is what creates value for Car-Mart. So, it is receivables – net of the provision for credit loss – per share that will matter most to long-term investors. (In June of 2014), Car-Mart (had) $310 million in net receivables and 8.75 million shares outstanding. That means the company (had) $35.42 in net receivables per share (versus a $38 stock price).”
So, when I picked it for the newsletter, Car-Mart had $35 a share in net receivables per share and a $38 share price. I thought that price (an 8% discount to net receivables) was a good one to buy Car-Mart at. So, let’s run those same numbers as of today and see if Car-Mart is a better bargain or a worse one than it was back in 2014.
We can see on the company’s 10-Q (over at EDGAR) that as of the quarter ended January of 2017, Car-Mart had $364 million in net receivables and 7.8 million shares outstanding. That means the company has a little under $47 a share in net receivables. Where’s the stock price? $35 a share. So, Car-Mart is trading at 75% of its receivables per share. The stock was trading at an 8% discount to its receivables when I first wrote about it in 2014. Three years later, it is now trading at a 25% discount to its receivables. The stock market is also about 25% more expensive now than when I first picked Car-Mart. So, the company is absolutely cheaper (trading at 75% of receivables now versus 92% of receivables when I first picked it). The stock is also relatively cheaper too. Car-Mart’s stock price has dropped about 16% relative to how I calculate intrinsic value. The stock market overall has risen 25%. The intrinsic value of the market has not risen at anything like 25% over the last 3 years. So, the stock market’s price rose faster than its intrinsic value while Car-Mart’s intrinsic value rose faster than its stock price. Normally, that would mean Car-Mart is more attractive now than it was in 2014.
Is that true?
There’s a catch. I wrote something very, very important in that 2014 report:
“The $396 million in car sales that Car-Mart made in 2013 is what determines the company’s receivable balance for the next couple years. Using retail sales as a yardstick against which free cash flow can be compared provides an opportunity to construct an owner earnings margin for Car-Mart. This is also helpful because receivable balance increases that come from sources other than additional sales – basically longer loan terms – are not desirable from Car-Mart’s perspective. Car-Mart’s owner earnings decrease versus sales when loan terms increase. Over time, Car-Mart (along with everyone else in the buy here pay here industry) has tended to increase the length of its loans.”
Let me repeat the key portion here:
“…receivable balance increases that come from sources other than additional sales – basically longer loan terms – are not desirable from Car-Mart’s perspective.”
Or, to put it even more simply:
Longer loans are bad for Car-Mart
For this reason, we shouldn’t be tricked into believing Car-Mart’s intrinsic value has grown when receivables go up but sales don’t. Car-Mart can always increase its receivables per share by simply making longer and longer loans. But, remember the most important thing you’ll read in this memo is:
Longer loans are bad for Car-Mart
That’s why I suggested valuing Car-Mart based on its sales instead of its receivables. If you don’t do that, you’ll be tricked into buying more and more shares of the stock at the exact moment in the cycle when things are getting worse and worse.
We can measure how bad the cycle is right now in a few ways. A really lagging indicator is actual loan charge-offs. Two other lagging indicators are Car-Mart’s provision for loan losses and then the amount of non-current loans. Those are all lagging indicators, though. We need a leading indicator to know where we are in the cycle.
I’d suggest loan length.
Let me explain this logically. If a borrower is as poor as ever – that borrower can only ever make the same regular loan payment. If you have a $200 payment due every two weeks on your loan and your income doesn’t go up and you don’t have any money left in your bank account after making that payment – there’s no way for you to ever make a bigger loan payment. But, can you buy a bigger car?
Yes, you can. There are two ways a borrower who is as poor as ever can spend like he’s richer than he really is. One, he can make a bigger down payment. A bigger down payment reduces the amount he’s borrowing. This works if you have savings. Car-Mart’s borrowers are bad credit risks. They’re generally poor people living in small, southern cities. They don’t have savings. So, that’s not a realistic option. What’s the other option?
