HEDGEYE

Having trouble viewing this email? View it in your browser

03/12/20 01:12 PM EDT

CACC | 1Q19 Review - Moving Old Faithful to the Long Bench

Josh Steiner

@hedgeyefig

Drago Malesevic

Takeaway: Despite fundamentals being largely in-check, we have tapped most of the upside in our original thesis and now await a more compelling setup.

Credit Acceptance Corp. (NASDAQ: CACC) reported first quarter GAAP net income of $164.4 million or $8.65 per diluted share, up +37% and +40% Y/Y, respectively. Removed from a favorable increase in tax benefits related to its stock-based compensation plan, CACC grew pretax income by +31% Y/Y, driven primarily by a larger loan book.

Better reflecting the cash economics of the business, Non-GAAP Diluted EPS of $8.08, was up +32% Y/Y, beating street expectations for $7.85 by +3%. Note, Non-GAAP bottom-line figures are adjusted to reflect the firm's estimated long-term effective tax rate, thus removing the effect of increased tax benefits realized in the GAAP results this quarter. Moreover, economic profit, calculated as the firm's dollar return on invested capital in excess of its cost of capital, increased +35% Y/Y in 1Q19, driven primarily by a larger loan book.

MOVING FROM AN ACTIVE BEST IDEAS LONG TO THE LONG BENCH:

Having initiated our long call on CACC back on May 17th, 2018, we have seen the stock move up north of +40%. Now, with a difficult comp setup ahead for loan growth and the productivity tailwinds of the firm's expanded sales force set to fade, we view our original thesis as having largely played out, especially given currently dampened short-interest and a historically elevated valuation. Moreover, with our Macro team calling for a Quad 3 transition, we have observed historically that CACC shares are more likely to underperform in this environment. In addition, without clarity on the firm's CECL forecast, a likely neutral or negative development, we think that it is prudent, at this particular juncture, to step off to the sidelines and hold out for a more compelling setup to re-engage.

Highlights from the quarter:

Loan Growth

With the number of active dealers up +9.9% Y/Y, unit and dollar loan volumes grew +0.4% and +5.1% Y/Y, respectively. Due to increasing competition, marked in part by a -8.6% decrease in the average volume per active dealer, growth slowed for the third consecutive quarter across active dealer counts, unit loan volume, and dollar loan volume; however, the level of growth remains respectable for the quarter given the set of tough compares in 1Q18. As the productivity tailwinds from the firm's recently expanded sales force fade, we see growth in higher active dealer counts and unit origination volumes continuing to moderate. Meanwhile, dollar volume growth will continue to be moderately driven by increasing loan sizes, the combined result of lengthening average loan terms, higher average vehicle selling prices, and the continued emergence of purchased loans as a percentage of total unit volume.

(VIEW LARGER IMAGE)

Credit Quality

On a total portfolio basis, collections forecasts held broadly stable in 1Q19 across the firm's ten reported vintages.

(VIEW LARGER IMAGE)

Recall, in our presentation on 05/17/18 (available HERE), we showcased management's demonstrated ability, notwithstanding brutal economic conditions, to precisely and swiftly recondition its estimates. Powered by the data insights of a 27-year, multi-cycle operating history, CACC is best positioned to diligently risk manage the current competitive lending environment.

(VIEW LARGER IMAGE)

Efficiency

Netting out provision expense and using the firm's longstanding disclosure of forecast realization rates, it is possible to monitor the firm's collections efficiency over time, which can be observed as both strong and quite stable. Note, in the stress testing of CACC's vintage-level profitability included below, we use a 16% cost-to-collect for added conservatism in our calculation of break-even IRRs and the corresponding level of insulation built on top of these figures.

(VIEW LARGER IMAGE)

Vintage Performance:

All of the firm's vintages appear on a steady trajectory to reach management's collections forecasts.

(VIEW LARGER IMAGE)

In our initial work on CACC, we highlighted that early-life variations in vintage performance are dominated and primarily driven by variations in term. Adjusting for such term effects, early-life performance across the firm's latest vintages is consistent with the performance of other vintages.

(VIEW LARGER IMAGE)

Moreover, using the latest expected collections figures, the resilience and robust nature of the firm's loan book remains ever present.

(VIEW LARGER IMAGE)

Valuation + buyside sentiment:

(VIEW LARGER IMAGE)

notes from the call:

Commenting on the competitive environment, management cited the status quo.
Regarding the progression of CECL, no definitive update was given, but management said it is continuing to work on the planned accounting change.
Estimated long-term effective tax rate was given as 23%.
Regarding the +31% Y/Y increase in Other Income, management denied the presence of any irregular or infrequent items, stating, as confirmed in the 10Q, that most of the increase was attributable to higher interest income and ancillary profit sharing.
In response to a question about the firm's ability to capture additional loan growth through greater spread compression on its new loans, management reiterated its data-rich approach to pricing products ex-ante with the primary goal of maximizing economic profit, despite historically having been able to, ex-post, price its loans more aggressively.
Regarding the growing presence of Purchase Loans in its total portfolio, management reiterated the firm's historically greater dependence on Purchase Loans in tougher competitive environments. Please note, on slide 24 of our initial deck linked above, we highlighted the cyclical nature of this dynamic.In addition, management revealed that its has been financing newer, more expensive vehicles than it had been 3-4 years, which, combined with the mix shift to purchase loans, has resulted in an increase in the average contractually owed payments and an increase in the average advance.
Management stated that none of the covenants under its various ABS facilities are particularly concerning.
Relating to business trends, the mix between franchised and independent dealers has held broadly stable, although the firm has had more success in recent years signing up larger franchised shops for its purchase program. Geographically, the firm is doing better in areas where it has been historically strong, and continues to struggle in areas with historically weak penetration.

hedgeye macro overlay:

(VIEW LARGER IMAGE)

Please visit https://app.hedgeye.com/feed_items/74973 for more information.

To unsubscribe and manage your research distribution, click here.