Description

Curo Group Holdings Corp. (CURO) - Long

Disclaimer:

The information contained herein (the “Information”) represents the views of the author as of the date submitted based on public information published or disseminated by the companies referenced below, including, but not limited to, through SEC filings, investor relations materials and public conference calls, or other third parties as of such date.  Securities of the companies discussed herein may have been, are currently, or in the future may be, portfolio holdings or short positions of the author or clients of the author’s firm.  The Information does not constitute investment advice or a recommendation, and it is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or other asset or to participate in any trading or investment strategy.  Furthermore, while research conducted by the author is based upon public information, not all relevant facts and information may have been considered in developing the Information and such Information is subject to change.  The author has no obligation (express or implied) to update any or all of the Information or to advise you of any changes to the Information; nor does the author make any express or implied warranties or representations as to the completeness or accuracy of the Information or accept responsibility for errors.  You should not rely on the Information, in whole or in part, without conducting your independent verification as to its accuracy.  The Information contains forward-looking statements, including observations about markets and industry and other trends as of the date hereof. Forward-looking statements may be identified by, among other things, the use of words such as "expects," "anticipates," "believes," “strives,” “targets,” or "estimates," or the negatives of these terms, and similar expressions. Forward-looking statements reflect the views of the author as of such date with respect to possible future events. Actual results could differ materially from those in the forward-looking statements as a result of factors beyond the control of the author and you are cautioned not to place undue reliance on such statements.  The Information may not be reproduced or disseminated in any manner without the express written consent of the author.

Summary:

With share price declines in Q4 2018 driven by what I view as limited duration operational issues, I think shares of Curo Group Holdings (“Curo” or "CURO") are mispriced, with significant risk to the upside. Curo is a market leader in terms of revenues in the subprime short-term lending space. I expect that as the company rebuilds investor confidence through execution in 2019 on what II believe is very attainable guidance, Curo shares should recover to a more normalized valuation. I see potential upside of 25%-43% within one year.

Description:

• Founded in 1997, Curo is a tech-enabled, multi-channel consumer finance company, offering unsecured and secured installment, line of credit, and single-pay loans

• In 2018, Curo generated $1.1bn in revenue and $218mm in Adjusted EBITDA and $1.86/share of Adjusted Diluted EPS

• From January 1, 2010 through December 31, 2018, Curo extended over $17.1 billion in total credit across approximately 43.8 million total loans

• I believe the company to have one of the best teams in the industry, led by CEO Don Gayhardt, a 25-year veteran of the short-term credit industry. Notably, spent 18 years with DFC Global, where most recently he had served as President and expanded the company’s operations in Canada and the UK, adding 715 stores in these geographies during his tenure

• The company has a strong storefront presence with 413 total locations in the US (~80% of revenue) and Canada (~20% of revenue)

• United States: 213 stores in 14 states

• Canada: 200 stores in 7 provinces and territories

• The company also has a large online lending presence

• United States: 27 states

• Canada: Alberta, Nova Scotia, Ontario, Saskatchewan and British Columbia

• Curo operates under several well-known brands in the space, including:

• Speedy Cash/Rapid Cash – US-based, multi-channel lending offering installment, line of credit, and single-pay products

• CashMoney – Canadian lending business, principally line of credit and single-pay products

• LendDirect – Canadian installment lending business

• Avio Credit – Online US installment lending business

• Opt+ - US Prepaid Debit card business

• The company serves an addressable market of subprime borrowers in the US and Canada who are historically underserved by traditional lenders where I believe demand is high and penetration is relatively low

• 95% of total revenue is generated by the company’s lending products. The charts below highlight Curo’s product and channel distribution at 12/31/18

• Curo’s IT  platform is key in its operations,  integrating  customer acquisition loan underwriting, scoring, servicing, collections, regulatory compliance and reporting activities into a single, centralized system. The company utilizes risk  analytics  powered  by  proprietary  algorithms  and  over  15  years  of  loan  performance  data  to  score customers’  loan applications.

