An Auto Lender on the Road to Strong Growth
By Richard Tortoriello
This week's S&P Focus Stock of the Week is Americredit (ACF ), which carries S&P's highest investment ranking of 5 STARS (buy).
Americredit, based in Fort Worth, Texas, is the largest independent auto finance lender in the U.S. It specializes in financing higher risk/higher return "subprime" auto loans. Subprime lending refers to extending credit to borrowers with past financial difficulties or short credit histories. The company should benefit from an improved competitive environment, lower interest rates, conservative lending practices, and increasing economies of scale.
Americredit works primarily with manufacturer-franchised dealerships and prefers to finance late model/low mileage used cars (73% of loans) or new cars (27%): the average mileage on cars financed is 27,000 and the average age is two years. The average annual income of ACF's customers is about $45,000, relatively high for a subprime lender. During fiscal year 2000 (June), the company purchased loans from over 14,000 of the estimated 22,000 auto dealers in the U.S.
The subprime lending industry underwent a boom in 1994-1996, as investors bid up stock prices and lenders increased volume at the expense of credit quality, realizing large gains on auto loan securitizations. A bust followed in 1997-1998, during which many of the major lenders folded or left the business-Mercury Finance and The Money Store were two of the better known casualties. Americredit, which entered the market in 1992, not only survived, but prospered, increasing EPS from $0.35 in FY 1996 to $1.11 in FY 1999.
DOMINANT POSITION. Americredit estimates that it now has a 4% share of a highly fragmented $194 billion market for subprime auto paper. Recently GE Capital exited the subprime auto lending business, enhancing Americredit's already dominant market position. Major competitors include Household International and, in the new car market, Ford Motor Credit and General Motors Acceptance Corp.
In February 2000 Americredit implemented price increases, in response to rising interest rates. Although interest rates have begun to decrease, the company's strong competitive position should enable it to maintain the price increases, widening profit margins and likely off-setting any rise in losses that might occur due to a slowing economy.
At the same time, recent short-term interest rate reductions have lowered Americredit's funding costs. Americredit finances its auto loan originations through warehouse lines of credit. It then packages large "pools" of such loans and sells them to investors as asset backed securities, using the proceeds to pay down credit lines and fund new loans. It has already experienced a 25 basis point (0.25%) reduction on its November 2000 securitization and, with the recent interest rate reduction by the Federal Reserve, expects to realize further cost reductions of 50 to 75 basis points on its upcoming February 2001 securitization.
KEEPING SCORE. Americredit has lasted so long in a tough business because of its focus on credit quality and collections. The company uses credit scorecards, developed from its eight-year database of delinquency experience, to evaluate and price loans. The customer's loan application, loan structure, and credit report provide the inputs to this system, with the result being a credit score.
Once a loan has been made, the company uses behavioral scores-- which include the customer's payment history with Americredit and other creditors, and insurance status -- to focus on those customers most likely to default. Call center employees call such customers almost immediately after a late payment, and follow up until a resolution is reached. The company finds that in many cases it can collect more by working with a customer and possibly even deferring payments than it can by repossessing the vehicle.
The ratio of loans charged off to the total managed loan portfolio fell to a record low of 3.6% for the quarter ended December 31, 2000. This compares favorably to a charge-off ratio of 3.4% for Household International, a more diversified competitor, and 3.9% for MNBA Corp., a leading credit card issuer. Based on Americredit's decreasing funding costs, we believe the company can absorb a 20% increase in loss levels (a charge-off ratio of 4.3%), without affecting current levels of profitability. In addition, the company has substantial loss reserves-equal to 8.8% of its managed portfolio.
ROOM TO GROW. Growth will continue to be driven by geographic expansion -- the company plans to add 15 to 20 branches to its current 202 branches over the next two quarters -- as well as through expansion of current branch business. Internal growth for branches open more than two years was 21% for the quarter ended December 31, 2000. ACF's branch network gives it direct contact with its dealers and enables it to supply them with same-day funding (of high concern to auto dealers).
New initiatives include Americredit's alliance with Chase Manhattan (now J.P. Morgan Chase & Co.), offering one-stop shopping to dealers by supplying both prime (Chase) and sub-prime (ACF) auto lending, and the Valued Customer Program, which offers pre-approvals to existing customers paying off loans as a result of trade ins.
Finally, as Americredit's size -- its managed auto loan portfolio surpassed $8 billion in the recent quarter -- and track record increase, operating expense ratios and costs of credit enhancements needed to support auto loan securitizations are declining.
The company's earnings per share should grow by 45% for the fiscal year ended June 30, 2001, to $2.30, with projected five-year annual growth near 25%. At a recent price of $32, Americredit trades at approximately 14 times our EPS estimate, and at a significant discount to its peers in the S&P MidCap 400 index, as well as its own historical high p-e ratio. The stock also trades at a p-e to growth (PEG) ratio of only 0.56, below the PEG ratio of 0.73 for the S&P MidCap 400.
We expect to see an expansion of the company's p-e multiple, as the market continues to reward its consistent performance, as well as earnings driven growth. Our nine to twelve-month target price, based on a multiple of 19 times our fiscal year 2001 estimate is $44, implying a little more than a 35% upside from the current level.
Tortoriello is an equity analyst covering diversified financial stocks for Standard & Poor's