Description

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We have previously written up Credit Acceptance Corp. (“CAC” or the “Company”) on January 14, 2016. Since then its share price has more than doubled but its multiple has remained the same at 13x LTM adjusted EPS while the market multiple has meaningfully expanded (current S&P PE ratio of 25x vs 22x in 2016, or current CAPE ratio of 32x vs 24x in 2016). The Company has done a tremendous job over the last four years and we believe continues to be well-positioned for the next downturn. We want to remind everyone of the opportunity as it remains compelling.

We won’t revisit its business model as it has not changed since our last writeup, instead we will focus on some key metrics and developments during this period. 

Earnings 

LTM adjusted EPS at the time of the original writeup was $15/share. This number has more than doubled to $35/share, growing at 24% p.a. 

The strong growth was primarily due to growth in earnings (21% growth p.a. during the same period) as well as ongoing share repurchases. 

Returns

Return on capital has remained stable, and loans continue to be extremely profitable. 

Loan growth 

Loan volume growth has meaningfully slowed during this period, going from 23% at the end of 2015, to 1% at the end of 2019 (dollar growth rates). This is due to the competitive industry backdrop, as capital remains highly accessible for all participants, including those who are currently underwriting loans with little tolerance for erosion in consumer fundamentals. 

We believe that a change in macroeconomic trends or access to credit will enable the Company to return to double digit growth and take share from its competitors. In the meantime, we are confident that the management will continue to test various strategies to improve productivity and return capital to shareholders should incremental attractive opportunities remain unavailable. 

CECL accounting

In August 2018, FASB issued a new rule changing the way financial institutions account for impairments. For CAC, this means moving from its previous credit deterioration model, where the Company books a loss provision only when collections underperform initial forecasted cash flows, to an expected credit loss model, where all expected losses to contractual cash flows are booked at origination. This means that during the initial periods of adoption, the Company’s loss provisions will be significantly overstated relative to the real economic losses incurred.

For large reporting companies, this methodology will be adopted for periods beginning in 2020. Needless to say, while GAAP earnings will be meaningfully depressed in particular near-term or if growth accelerates, this accounting change has absolutely no impact on underlying economics of CAC’s business. The Company has also made amendments to its debt covenants in order to ensure that there will be no impact on its liquidity. 

We believe that a misguided focus on GAAP accounting over business economics by market participants may be creating some overhang on the Company’s share price, and this presents a highly attractive buying opportunity.

Catalyst

Macroeconomic downturn