April 26, 2011 - 10:06am EST by
2011 2012
Price: 12.25 EPS $1.40 $1.55
Shares Out. (in M): 12 P/E 8.8x 7.9x
Market Cap (in $M): 145 P/FCF 7.3x 6.3x
Net Debt (in $M): 115 EBIT 40 46
TEV ($): 260 TEV/EBIT 6.5x 5.7x

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Nicholas Financial

Nicholas Financial has been written up 5 times on VIC. All the previous reports provide a great overview of the company and its superior business model to competitors.  This report will try to avoid or skim the information that has been mentioned previously and focus on new information and the special event catalyst that has recently arisen.

Nicholas Financial is currently trading for $12 per share compared to our fair value estimate of $16-$19.  Investing at this price offers a low downside and reasonable upside potential.  In addition, there is a strong likelihood of a buyout in the near future.  On January 11th , 2011 the company issued a press release stating it received an indication of interest from a third party to acquire the company.  It also hired Hyde Park Advisors to evaluate strategic alternatives.

Irrespective of the potential of the buyout, the company is trading at a reasonable price. The strong likelihood of a near term buyout makes an investment in Nicholas Financial an interesting situation.   



Nicholas Financial is a consumer finance company that acquires and services contracts for new and used automobiles and light trucks.  Nicholas Financial also makes direct loans and sells consumer-finance related products but this represents only about 2% of their business.

The Company presently operates 56 branch locations in 14 Southeastern and Midwestern states.


Advantages of Nicholas Financial's Model:


  • Competitors use credit scores as the main indicator of credit risk, allowing their central offices to process large volumes of loan applications and approvals to keep costs low. NICK primarily measures risk through factors other than raw credit scores, such as impressions made during an interview, income level, stability, type of vehicle and others. This is why the company has a lower charge-off rate than would be expected for its average FICO score.
  • The CEO believes that they can never be successful in a new market without first developing a relationship with the dealers in that market and understanding how they operate. The branch network model allows them to make better credit decisions. The branch manager is paid based on the performance of the loans that manager underwrites.
  • The hands on approach that allows the company to establish a relationship with its customers, combined with the other factors above, results in a lower delinquency rates than competitors.
  • Because the company's return on assets is so much higher than a typical financial company, they are able to maintain a much lower debt to equity ratio than competitors.
  • They also hold all of the loans they make on their own balance sheet. When you own the loans you underwrite, you care much more about the quality of the loans.



Peter Vosotas, age 68, and Ralph Finkenbrink, age 49, are the CEO and CFO of the company respectively.

The directors and officers as a group own 19.1% of the company. Peter Vosotas owns 15.3% of the company.  He founded the company in 1985. It is obvious that he operates with very high standards.  In an industry where quality is sacrificed for quantity and next quarter's earnings are more important than next year's, it is really amazing to see a company operated like Nicholas Financial.


Strict Underwriting Discipline

Previous reports have mentioned Nicholas Financial's high underwriting standards and this is one of the most important factors to analyze.  Many auto lending companies become lax in their accounting to boost net income. If an auto lender understates its provision for loan losses, net income and book value will be higher.  Then, the company can borrow more from lenders and make more loans which in turn have an understated provision for losses.  he process continues until a recession or other event triggers bankruptcy.  This is similar to what happened in the mid to late 1990s when a handful of companies went bankrupt (Mercury Financial, First Merchandise, First Enterprise, Jayhawk, Eagle Finance, Mississippi Finance, Keller Financial etc.  This was mentioned in engrm842's report in 2004.

Peter Vosotas the CEO of Nicholas Financial, approaches his business much like a value investor approaches investing.  He pulls back when the market heats up and the risk premiums compress.  Then during recessions the company is able to seize more market share with higher quality loans.


Here are a few quotes from the CEO and CFO to underscore this point:

"When yields on loans look temptingly high, we always try to remember that the return of your money is more important than the return on your money." - Inside cover of 2010 annual report

"The Company will not sacrifice credit quality, its purchasing criteria or prudent business practices in order to meet the competition." - Page 10 of 2007 10-K

"We try to finance people who may have had trouble because of a divorce, medical problems or job loss, as opposed to 'credit criminals,'' said CFO Ralph Finkenbrink.

