Nicholas Financial’s Financials

A reader weighs in:

I am not averse to buying microcaps and have in fact made some good money doing so. I bought stocks that had a good business model and became big companies. This is why I think I can help with regards to NICK.
First, the finance receivables is very large compared to any other part of the left side of the balance sheet. Basically, you are buying the receivables, as a shareholder. You are buying them leveraged a bit (as you mentioned 2:1). You’re not really buying the operations of the company because again, earnings and cash flows are tiny compared to the asset side of the balance sheet; there will also be no earnings if receivables shrink and the company can no longer collect interest.
With that being said, I’d like to point out that last quarter there was a charge off of close to $20M, applied to the receivables. This was 9% of the receivables, or roughly 20% of the equity. Meaning your shares, as they represent equity, should have declined by at least that amount — assuming there was no reason book value would increase in the near-term, which would be a long shot as “charge-offs” tend to be just that… off… for good. These are not to be confused with unrealized losses which occur due to mark-to-market fluctuations.
Delinquencies on payments also increased across all time periods, indicating that further charge offs are in the wings. If the economy recovers soon there’s not much to worry about. If consumers pull pack (in Florida in particular) then even just a 20% charge off will have a massive impact. Because the company is leveraged about 2:1, that’s a 40% decline in equity. That’s also a cumulative ~30% decline in the receivables portfolio, meaning that next year revenues will decline by about 30% as well, because they make money from interest payments. The costs of running the company and collecting those payments are relatively fixed, so you will get an earnings decline of more than 30%, under this scenario. The cost of debt isn’t likely to get cheaper either, increasing another cost in the short run.
Finally, in the last year there was a share offering which diluted your ownership stake by another 10-20% depending on the time periods you compare.
If you know the risks then that’s fine. I respect the bet, which will either have a huge upside or go to zero. But this really is a bet on the consumer and finance receivables. There is no sustainable operating company if borrowing rates increase and the consumer weakens further. I didn’t feel that your post stressed this point enough.
I hope my input is of value. I started looking through the financial thinking you’d spotted a gem. Under most economic scenarios there’s no operating company going forward. If we recover, then you are absolutely right, the stock will jump. But don’t expect this company to be around in six months if the economy gets much worse.

Posted by on October 23rd, 2008 at 10:46 am


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