NICHOLAS FINANCIAL, INC.
(NASDAQ - NICKF)
March 11, 1998
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| NICHOLAS FINANCIAL, INC. |
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| Recent | 52 Week | Earnings Per Share* | P/E Ratio | Indicated | |
| Price | Price Range | 1996 1998 Est. 1999 Est. | 1998 Est. 1999 Est. | Dividend Yield | |
| $3.25 | $2.50 to $5.06 | $.33 $.38 $.45 | 8.6 7.2 | $0.00 $0.00 | |
* Fiscal year ending March 31st
December Quarter Results
| Book Value: $2.86 | Price/Book: 114% | |
| Shares Outstanding: 2,357,013 | Market Capitalization: $7.7 million | |
| ROA: 2.48% | ROE: 11.37% | |
| Loans 60 days past due: 2.0% | Reserves/net loans: 15% | |
| Equity/Assets: 21.6% |
Quarter Ending 12/97 9/97 6/97 3/97 12/96 9/96 6/96 3/96 EPS .08 .11 .09 .09 .05 .11 .10 .08
Commentary
Nicholas Financial Corp. is a small consumer lender. It specializes in used car loans which it purchases and originates through a network of 14 branches (11 in Florida, 3 in Georgia). Because of the risky nature of used car receivables and its small size, this stock should be viewed as a speculative security.
Nicholas Financial began as Nicholas Data Services in 1985. The founder, Peter L. Vosotas, had been the Vice President of Sales for Paradyne Corp. prior to its acquisition by AT&T.
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Nicholas Data was a software company which designed custom software for various small business applications. Starting in 1990, they switched their emphasis for future growth to the purchase of used vehicle loans from car dealers.
Nicholas Financial’s proprietary software allows them to closely track both the quantity and quality of quarterly loan pools from each branch office. This allows for very targeted incentive bonuses for its branch managers. Negative variances in loan quality are picked up in early stages before they grow into real problems.
Nicholas Financial’s growth has been held back over the past two years by the presence of foolish competitors. The "sub-prime" lending market had been a Wall Street favorite and many such companies were brought public. So much money was raised, that there was soon too much money chasing too few good used car loans. Nicholas Financial is frequently outbid for such loans at prices which they do not believe make economic sense.
Newly public companies in the sub-prime auto business had to keep their volume of loans growing to make the aggressive earnings growth, which was expected by investors. They mostly securitized their loan production and reported large gains on sale as these were sold in the bond market.
Securitization is a valid method for financial companies to get loans off their balance sheets and generate funds for new lending. These loan sale "profits" under securitization are a statistical estimation of future earnings from the servicing of packaged loans. Estimates of future credit losses and prepayments are necessary to compute the "gain on sale." Many public "sub-prime" lenders have gotten in serious trouble when delinquent loans underlying their securitizations produced much worse loan losses than were originally estimated. Many of initial recognized "gains" were subsequently reversed.
Nicholas Financial is a portfolio lender. The car loans they originate and purchase are held on their own balance sheet, where they earn a spread over their cost of funds. In fact, net interest income (after provision for loan losses) comprised over 90% of the company’s income in the December quarter.
Nicholas Financial experiences higher loan losses than a bank due to the lower credit ratings of its borrowers. About 1 in every 5 used car loans becomes delinquent before maturity. They know this from experience and reserve for this level of loss up front. They also hold back "dealer reserves" by paying less than the face amount of the loans when initially purchased. These reserves absorb loan losses before the company’s loss reserves are charged.