Amazingly, the company turns down 85% of potential clients. NICK's unusual credit review process allows it to purchase loans that most competitors wouldn't touch but actually offer a better credit risk.


Analysis of Credit Losses:

Earnings are significantly affected by certain assumptions such as the reserve for loan losses. So it's very important to figure out the quality of the loan underwriting. Nicholas Financial structures its business so that the people making the loans have an incentive to make good underwriting decisions.

There are two ways to determine the quality of loss accounting. 1). If discounts accreted back into income, goes negative. This would indicate the company is trying to cover up inadequate loss accounting over the life of the loans with a lump sum adjustment at the end of the life of the loan pool.

But in NICK's case the financial statements suggest that NICK over reserves for loan losses and then at the end of the life of the pool they have to go back and add the difference to earnings.

2). Another way is to calculate ("Discounts Acquired On New Volume" + "Current Year Provision" + "Recoveries" + "Discounts Accreted" ) minus ("Losses Absorbed"). Then look at the total "Balance At The End Of The Period" and divide this by the "Net Finance Receivables"

If this percent is calculated every year you could determine if they are becoming lax or not on their loss reserves.  If this number is growing then they are adequately accounting for losses and the "Balance At The end Of The Year" is increasing year after year. This is a good sign.  Especially in an improving economy.

The total loan loss reserves for 2008 were 10.7% of the total loan base. In 2009 it rose to 13.3% and further increased to 13.6% in the 3rd quarter. Even though the recession is over and delinquencies are decreasing, this number is increasing.  This shows how conservative Nicholas Financial accounts for loan losses.  The recession had a number of benefits to the company. In 2008 the company increased its lending standards by increasing income requirements, reducing how much would be advanced on certain loans and restricting branch manager approvals on certain loans.  These higher quality loans are partly why earnings have come back so strong and will benefit them in the future as well.

NICK purchases its loans at a discount to the loan amount usually 1-15% with the average being 8.75%.   It accounts for this discount as a reserve for credit losses.  Then when the loan is nearly paid off it accretes the portion of this reserve not charged off, to income.  Net income is slightly understated because the provision for loan losses has historically been greater than the losses actually incurred.



Since 1996 book value has increased from $3.3 million to $110 million a compound annual growth rate of 28%.  This is incredible when you factor in the relatively low leverage they employ.  Throughout its history, the company has never been unprofitable, even during the recent financial crisis.  During the weaker parts of the credit cycle, NICK simply slows its branch openings and waits out the recession while weaker competitors go bankrupt.

The Investment Opportunity

Nicholas Financial is trading at a market cap of $145 million. During 2010 the company had net income of $11 million.  So far in the first nine months of fiscal year 2011 the company made $12 million. It's likely that net income for the year ended March 31st 2011, will be around $16.5 million. Thus, the current multiple to earnings is 8.5x.  A 15% ROE company with enticing growth prospects should not trade this cheaply. To get a sense of how much larger the company could be, let's return to a statement made by the CEO of the company in each annual report. He said each branch office's goal is to reach $7.5 million in receivables. With 56 branches this would result in $420 million in net finance receivables. The historical average pre tax yield is around 9.5% which would result in operating income of $40 million and net income of $26 million. The company expects to continue opening new branch offices.


For fiscal 2012 we estimate net income will be $19 million or $1.60 per share due to growth in finance receivables at new and existing branches, a decrease in write offs offset slightly by the possibility of higher interest rates.  At a 10-12x multiple of next year's earnings the company is worth $16 - $19 per share.  NICK should continue to grow at least 10 - 15% a year in the future.


According to the January 11th 2011 press release the company received an indication of interest from a third party to acquire the company.  Nicholas Financial has retained Hyde Park Advisors to explore strategic alternatives.  Peter Vosotas is 68 years old and as the majority stockholder, it's likely he is looking to sell his business.  If he cannot get his price now it's likely that he will sometime over the next couple years. 





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