You can extend the term of the loan. Let’s say a borrower takes out a $5,000 loan and pays a 15% interest rate. That borrow needs to pay $750 a year in interest (I’m simplifying here, they pay less as the balance declines). That’s $63 a month in interest. If the borrower is repaying the entire loan over 30 months, they also need to pay $167 a month to reduce the loan balance. So, this borrower would be paying $230 a month. Let’s say the borrower is tapped out at this point. They are left with nothing after paying $230 a month out of their monthly cash flow. How can that borrower – in the loosest part of the credit cycle – get an $8,000 loan instead of a $5,000 loan? You simply extend the loan term from 30 months to 48 months. The monthly payment in both cases is $230 a month. From the buyer’s perspective, both loans are equally manageable. So, the way “buy here pay here” car lenders compete with each other in the loose part of the credit cycle is by extending the length of the loans they make. Increasing a loan’s length is really the only way lenders like Car-Mart can reach more and more marginal buyers and/or make bigger loans to their existing customers.
Longer loans are more dangerous loans.
So, we need to know what’s happened to Car-Mart’s loan length in the 3 years since I wrote that report.
Here are the vital stats for the average loan Car-Mart is making when selling a car off its lot today.
Car-Mart’s Average Sales Terms in 2017
Down Payment: $620
Interest Rate: 15.7%
Bi-Weekly Payment: $ 177
Term: 31.9 months
The one problem area here is “term”. It was 29.8 months on average in 2014 and it is now 31.9 months on average in 2017. That might not sound like much of an increase. But, it’s 2.3% a year. If you kept lengthening your loan terms at that rate, you’d go from making 2 and a half year loans now to making 3 and a half year loans in 15 years from now. Can you keep doing this? Sure. I can imagine Car-Mart making 3.5 year loans in 2032. But, is it as safe to make loans that take 3-4 years to pay off as it is to make loans that take 2-3 years to pay off?
No. It’s definitely riskier. And Car-Mart is already making very risky loans. At any point in time, about 20% of Car-Mart’s loans are non-current and Car-Mart is usually provisioning for credit losses of about 25 cents on the dollar. So, this isn’t your typical lender. The fact Car-Mart lends very short is an important part of how it manages to lend to these kinds of borrowers at all. A short loan length is critical to this business model.
Here’s what Car-Mart’s CFO had to say about loan length in the company’s most recent earnings call:
“…Our weighted average contract term for the entire portfolio, including modifications, was 31.9 months, which was up from 30.9 at this time last year and basically flat sequentially. The weighted average age of our portfolio was 8.9 months, that’s up from 8.6 at this time last year and up from 8.5 months sequentially. Due to the slightly increasing (average selling price) and for competitive reasons, our average term lengths may continue to increase some into the future, but we remain committed to minimizing any increases. If competitive offerings get more conservative, we will have room to keep terms down.”
The other indicator of competitive pressure is that Car-Mart has seen more people visiting its lots but fewer people actually closing a deal:
“…lot traffic was actually up a little bit. The quality of that traffic was a little spotty but the traffic was up. And it just seems like going into several years of excess lending and excess offerings to our customer, it just seems like there is a little fatigue out there with the consumer at this point.”
Those bold and underlines are mine. But, when you hear a company’s CFO say that competitors have engaged in “several years of excess lending and excess offerings to our customer”, you have to worry about the quality of the loans being made in this industry right now.
Car-Mart tries to be a disciplined underwriter. Each lot is run independently. And the managers of those lots are compensated with low base pay and a potentially high bonus based on the performance of the loans they make. This incentivizes managers to make good loans. But, it also incentives them to make loans period.
Car-Mart has continued to buy back stock. I like that a lot. I like this company a lot. But, I don’t like the industry it’s in.
So, what about the timing of buying this stock now?
On the one hand, I think that some of the worst auto loans you’re ever going to see be made were the ones made in the last year or two.
On the other hand, I think Car-Mart is trading at about a 25% discount to its receivables per share and it had historically compounded those receivables at about 13% a year. Realistically, this is a stock that should trade at more than one times receivables – not less.
I like the business and I like the price. But, I don’t like the industry. And I’m really worried the industry will – over the next few years – pay the price for loans it is making now.
So, I’ll be watching for two things. One, what is Car-Mart’s share price relative to its receivables per share. Two, when will shrinking loan lengths tell us the loose part of the auto lending cycle is finally over.
Verdict
- Geoff will NOT buy shares of Car-Mart at this time
- Geoff WILL add Car-Mart to his watchlist at a price of $34.50
- Car-Mart will move to #3 on Geoff’s new idea pipeline behind Grainger
(Read Geoff’s original report on Car-Mart in the library)