CymorFund Investment Letter Stock Picks – Carfinco Financial Group Inc (TSX-CFN $11.12)
What is the SubPrime Market
Our new stock pick is Carfinco Financial Group Inc. This is a lender in the SubPrime market.
A recent phenomena in our society, is the recognition of the “subprime market”. Included in our population, and indeed in all populations, is a significant number of people that have ‘challenged’ credit. They are credit challenged because they have not made payments on time, or they have declared bankruptcy, or their credit scores are very low (lousy credit), or they have no credit history.
You may have heard of this group in a description of subprime mortgages in the 2008 economic meltdown, when the Wall Street Investment Bankers were issuing ‘collateralized mortgage securities’ that were in fact a promise by borrowers to pay securitized by countless worthless mortgages – that is mortgages that were registered on properties where the amount of the mortgage was greater than the value of the property. These eventually came to be known as ‘subprime’, or in other words, the people owing these mortgages would not normally be granted credit by financial institutions, because of a greater risk of these people defaulting on their loans.
Although the name ‘subprime’ has only been in general use in recent years, this market has always existed. It is not to be confused with the 2008 meltdown. It is loaning money, or extending credit of one sort or another, to people that have bad credit.
How Many People are SubPrime?
There are many different estimates of the size of this group within the population, but generally it is considered to be approximately 28% to 30% of the population. This means that approximately 30% of our population cannot borrow money from conventional lenders. They cannot easily lease a car. They cannot easily get a mortgage to buy a house. They cannot easily get a loan to buy a car.
The needs of this large group of people attracted lenders who perceived a way to make profit, and out of this came PayDay Loans, short term financing, large up front fees on any type of financing, and all sorts of other innovative schemes.
Carfinco Financial Group Inc. was created to service this market, and they have a very safe and very profitable operation.
How Do Banks Make Money?
They borrow money from their depositors and they loan that money to borrowers. If they pay their depositors 2%, they will loan the money to borrowers at 6%. That 4% spread pays their expenses and provides them a profit.
SubPrime Lenders have figured out novel ways to earn this spread and more – lots more. They simply pay the banks or people that lend them money one interest rate, and charge a higher interest rate to the borrowers. In addition they charge fees, and sometimes take alternate security. Their essential service is to provide:
- Emergency cash
- Monthly payments that are affordable
Carfinco is such an entity. They borrow money at approximately 4% and lend it out at 29%. Then they charge a fee on each loan up front, making their total charge effectively 33%. The difference provides a very substantial profit to Carfinco. If they incur losses from bad credit borrowers, the large interest spread protects them from any losses, and when losses are subtracted from interest charged, there is still a large profit.
The Carfinco Safety Net
Carfinco deals with automotive dealers who wish to sell cars. In order to sell these cars, a significant proportion of prospective buyers require financing. Bank and conventional lenders will not usually loan to subprime borrowers. ENTER CARFINCO.
Carfinco will consider every prospective borrower. The automobile dealer obtains all necessary information from the borrower and submits that information together with the proposed car purchase details to Carfinco, who immediately checks out the borrower and decides whether to approve the transaction:
- approves approximately 30% of these applications
- borrowers must have reasonable credit history including residence and job history
- lien registered on vehicle
- Auto dealership shares in risk. Carfinco only advances a portion of the loan and the dealership only gets the balance when the loan is paid out. The largest part of the risk is therefore taken by the Auto dealer, not Carfinco
- Average loan requires $400 monthly payment
- Every vehicle has a GPS installed for vehicle location. GPS also warns driver if payment is late. GPS disables vehicle.
- Advanced technology for tracking and maintenance
- Modern collection system for defaults including dial-er telephone system for defaulting debtors
The Stock Price of Carfinco Financial Group Inc (CFN)
The following is a stock chart taken from Big Charts.
This company has been public since 2005 when it traded between $3 & $4. It fell to a penny stock in the 2008 crisis, and then as people started recognizing just how solid this company is, it started to rise, reaching $11.68 in December 2012. It then fell to $8.00, and recently recovered to the $11 range, where it rests for almost a month now.
In technical terms, this pause is known as a stock ‘gathering strength’ before it again takes off. The stock has been very strong in this period and has remained in a very tight trading range. As there have been very positive moves by the company, this stock is likely to again take off and the time to buy is now. If you compare the stock price to when it stopped its last large rise in December 2010, it represents a simple gain of about 18% per annum.
