Description

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Summary and thesis:

At current levels we believe Enova (NYSE:ENVA) represents an extremely attractive investment – very strong downside protection and very large long-term upside.

We’d recommend earlier VIC posts and Company material for background, but here are key points:

-          ENVA is a subprime and near-prime online lender to consumers and SMBs.

-          Spun-off from Cash America in 2014.

-          At time of spin, half of profits came from UK business that was forced to shut down for regulatory reasons (not ENVA specific).

-          Following implementation of CPFB regulations in 2017 (not ENVA specific), ENVA transitioned its US business from short-term payday lending to installment loans and lines of credit.

-          Despite the above headwinds, ENVA has very successfully pivoted its US consumer business and consistently taken profitable share from competitors.

-          In summer 2020, ENVA opportunistically acquired OnDeck (fka NASDAQ:ONDK), a leading online small business lender, when OnDeck faced an expected tidal wave of defaults in the wake of COVID. Due to government actions, those defaults never materialized and ENVA’s acquisition proved incredibly accretive.

Today, ENVA’s leading position provides it with scale advantages related to data/analytics, marketing/customer acquisition, and cost of capital.

Our thesis distills to:

-          The stock is very cheap, and the business is substantially overcapitalized/underlevered.

-          The Company is exceptionally well run and well positioned with a very long runway for earnings growth.

-          Management is aggressively repurchasing shares at highly accretive prices.

-          The market is overestimating the risk of material consumer credit losses.

The stock is very cheap, and the business is substantially overcapitalized/underlevered:

ENVA earned GAAP EPS of $11.70 in 2020 (due to much lower-than-expected losses on its and the acquired ONDK loan book), $6.79 in 2021, and will earn $6-$7 this year. Assuming further normalization of credit (a relative headwind vs. the benign conditions of the last 2 years) and continued loan book growth, ENVA should earn $8 in 2023 and $9-$10+ in 2024. If the Company is more aggressive with buybacks, those numbers will be higher. Recent comments by the CEO support a NT-MT EPS run-rate of >$10.

As of 2Q22, ENVA had $2.5bn of loans financed by $800mm of tangible equity and $1.8bn of debt; by contrast, at YE19 ENVA had $1.1bn of loans financed by $100mm of tangible equity and $1.1bn of debt [FWIW: shares outstanding are down over that time, despite 6mm shares being issued for the ONDK transaction]. ENVA’s committed debt capacity is $2.7bn or another $900mm of loans (assuming no further equity creation from earnings) – the incremental loans (which we believe ENVA will bring on over the next 12 months) will yield significant incremental EPS. As earnings and equity grow, ENVA will of course have further debt capacity to fund additional loan growth.

We’d note that ENVA trades near the lowest it ever has on either a P/BV (1.1x) or P/TBV (1.5x) basis – a source of strong downside protection.

The Company is exceptionally well run and has a very long runway for earnings growth:

In our conversations with management, as well as from their quarterly conference calls and conference presentations, we have found management exceptionally thoughtful about their business. Our numerous calls with former employees and competitors have strongly supported that view. We also think the successful pivots management has executed provide additional evidence of their capabilities.  We’d also encourage interested parties to go back to ENVA’s pre-COVID conference calls where management resisted pushes to grow their SMB loan book more aggressively as they did not think the environment (highly competitive at the time) offered prudent and profitable lending opportunities.   

Thoughtful/prudent/disciplined underwriting and operational intensity are requisite for success in any form of lending – in subprime and near-prime lending, that is more so the case [loans are generally short-term and amortize weekly or bi-weekly on the day of payroll. ENVA’s platform captures all its customers banking data and can adjust underwriting criteria within 24 hours if signals shift].

The promise of sustainably profitable online lending has never really been fulfilled as the material benefits to scale are undermined by the material challenges to get to scale. We believe ENVA has achieved the necessary scale and is extremely well positioned to benefit from that scale:

-          Fixed cost base: it is expensive to run (well) an online lender and sufficient (profitable) volume is necessary to cover that expense base. For LTM, ENVA spent a combined $300mm on fixed costs – e.g., “Operations and technology” + “General and administrative.”

