This article is authored by MOI Global instructor Rimmy Malhotra, portfolio manager at Nicoya Capital, based in Menlo Park, California.

In late August [2019] I had the opportunity to travel to Florida to meet with Doug Marohn, the company’s CEO and attend the annual shareholder’s meeting. I am glad I did. What was palpable when meeting Doug and the board is that all the hard work and cleanup over the last two years is finally bearing tangible results. I’ll refer you to Doug’s excellent shareholder letter for the details but in summary:

  • The company has refinanced its credit line with a lender whose structure and terms are more amenable to the company’s current posture and needs
  • The company has re-centered the field offices to their former culture and strategy – which is to focus on the independent used car dealer, match on price and then use their local presence to win deals on service
  • They have implemented a modernized loan servicing platform that will allow them better analytics that support the business from multiple dimensions e.g. legal, compliance, finance, and strategy
  • The legacy loan book has substantially burned off and newer credit vintages are performing in line with historical metrics
  • The company is finally playing offense, and recently completed its first acquisition in history
  • The company initiated a one million share buyback (12% of shares outstanding)
  • The board and insiders own in excess of 30% of the company and are adding to their stake at a rapid pace

In a business such as this I believe that the loan KPI’s are an excellent leading indicator to future financial performance, so let’s take a moment to examine an excerpt from their most recent press release.

Table I:

Table II:

Table I illustrates key loan origination KPI’s since Doug’s return. Across every metric Doug has dramatically increased the quality of loan originations by decreasing size and term, while at the same time increasing rate and dealer discount. These loans will return the principal outlay quicker thus reducing the company’s risk. What you don’t see in these numeric KPI’s are the qualitative factors behind these borrowers. These loans are made to vetted borrowers who are looking to finance basic transportation to and from work. This means the borrower has documented income, is financing a much more modest car and needs that car to provide for themselves. I could bore you with the loss curves by vintage demonstrating post and pre- Doug’s reign but rest assured Doug has returned Nicholas to its underwriting roots, and we are seeing that in a dramatic reduction in credit losses as evidenced in Table II above. Credit reserves as a percentage of outstanding receivable have dropped 40%, and we see an acceleration of this metric. We believe that the legacy portfolio which continues to burden the financial statements will be completely eliminated by June of 2020 allowing investors see that the new “Nicholas” is an earnings story.

I am convinced that the foundations of the operational turnaround are firmly in place, the capital structure is stable and incentives all-around are completely aligned. The company is finally growing volumes albeit modestly. When loan volumes do increase, we see a clear path to $2.50+ of EPS using modest assumptions. Assigning any reasonable multiple to this earnings stream leads to a stock price three times the current. Finally, with the stock trading at 65% of liquidation value and with very modest leverage, the downside is extremely well covered. It’s been a long road, but Nicholas Financial represents a compelling company that we’re excited to be owners of.

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