Payday Lender Advance America: Numbers Look Good, But Can You Stomach the Business?

Value investors are accustomed to turning rocks over and finding lots of creepy crawlers. The bugs help keep the faint-of-heart away, making many beaten-up companies cheap and, over the long haul, attractive if only one can see though the mess to the strength of the underlying business. It’s more work than hopping on a shooting star – Netflix (NFLX) and (CRM) come to mind – but ultimately more psychically rewarding to stand apart from the momentum-stock mob. Especially when the market turns downward.

In search of such bargains, YCharts has talked up RadioShack (RSH), Pitney Bowes (PBI) and H&R Block (HRB) in recent months, each one somewhat unsightly yet with substantial (and perhaps under-appreciated) earnings power.

RSH Stock Chart by YCharts

But can a financially-well-positioned company be too ugly to consider, even for grizzled value investors? Certainly, some people won’t touch Altria (MO), Philip Morris International (PM) or other tobacco stocks because of the deaths associated with their product – and the zeal with which the industry denied health claims early on. And perhaps you’re worried about greenhouse gas and thus avoid coal stocks. More power to you.

Coming out of the 2008 financial crisis, there’s another sector that, while holding the promise of gains, might give you pause: the low end of the consumer lending market, the folks who created and popularized subprime mortgage and other lending categories that turned toxic when turbo-charged by Wall Street. Advance America (AEA), which operates 2,347 payday lending offices around the country is one such stock; rated attractive based on historical comparisons by YCharts Pro, and seen as a bit undervalued with its p/e ratio at about 9, you might win with it but you’d be winning ugly.

AEA Stock Chart by YCharts

Advance America posted profit of about $35 million in 2010, roughly half the sum it earned in the heyday of 2006, as tougher regulations and a crummy economy hurt its business. But the first quarter was improved: net income up 33% and same-store revenues up an impressive 5.9%. The earnings yield on Advance America shares is a whopping 11% or so. At that depressed price, Advance America’s modest dividend is yielding more than 4%.

AEA Stock Chart by YCharts

Payday loans are very short-term – 18 days on average at Advance America last year – and very expensive. The average $370 borrower was charged $55, which Advance America prefers not to call interest but which works out to about 300% annualized. And on its web site, the company cops to charging what amounts to 404% in Illinois, 456% in Alabama and 533% in Texas (those who borrow online, as opposed to going to an Advance America store, in Texas pay 664%). Stiff, eh? If you’re not one who lives paycheck-to-paycheck, the demographics of the business might shock you: median household income of about $49,000.

Consumer advocates use the words “predatory” and “abusive” in discussing the payday loan industry, and some states have increased regulations and in effect run Advance America and others out of town. Congress mulled, but didn’t enact, bills to cap interest at 36%. Advance America doubts it could stay in business charging such rates.

That all sounds bad enough, but here’s the truly ugly part of the business model: Advance America says it hires a new customer service rep for every 100-to-150 new customers. Eeesh. Talk about labor intensive. And the day before a payment’s due, everyone gets a personal phone call of reminder. That’s hand-to-hand combat compared to the anonymous drone bombing of millions of pieces of mail that the super-efficient credit card industry engages in. The provision for bad loans was $104 million last year, exceeded on the expense ledger only by labor costs in the stores of $180 million. All that to make $35 million in profit?

Widespread availability of credit is a great thing. And lenders deserve to charge a rate that produces a profit, within reason. But, as with sub-prime mortgages, many payday borrowers could quality for cheaper loan rates elsewhere. Payday lenders thrive on borrower ignorance. Advance America shares are cheap, but owning them mightn’t make you proud.



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