• In its core lending business, the company’s multiple installment and open-ended line of credit products comprise a significant majority of its nearly $700mm in loans receivable. Over time, the company has meaningfully reduced its exposure to single-pay loans (traditional payday loans), which we view as positive for managing the company’s regulatory risk

• Curo’s employs an omni-channel strategy, where the company leverages its competencies in both storefront and online/mobile-based lending to enhance the company’s reach, improve approval rates, and improve customer retention

• Ownership - 69% of shares are still owned by sponsor, FFL Partners (purchased stake in 2008), and founders, so there is a limited public float. In April 2019, FFL and founders filed a Form S-3 shelf registration statement

Situation Overview

• I believe Curo is among the best operators in its space and its shares are undervalued vs. its most relevant comp, online lender Enova International, Inc. (ticker: ENVA)

• 4.9x Bloomberg Consensus 19E Adjusted Diluted EPS

• 5.2x Bloomberg Consensus 19E Adjusted EBITDA

• Trades at a significant discount to ENVA, Curo’s closest comp, which trades at 8.1x Bloomberg Consensus19E Adjusted Diluted EPS and 6.7x Bloomberg Consensus 19E Adjusted EBITDA

• Following its IPO in late 2017, Curo shares performed very well for most of 2018 amid favorable operating results

• IPO price was $14/share

• CURO hit a 52 week high price of $32.20 on 9/28/18

• However, I believe a combination of late 2018 market malaise and several company-specific issues that manifested starting in Q3’18, caused share prices to decline to well below the $14/share IPO price. As of 5/2/19 shares are trading at $12.25 vs. all-time low of $8.74 in December 2018 and peak of $32.20 in September 2018

• Traded at peak multiples of roughly 13x forward Adjusted Diluted EPS and 8x forward Adjusted EBITDA

• Prior to Curo’s declines in late 2018, the stock traded at virtual multiple parity vs. ENVA at roughly 11x forward Adjusted Diluted EPS and 8x Adjusted EBITDA

• Both companies are market leaders with excellent growth profiles

• I believe ENVA does warrant some multiple premium to CURO due to having a pure online model and better recent earnings track record than Curo

Unexpected Canada transition results in share price declines

• Shares have yet to fully recover from massive declines following an unexpected large miss in Q3’18 results vs. guidance and street expectations, still trading down more than 60% from peak levels

• I believe the principal catalyst for the stock’s precipitous decline was a more rapid-than-expected product shift in the company’s Canadian business (~20% of revenue), which meaningfully compressed Adjusted EBITDA margins. I believe this transition was very poorly telegraphed and communicated to the market and has turned Curo from a high-flier to a show-me story

• In anticipation of certain regulatory changes in Canada, and amid very strong customer demand, the company accelerated its conversion of its Canadian loan book from traditional single-pay products to a regulatory-friendly line-of-credit product

• The conversion resulted in significant loan book growth in Canada to $194mm in Q318 from $122mm in Q218 due to a more than doubling of the multi-pay, line-of-credit loans outstanding

• Any loan growth is accompanied by significantly higher upfront provisioning costs, and given the extraordinary growth here, Adjusted EBITDA margins turned negative, as the Canada business generated -$3.4mm of Adjusted EBITDA in Q3’18 vs. $10mm of Adjusted EBITDA in Q2’18

• This ultimately led to a meaningful reduction in the company’s 2018 guidance ($215mm-218mm of Adjusted EBITDA vs. $245mm-$255mm prior guidance) and a resetting of forward expectations

• The chart below illustrates the very significant shift in loan book composition in Q3’18 into multi-pay loans, as well as the rationale for the acceleration of the transition

• In addition to the Canada issue, on 2/25/19 the company announced the closure of the company’s small UK business (4% of 2018 revenue) due to regulatory pressure and costs, which I believe has further exacerbated investor concerns