The stock is currently paused and in technical terms, it is gathering strength for its next move up. This is an opportunity to buy the stock.
Dividends
Carfinco yields a nice dividend of approximately 4.8%. It pays a monthly dividend of $0.04 and in recent years it has declared a year-end extra dividend of slightly more. Based on this pattern, it is expected to have a yield of just under 5% this year. It is nice to get paid while you simply hold the stock.
Analysts Coverage
The stock is covered by a number of analysts who have targets ranging from $11.75 to $14.00. At the lowest target of $11.75, this is a gain of $0.63 or 5.5%. Together with a 4.8% dividend yield, this represents over a 10% return, which is quite good.
At the higher Analyst target of $14.00, this is a $2.88 gain, or a 25% gain. When combined with the dividend yield of 4.8%, this is over 30% in one year.
We think this target is too modest. Given the excellent track record of the company, its very low loss experience, and the very impressive expansion by two proposed acquisitions this year (the first already completed), including a dramatic expansion into the USA, we think this stock could go much higher. Our target is in the mid teens, for an expected return of 50+%.
Financial
- Under 27,000,0000 shares fully diluted
- Unlike almost every other company, there are zero options out and zero warrants out – a pleasant situation
- Current market cap is approximately $280,000,000
- Current sum total of all outstanding loans is approximately $220.000,000
- Approximately 22,000 customers
- Maximum leverage ratio is 3.25:1
Why Do We Think This Stock Will Rise in Price
- They have a significant portion of a market that will never disappear. There always has been, and always will be those that are credit challenged
- This company developed the hard way – by experience. They had their losses, their problems and survived and thrived. They have a remarkable formula for lending that removes most of the credit risk
- They were an Income Trust and converted to a Corporation when Income Trusts were eliminated, but they have still maintained a healthy dividend. This dividend has risen year by year and continues to be increased
- The company’s own credit rating continues to rise and they have just had a significant decrease in their borrowing costs, which means more profit. The borrowing rate (BA Rate) was just reduced from 4.47% to 3.97%. This decreases the monthly costs by more than $56,000, which means the Profits Are Increasing by $56,000 per month
- Carfinco is growing – a lot. Press release of Nov 1, 2013 – Carfinco Offers to Acquire Western Funding Incorporated under Chapter 11. They have become the “stalking horse bidder” and proposed plan sponsor for the acquisition of all of the new equity ownership interests of Western Funding Incorporated (“WFI”) and Global Track GPS LLC . This means – if successfully completed – Carfinco anticipates the net (additional) finance receivables to be in excess of $30 million upon closing
- Carfinco is growing – a lot. Press release of September 4, 2013 – Carfinco today announced the acquisition of the issued and outstanding shares of Massachusetts based, Persian Acceptance Corp. (“PAC”), an indirect lender in the sub-prime retail automotive industry …….. The acquisition was closed on September 4, 2013. This represents a major move into the USA, and a much larger market.
RISKS
The biggest risk is a historical bad track record of Canadian companies expanding into the large USA market, who then often retreat licking their wounds. We think the Carfinco model is strong enough to succeed in this tougher USA market, but history urges caution.
Another risk, is a significant increase in interest rates. Should interest rates jump significantly, the cost to borrowers will also increase, thereby reducing demand for new loans. Carfinco borrows at one rate and loans the money out at a much higher rate. When its own costs rise, they must charge more to consumers, and the greater the cost to consumers, the less that consumers will be able to afford the borrowing. A reducing revenue model cannot sustain existing overhead costs which are designed to support the current level of business as well as future growth.
CymorFund Investment Letter Stock Picks – Buy Carfinco Financial Group Inc (TSX- CFN $11.12)
We may or may not have positions in the securities mentioned. In making an investment decision, consider numerous factors such as portfolio balancing, timing, cash and capital reserves, asset allocation and other criteria. Do your own research. Matters discussed herein contain forward-looking statements that are subject to risks and uncertainties and actual results may differ materially from any future results, performance or achievements expressed or implied.
Views expressed are opinions and not investment advice. Retain a licensed professional to guide you and do not rely on the opinions expressed herein. This report is neither a solicitation nor a recommendation to buy or sell securities. We are not a registered investment advisor nor a broker-dealer. The information contained herein is based on sources which we believe reliable but is not guaranteed as being accurate or a complete statement or summary of the available data.
