February 18, 2015 - 11:52am EST by
2015 2016
Price: 2.51 EPS 0 0
Shares Out. (in M): 21 P/E 0 0
Market Cap (in $M): 53 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT 0 0

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  • Subprime Lending
  • Credit Services
  • Automobile Finance
  • Canada
  • Insider Ownership


Near-term concerns over low oil prices and heightened competition have led to a greater than 60% decline over the past six months in the share price of a fast growing, high ROE auto lender. While the next few quarters could produce cyclically low results and put further downside pressure on the stock, those with a multi-year time horizon should be rewarded by owning shares of this Canadian company.


Business Overview

Rifco Inc. is a Canadian auto lender targeting borrowers in the top range of the non-prime credit spectrum with a primary focus on B and C credit scores (which constitute approximately one-third of the population). Rifco operates in all Canadian provinces except for Quebec.


Since commencing operations in 2002, Rifco has lent over $475 million. At inception they set a goal to achieve annual originations in excess of $100 million and achieved this milestone in 2014. They have reset the bar to $500 million.



Over the past three years, Rifco has generated revenue growth of 22% alongside net income growth of 36%.



Margins have improved as Rifco’s funding costs have dropped from north of 7% to south of 5% resulting in a portfolio spread of approximately 14% today. Importantly, Rifco has produced these results while maintaining its underwriting discipline. Credit losses have averaged less than 3% over the past three years (although historically it has been 4-6%) and the company showed its strength during the 2008-2009 economic recession when credit losses rose to as high as 6% amidst a doubling of local unemployment rates. The company sustained annual profitability and grew through the crisis.


Unlike in the U.S., the non-prime auto lending space in Canada is served by just a few sizeable players (three exited the business after 2008). Rifco competes primarily with two large banks, TD Bank and Scotiabank, who control >95% of the $4 billion non-prime market. Rifco controls less than 5% of this market by offering superior service, centered on quick response times and a customized approach to underwriting.


The large banks tend to have more regimented and formulaic approaches to processing credit applications. Frequent complaints include slow turnaround times and an unwillingness to evaluate a customer’s story, instead restricting the decision to numbers and check-the-box forms. However, the larger banks have a lower cost of funds and often underprice the smaller players.


Rifco generally charges rates anywhere from low double digits to 25%+ and uses a loan agreement that allows them to seize the vehicle and sue the customer. The average loan size is approximately $23,000 and the typical customer’s credit rating impairment is due to a divorce, job loss or medical expense which has caused a non-prime rating that will stick for several years. Everyone is on auto-debit and the company knows right away if there is an insufficient funds situation allowing them to act quickly to start the collections process. Possessing a car is very important to Rifco’s customers as Canada is spread out and does not have a robust public transportation system.


Customer Feedback

We spoke with numerous auto dealers in Canada to get a better understanding of Rifco and its competitors. Here are some of the comments we heard:


                “Rifco is much more open to hearing a customer story. They are much less bureaucratic.”

-          Alberta-based auto dealer


“Rifco is able to verify income in minutes. TD takes hours or days. Scotia can take multiple days.”


“Rifco is much more story oriented than the bigger banks. An applicant might not have a proper pay stub because he’s being paid in cash. If Rifco sees a steady stream of bank deposits, they would approve the loan.”

-          Alberta based auto dealer


“You can work with Rifco. Other banks give you automated replies like ‘system declined’.”

-          Edmonton base auto dealer


Naturally, one might worry that Rifco is taking on the riskiest loans. However, this is inconsistent with management’s philosophy, the numbers to date and the comments from dealers. Management is emphatic that they will not pursue market share at the expense of underwriting standards (they own 23% of the company) and as noted previously the credit results since its founding demonstrate they are adhering to their discipline.


                “Rifco is pickier on credit quality.”

-          Edmonton based auto dealer


                “Rifco seems to be choosier when buying deals.”

-          Edmonton based auto dealer


“Rifco is much more inflexible on pricing than the larger banks.”

-          Alberta based auto dealer


Due to its smaller size and hands-on approach, it is important that Rifco maintains control over the total volume of applications it processes. The strategy is to find the right dealers not just aim for increasing the total number of dealers on the platform. Therefore, they often run a trial program with dealers to sort out the ones most well suited for Rifco. Additionally, they actively monitor the dealers on the platform and will cut those that are a poor fit.


“After three months, Rifco pulled the relationship.”

-          Calgary based auto dealer


“We used Rifco but they withdrew.”

-          Calgary based auto dealer


A recent initiative that is off to a strong start is the Fast Forward 500 Club loyalty program. It is an invitation only club offering a dedicated account representative and a heightened level of service with guaranteed response times. As dealers ramp up to gain access to the program loan volume increases and once they are in, there is a required activity level to maintain the benefits. More than half of recent loan volume has been coming from this program and these dealers are doing 5-6x the volume as others with significantly better credit performance. Due to the success of the program sales representatives are incentivized not to grow loan volume but to onboard more dealers into the program.


