We thought the note below form our Financials Team highlighted an interesting data point related to gold from our Financials Team. In effect, the largest pawn operators in the United States are reporting that their clients are basically running out of gold to pawn. Cash America (CSH) reports this Thursday and will likely provide further confirmatory evidence of this trend (as well as disappointing earnings).
A New Issue in Pawn Lending: Clients Running Out of Gold
An ominous trend emerged from EZ Corporation's F2Q12 earnings report last week. The company reported slowing growth in their U.S. pawn operations and lowered their guidance for FY 2012 by 6%. Management said the reason for the decrease was a mix shift among pawn borrowers towards general merchandise and away from gold. In other words, gold pawning is declining. This manifested for EZPW in the form of a 14% decline in same store sales in retail jewelry in the U.S. (as distinct from scrap sales) and a 15% decline in gold volume overall.
We saw a similar pattern out of FCFS earlier last week: In the U.S., scrapping rose just 3% YoY, a decline of 11% on a per-store basis. In Mexico, the story was similar, with -2% YoY total scrapping revenue and -20% on a per-store basis.
EZPW management made three comments on the call that gave us pause:
- They noted that gold volume declines have been ongoing for at least three quarters (in terms of scrapping volumes, there have been four consecutive quarters of decline), but the revenue impact has been masked by rising gold prices.
- "Absolutely gold has been priced to some degree out of the range of some of our customers" - increasing gold prices are pushing retail gold out of reach for some borrowers. The knock-on effect is that this gold is not recycled back into the community for use in future pawn transactions, so the available collateral in the community is diminished.
- The pawn customer is running out of gold: "Frankly, yes, their piggy banks are certainly emptier than they've been and what they have, they're hanging on to." This implies higher redemption rates of pawn collateral as well as lower overall volume. We find this quite plausible - while there are no hard statistics available, we expect that much of the gold that has been purchased by pop-up gold buyers and the like ends up as scrap and doesn't find its way back to the low-income borrower.
Implications for the Industry
In our recent black book on this space, our primary concern with gold was a decline in the price of the commodity, not a decline in volume. However, from a revenue perspective, a volume decline has nearly the same effect. Margins would be unaffected, but revenue growth is directly linked to expanding volume. We estimate the following as a rough heuristic for top line growth. Gold CAGR, store growth, and total revenue growth are actual values, leaving the 3% long-term same store sales estimate.
Gold CAGR (tailwind): 9.6%
Store growth (tailwind): 5%
Same Store Sales (including gold volume increase): ~3%
Total revenue CAGR: 18%
For gold-sensitive lenders, this tailwind appears to be set to become a significant headwind. Ongoing gold price increases mask the effect, but should the commodity reverse (as we believe is ultimately likely) then the problems compound.
Where does this leave investors? We return to our original conclusion, published with our Black Book on April 11th. The best-positioned name, DFC Global (DLLR) has the least exposure to gold while still sharing the aggressive growth profile of the rest of the industry. Overall, we see Cash America (CSH) as being the worst posiitoned of the group through the combination of their high pawn (gold) exposure coupled with the highest relative exposure to US payday lending, where we see considerable regulatory risk. On the gold front, however, as the chart below shows, EZPW and FCFS are the two names with the highest gold exposure. Despite CSH's decline following the EZPW report (the stock was down roughly 5% compared to EZPW down 14%), we would still carry a short bias into the quarter. We are currently expecting $1.16 in EPS compared to consensus of $1.18.
Joshua Steiner, CFA