-          Data: it is expensive – in the form of credit losses – to build a database to have a differentiated underwriting engine. If a company tries to short-cut its way there by ramping too quickly, they’re likely to blow themselves up (plenty of examples of that). ENVA’s years of operations and investments have yielded differentiated data and a differentiated underwriting engine. The result is ENVA’s normalized loss rate (as a % of gross finance receivables revenue) has declined from 40%-50% overtime to 35%-45%.

-          Customer acquisition: repeat customers are much more profitable to serve than 1^st time customers, both with regards to lower customer acquisition costs and superior credit performance. The margin differential between repeat vs. 1^st time customers can be 20% (10% from marketing + 10% from credit).  (In recent quarters, as credit has outperformed ENVA’s underwriting expectations, ENVA has used the excess economics to onboard more new customers who are likely to be income statement negative on their first loan; that ENVA has been able to maintain overall credit in line with pre-COVID levels despite the new customer growth is very impressive) 

-          Cost-of-funds: new lenders have materially higher cost of funds and less available funding channels than long experienced incumbents. That is especially true at times of market stress.

Taken together, the benefits of scale are extremely material: directionally, 500 bps from G&A, 500 bps from underwriting, 1000 bps from repeat customers, 250 bps from cost-of-funds.

Countless online lenders have blown up trying to scale too quickly. ENVA has never done that. It has consistently demonstrated prudence, thoughtfulness, discipline, and operational intensity in pursuing sustainable scale that yields sustainable profitability.

ENVA is now uniquely positioned in its markets to benefit for many years from: higher yields with lower credit costs, lower operating costs, and lower funding costs.

Management is aggressively repurchasing shares at highly accretive prices:

ENVA has repurchased $217mm of shares over LTM, against a current $1.2bn market capitalization.

Given that shares trade around 5x-6x current year earnings and meaningfully lower on 2023/2024 and beyond, we think those repurchases are an excellent use of excess capital.

Critically, management is very thoughtful in weighing the relative tradeoffs of repurchasing shares vs. growing the loan book (or alternative uses of capital such as M&A or dividends). Specifically, management has proven price sensitive and opportunistic as to when to aggressively repurchase shares: the basic litmus test being that they’ll repurchase shares when doing so matches the 30%-40% return they get from deploying into new loans.

ENVA’s credit agreements permit it to use 50% of earnings to repurchase shares. With our expectation that 2022 net income will be >$200mm and grow substantially from there, ENVA will be able to repurchase large amounts of its own stock.

We think ENVA will end up being one of those boring but highly profitable franchises that allocates their prodigious cash flows to repurchases resulting in extremely strong long-term earnings growth and improved market perception.

The market is overestimating the risk of material consumer credit losses:

This isn’t a macro call (which we don’t feign to have a clue about) but an industry call.

While it’s reasonable to worry about consumer credit in the context of a) bad lenders; b) a recession will undoubtedly hit consumer credit, we think the general view that every consumer credit company is bound for disaster is misguided. The GFC was awful for consumer credit and underwriting going into the GFC was awful.

Good lenders – e.g., ENVA, LC, OMF, COF, etc. – have lent very well over the 2+ years. Anything lent pre-COVID has already been paid off and given the radical uncertainty of the past 2+ years, the good lenders have been uber cautious. With the competitive environment far more benign as bad lenders have taken it to the chin and funding has all but dried up for new ‘disruptive’ start-ups, we think ENVA (as well as LC) is supremely well positioned.

Conclusion:

-          The stock is very cheap, and the business is substantially overcapitalized/underlevered.

-          The Company is exceptionally well run and well positioned with a very long runway for earnings growth.

-          Management is aggressively repurchasing shares at highly accretive prices.

-          The market is overestimating the risk of material consumer credit losses.

We think ENVA will earn $8 next year and $10 in 2024. We doubt shares will trade at 3x-4x earnings. 6x-8x, yielding 50%-150%+ upside from here, seems more reasonable. But if shares continue to trade exceptionally cheaply, we expect management will continue to repurchase them aggressively.

Catalyst

See above