Recent Troubles

During the first quarter of 2015 (Rifco uses a March 31 fiscal year) loan delinquency jumped from 3.1% in the preceding quarter to 3.98% causing an earnings miss. Management attributed negative development to high staff turnover late in the quarter, noting this has occurred in the past and anticipating a return to normal levels. However, second quarter results showed delinquency rates remained elevated and had actually increased to 4.06%. Management commented that while staffing levels had come back, the average tenure in the account maintenance department is shorter than normal. We talked to the CFO who explained the delinquency rate increase was related to a confluence of factors. The company moved from a monthly to a bi-weekly payment plan offering which led to a wave of activity from customers who preferred the new flexibility. This change combined with a software conversion, the onboarding of new employees and continued high loan origination growth led to the stumble.


Most recently, the third quarter results (12/31/14) showed another increase in the delinquency rate, this time hitting 5.21%. The company attributes the increase to both the continued work with the collections department as well as the impact of the rapid decline in petroleum prices. They are back at desired staffing levels and they have brought on and trained an outsourced collections firm which will go live next week. This will allow them to ratchet up and down collections resources as needed and much more quickly than they could with internal resources. Additionally, they terminated the previous manager of the collections group and brought on a new manager who has been there about a month. In the underwriting department they are now limiting loan size based on employment tenure and job type (skilled vs. unskilled).


While it is hard to know Rifco’s precise exposure to the oil industry, we know that half of their loan book is in Alberta (69% in Western Canada) where oil is a dominant industry.



Capital expenditure budget cuts have already begun and some layoffs have been announced. Certainly the forward path of oil prices will impact where things go from here. As a result of this headwind and heightened competition, the stock has sold off more than 60% over the past six months. Management stated in its most recent press release that they are experiencing unusually aggressive competition. Competitors are loosening credit standards and pricing risk aggressively. The company thinks this may be in response to banks’ need to boost performance in one area of operations to make up for weakness in others. They have seen moves like this in the past which usually persist several months before problems begin to surface and the strategy is reconsidered. Management is emphatic they will not mirror this behavior.


Clearly, the company is facing some near-term challenges and the stock market has responded. But it has responded in a particularly harsh manner. To gauge the potential impact of sustained low oil prices on Rifco, one can review the company’s performance during 2008-2009. During that time Rifco saw delinquency rates north of 5% and loss rates hitting 6%.



That period saw oil prices drop from north of $130 to the $40s where they stayed for several quarters. Moreover, that period was characterized by broad economic stress as bank lending dropped, housing weakened and Alberta unemployment more than doubled.  



Today the environment is less severe as there is really just one isolated headwind. On the flip side, lower oil prices are a positive for many of Rifco’s borrowers. Using 2008-2009 for context, we see that Rifco felt the pain of that recession and saw earnings impacted but ultimately remained profitable. Today, Rifco is a stronger company with better access to capital. The CFO met with all of their lenders last month who said they are comfortable with the exposure and set to grow with them.



Today Rifco trades at approximately 10x trailing earnings and 2.2x book value. Historically, RFC has traded around 13.1x forward P/E and a 7.2x P/B. Management has laid out a goal to get to $500 million in annual originations. They feel they can grow 30-50% annually and historically the growth rate has ranged from 25-65%. Using the low end of the historic rate and normalizing for credit losses, we see fiscal 2017 EPS of .55-.60. Applying the historical forward multiple yields a stock price in the $7-8 range.



Management Ownership

As shareholders, our interests are nicely aligned with those of management who own 23% of the company. The business is led by the CEO, Bill Graham and CFO, Lance Kadatz, who have both been with the company since its founding and who used to run up personal credit card debt to make payroll in the early days. While they have managed to run the company with a high growth strategy, they understand the growth must be accompanied by strong underwriting standards and profitability. Moreover, they recognize the attractiveness of the platform to a potential acquirer with access to cheaper funding and are reducing the barriers to purchase by taking steps such as getting rid of the weakest credit risks, migrating up the credit spectrum and writing debt provisions to allow a buyer to pay down debt on 60-days’ notice. There is precedent for such a transaction as seen by the TD Bank purchase of VFC in 2006, the Scotiabank purchase of Travelers in 2007 and the Santander purchase of Carfinco in 2014.



·         Given the current headwinds that will likely impact near term earnings and the trading volume in the stock, it is possible the stock moves lower before recovering.


·         Sustained low oil prices could lead to increased unemployment levels in western Canada that exceed the 2008 recession levels.


·         Heightened competition from TD and Scotia could persist longer than expected hurting Rifco’s growth opportunity.


·         Rifco could face increased competition due to the Santander acquisition of Carfinco. Carfinco has historically competed in a lower part of the credit spectrum but that could change given the new ownership.



·         Rifco could lose access to funding. Currently they have access to more funding than is needed but a different lending environment could prove to be an inhibitor to growth.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.



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