Subsequent operating results show significant improvement

• Overall Q4’18 results reported on 1/31/19 were an improvement from Q3. Curo met/beat consensus and guidance across most metrics and showed a meaningful recovery in Canada results after the Q3 pivot

• Revenues were $301mm, up 13% YOY

• Adjusted EBITDA was $55.6mm, down 11% YOY on higher Canada provisioning but up significantly on a sequential basis vs. $38mm in Q3

• Adjusted Diluted EPS of $0.52/share was slightly ahead of $0.51/share Bloomberg Consensus

• Notably, Canada operations generated $9mm of Adjusted EBITDA vs. -$3.4mm in Q3’18

• The company had previously suggested that the normalized run rate for Canada is in the $10mmrange per quarter, so made great strides within a single quarter to get back up to the earnings generation level

• Subsequently, on 4/29/19, Curo reported strong Q1’19 results that featured both sequential and YOY improvement in Canada Adjusted EBITDA

• Revenues of $278mm were up 11% YOY

• Adjusted EBITDA of $73mm, was down 5% YOY but beat Bloomberg Consensus of $65mm

• Adjusted Diluted EPS of $0.80/share beat Bloomberg Consensus of $0.73/share

• Canada Adjusted EBITDA of $11.7mm was up 9% YOY and up 34% vs. Q4’18

• As part of its Q1’19 results release, the company also reaffirmed its 2019 guidance, adjusted for UK segment closure, previously provided via 8k in March 2019

• 19E revenue guidance of $1.15-$1.17bn –vs. $1.05bn a year ago

• Adjusted EBITDA guidance of $240-260mm vs. $218mm in 2018

• Adjusted Diluted EPS guidance of $2.35-$2.65 vs. $1.86 a share in 2018

• The table below shows the historical financials of the Canada segment and the drastic decline in margins during the transition of the Canadian loan book and the meaningful recovery in Q4 and Q1 results

• On the Q318 and Q418 earnings calls, CEO Don Gayhardt had signaled this rapidly improving trajectory for the Canada business, which was further validated in Q1’19 results. .

• “We should note that a significant part of reduction in earnings relates to the allowance builds for line of credit product, which grew $7.5 million sequentially. We expect our Canadian business to generate positive adjusted EBITDA in the fourth quarter as the line of credit portfolio growth will be solid in the range of $20 million sequentially but not at the level that we saw in Q2 and Q3, which will lead to a much smaller build in the allowance and return to profitability. In terms of full year earnings, Canada had adjusted EBITDA of $54.6 million in 2017, and will probably end 2018 with a full year adjusted EBITDA of less than half that. But absent any new regulatory or macroeconomic changes, 2019 should see very meaningful year-over-year improvement in revenue and earnings from our Canadian operations.” – Q3’18 earnings call November 2018

• “Our Canadian business did make substantial progress on a sequential basis, and exits the year with very strong position both operationally and from an earnings perspective” – Q4’18 earnings call February 2019

• “I mentioned Canada earnings were down year-over-year but the results were in line with our expectations and we made a strong return to profitability in the fourth quarter following our Q2 and Q3 product transition“– Q4’18 earnings call February 2019

• As we've discussed over the past couple of quarters, and important focus in Canada as the ongoing product conversion in Ontario, where we introduced a line of credit product in February 2018 and converted a substantial portion of our customers to this product, which provides a very flexible open-ended contract with generally more available credit and lower rate structure. We were confident that our customers in Canada will like and appreciate this product and we think that this quarter's results validate that approach. As I mentioned about, Canadian revenue grew 12% and adjusted EBITDA grew 8.9% year-over-year. Further, adjusted EBITDA from Canada was $11.7 million for the quarter versus $8.8 million in 4Q 2018 as we met our goals in another sequential increase on earnings from that market. And credit performance for the open-end product met our target for the quarter – Q1’19 earnings call April 2019

• Additionally, with regard to the UK segment, while not a significant part of the overall business, the company had included in its initial 2019 guidance UK contribution of up to $10mm of Adjusted EBITDA in 2019 (was Adjusted EBITDA negative in 2018). In the long run, I believe that UK closure allows for management to tighten their focus on the core US and Canada segments