BALANCE SHEET ANALYSIS
12/31/97 12/31/96 Change % ASSETS: Cash and Equivalents $ 113,812 $ 188,785 -40% Finance Receivables (Net) 29,794,264 21,225,550 40% Accounts Receivables 15,472 19,433 -20% Prepaid Expenses & Other Expenses 384,641 455,700 -16% . Premises and Equipment 188,840 194,911 -3% Deferred Income Taxes 740,778 343,715 116% Total Assets $ 31,237,807 $ 22,428,094 39% LIABILITIES: Line of Credit $ 21,230,594 $ 13,755,594 54% Notes Payable Related Party 1,741,595 1,756,095 -1% Accounts Payable 1,248,559 675,270 85% Other Liabilities 266,600 430,596 -38% Total Liabilities $ 24,487,3481 $ 16,617,555 47% SHAREHOLDERS' EQUITY: Common Equity 6,750,099 5,810,539 16% Total Shareholders' Equity $ 6,750,099 $ 5,810,539 16% LIABILITIES AND EQUITY $ 31,237,447 $ 22,428,094 39%
A strong 40% growth in net finance receiveables drove the 39% increase in Nicholas’ balance sheet. This growth in the balance sheet ($8.8 million) was financed mostly by a 54% increased in line of credit borrowings.
Sub-prime auto lending is characterized by a higher level of delinquent loans than standard auto lending. At December 31st, 6.5% of Nicholas’ outstandings were delinquent by over 30 days. Only 2% were over 60 days delinquent, however, and it is not unusual for sub-prime buyers to fall behind occasionally by a payment or two.
Total loss reserves were $5.2 million at December 31st or equal to 178% of all delinquent loans. The company has traditionally taken early action to bring delinquent borrowers back on schedule, and kept loss reserves at appropriate levels. The final step of delinquency remediation is the repossession and sale of the car involved through a dealer auction. About 50% of the loss if recovered in this way. Total reserves at calendar year-end were 15% of total loans.
LAST QUARTER INCOME STATEMENT ANALYSIS
| 12/31/97 | 12/31/96 | Change % | |
| Interest Income | $ 1,898,889 | $ 1,344,454 | 41% |
| - Interest Expense | 534,444 | 395,867 | 35% |
| Net Interest Income | 1,364,445 | 948,587 | 44% |
| - Loan Loss Provision | 250,115 | 177,000 | 41% |
| Net After Provision | 1,114,330 | 771,587 | 44% |
| Other Income | 105,175 | 112,301 | -6% |
| Total Income | 1,219,505 | 883,888 | 38% |
| - Operating Expense | 906,539 | 676,261 | 34% |
| Pre-Tax Income | 312,966 | 207,627 | 51% |
| - Tax Provision | 124,157 | 82,080 | 51% |
| Net Income | $ 188,809 | $ 125,547 | 50% |
| Average Common Share | |||
| Earns Per Share | $0.08 | $0.05 | 60% |
| Tax Rate | 40% | 39% |
Income Statement Analysis
A 41 % increase in interest income was primarily due to a 40% growth in loans held. Net interest income grew by 44% due to an .87% decrease in funding costs and a smaller increase of 35% in interest bearing liabilities.The growth in loans was propelled by the opening of 3 new branches since last year’s similar quarter. The provision for loan losses was also increased by 41% to keep pace with loan growth.
Total income (after provision for loan losses) grew by 38%, while operating expenses increased by only 34%. This favorable combination lead to a 50% increase in net income.
We anticipate that the maturation of recent opened branches, additional branch openings, and continued good expense control will lead to favorable growth trends for the foreseeable future.
Conclusion
Nicholas Financial is a junior growth stock in the sub-prime car loan business. (As a portfolio lender, their earnings are more conservatively stated than their "securitizing" consumer lending peers.) They do, however, have more intrinsic credit risk than most depository institutions.These speculative shares are suitable for capital gains-oriented investors where income is not a concern. We believe that Nicholas’ shares are undervalued and could have considerable upside potential from current levels.
Samuel J Beebe, CFA
(813) 526-5658
ADDITIONAL INFORMATION AVAILABLE UPON REQUEST. (Copyright 1998 Samuel J. Beebe, CFA). The material presented in this report was been obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. Mr. Beebe has no financial relationship with the company, but is the portfolio manager of the "Beebe Fund" - a member of the C/Funds group of no-load funds from Venice, Fla. The "Beebe Fund" owns 8,500 shares of Nicholas Financial (2.6% of its total stock positions) as of March 11, 1998.
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