Company Analysis

Unbanked and Underbanked Community Opportunity

One segment of society that I think is misunderstood is the unbanked and underbanked community.  Specifically, there seems to exist the perception that anyone offering any kind of financing to this community is somehow taking advantage of it.  While that may be true in some instances, that is certainly not the case for the publicly traded companies I have analyzed that provide valuable services to this community at reasonable prices.

The unbanked are individuals who do not use banks or credit unions for their financial transactions.  The underbanked have either a checking or savings account but also rely on alternative financial services.  People find themselves in one of these two categories for a variety of reasons, including poor credit history, outstanding issues from a prior banking relationship, negative experiences with banks creating mistrust, low-income forcing the consumer to live paycheck to paycheck, and/or simply lack of relevant education.

This group of people still needs to make major purchases, such as buying a car or household appliances.  Obviously, they will not be able to come up with the cash to buy the products out right so will need some sort of financing.  Many of them are in situations where they work in one country and have to send cash to their home country to feed their families.

Unfortunately, because of the poor reputation of places such as pawn shops and pay day loans, most people simply assume that anyone providing financial-related services to this community is in some way taking advantage of them.  For certain companies, nothing could be further from the truth.  In fact, it is actually counterproductive for businesses to take advantage of these consumers because the businesses will lose those consumers when they go bankrupt or simply default.  We look for companies that understand this type of consumer and, therefore, charge only the rates or fees appropriate for the risk, focus on strong relationships, and provide a necessity (such as a car) instead of a luxury (such as a 52-inch TV).

The size of this community will probably surprise you as it did me.  According to a survey conducted by the FDIC in 2009, an estimated 30 million households in the United States fall into one of those two categories, which is 25% of all U.S. households.  That is an astounding number of households that generally cannot get certain financial-related services through normal channels.  The largest concentration of this community is in the southeast part of the U.S.

America’s Car Mart

One company in particular that does everything right is America’s Car Mart (CRMT).  CRMT is in the “Buy Here, Pay Here” niche of the used car dealership industry.  The company focuses on unbanked and underbanked consumers with credit scores generally too low to get financing for cars through normal channels.  The “Buy Here, Pay Here” market is exactly what it sounds like.  Consumers buy the cars from the dealership and then physically go back to the dealership every week, two weeks, or a month (depending on how often they get paid) to make their car payments.   CRMT finances the purchases itself and keeps all loans in-house.  The company does not bundle and sell-off any of its loans, thereby creating greater incentive to minimize default rates.  Further, each dealership’s general manager is responsible for 100% of the decisions made at the dealership, including all financing decisions.  Those general managers are also partially compensated on how affective those decisions are, particularly the financing decisions.

CRMT has over 100 dealerships across the Southeast, targeting small towns of less than 50,000 people.  The company has a great management training and development program, well thought out processes, a strong focus on customer relationships, and a solid back office that the mom-and-pop competitors simply cannot compete with.  Most telling is the inventory turnover per dealership that is over twice that of the industry average as well as the ~21% default rate versus the industry average of ~30%.  Further, 30% of their total business is repeat business – 50% at their more mature operations.  The average interest rate on its loan receivables is 13%, which is reasonable given the risk implied by the high default rates.

CRMT’s growth opportunity lies in the fact that there are plenty of untapped markets in its target region.  The company plans to increase the number of dealerships approximately 10% annually, and the new dealerships generally reach a ROIC of 15% within a year or two thanks to the meticulous processes and business model CRMT has honed over the past 30 years.

We think CRMT has roughly 100% upside at the current price, partly due to Wall Street’s misunderstanding of the business and the community it serves.  The industry also faces potential additional regulation as a result of the Frank-Dodd act.  However, we believe any material regulatory changes to be unlikely because the industry provides such a valuable service and its largest competitor and de facto face of the industry, CRMT, provides a very good example of how fairly the unbanked and underbanked community is treated.  Besides, any regulatory changes would only benefit CRMT by negatively affecting its competitors since CRMT is better equipped financially and staff-wise to deal with those changes.

Disclosure: Long CRMT

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