I think the stock is mispriced and continued execution over 2019 will allow the stock to return to a more normal valuation

• I believe that these company-specific issues that have dogged the stock are largely short-term in nature and expect the medium-term outlook for the company to meaningfully improve. The aforementioned Q4’18 and Q1’19 results have showed solid execution vs. reset expectations

• Curo is currently trading at roughly 4.9x 19E midpoint guidance Adjusted Diluted EPS. I believe investors are waiting to see more execution in 2019 from Curo before giving it a market multiple

• I think reasonable medium-term valuation for the stock should be in the $15.26-$17.50/share range, On a 50/50 weighted basis between Price/Adjusted Diluted EPS and EV/Adjusted EBITDA valuations, I believe total return will be 34% to a $16.38 share price

• Using 7x 19E midpoint guidance Adjusted Diluted EPS (1.0x multiple discount to ENVA) gets us to a $17.50 share price

• Using 5.9x 19E midpoint guidance Adjusted EBITDA (0.75x multiple discount to ENVA) gets us to a $15.26 share price

• Absent any major regulatory issues (a big asterisk, yes, and long this position is inherently short a Bernie Sanders presidency), I believe that over the next 2-3 years, Curo should exhibit 20-30% annual Adjusted Diluted EPS growth and double-digit annual Adjusted EBITDA growth, consistent with current consensus. I believe this is an excellent business and near- term execution will meaningfully reduce the massive discounting of future expected results.

• Looking beyond 2019, we also believe the company’s partnership with Metabank (ticker: CASH) could provide a very meaningful uplift to Adjusted Diluted EPS in 2020. While there is limited visibility currently into how this partnership could unfold, I believe there is very large potential for earnings growth not captured in today’s valuation

• Announced in June 2018, Curo currently has a partnership with Metabank (Ticker: CASH) for a new line of credit product to be marketed in over 40 states, which would meaningfully expand the reach of Curo’s products

• Would use Metabank’s balance sheet - Metabank will carry up to $350mm of receivables on balance sheet for the first three years of the agreement

• Curo management has indicated that potential earnings impact is a 2020 event

• In terms of rough economics, the earnings potential of the Metabank partnership has been framed as an up to $1.50-$1.70/share of Adjusted Diluted EPS opportunity assuming a full deployment of $350mm in balances. While the company has not disclosed the mechanics of the agreement, it has given a few guideposts on the Q2’18 earnings call

• “We've said low 30s return on assets”

• “So $350 million of earning assets, north of $100 million of -- of essentially net revenue to us..a little bit of an incremental overhead against that $100 million of net revenue but by and large, a very high percentage of that auto flow to the pre-tax line”

• “We expect it to contribute meaningfully in 2020 and using the numbers that Don just laid out, it's anywhere from a $1.50 to $1.70 a share”

• We do note that commentary on calls has also suggested that the timing of the Metabank partnership rollout has been slow, so we view it largely as a “free” option with high likelihood of occurring

• “We’re still running a bit behind schedule and are probably looking at a Q2’19 launch right now. We don’t have any more updates in terms of financial impact other than to say we don’t expect any meaningful contribution from this relationship until 2020.”  - Don Gayhardt on Q4’18 earnings call 2/1/19

• Question - John Rowan, Analyst: “Okay, and last one. How do you feel about getting the MetaBank product off the ground by the end of the year?

• Answer – CFO Roger Dean: “It's -- we've said, I guess, I can leave it at what we said. We continue to -- we've worked hard with them from a system standpoint, from an underwriting standpoint, from a process standpoint and so they've got some internal hurdles to clear. So we continue to have a lot of good dialogue with them and we'll remain hopeful we'll get it going here soon” -  Q1’19 earnings call 4/30/19

Catalyst

(i) Proving out earnings power, (ii) Regulatory clarity and/or further developments, (iii) Status of Metabank partnership