Investors, mainly on fears that have failed to materialize, have thrown away CURO Group Holdings Corp. (NASDAQ: CURO), like many other financial companies catering to the sub-prime borrowers, away. In the meantime, the core business is starting to come back and Katapult, in which CURO owns a minority stake, continues to perform well.
No doubt, the business faces some risks, ranging from an economic slowdown that may lead to a rise in delinquencies amid deteriorating creditworthiness of the borrowers it serves to taper off of stimulus that has helped the borrowers in the US to bridge the lockdown driven economic collapse. Longer-term, there is a risk of increasing interest rates leading to higher cost of borrowing, similar to any other financial institution.
But these risks are more than offset by favorable dynamics of the sub-prime lending industry in general that has benefited immensely from the stimulus package provided by the US government and company-specific factors, e.g. CURO’s exposure to the Canadian market and superior execution.
Now that the investors are entertaining ideas of a situation where the economy starts to come back, the vaccine is launched and Fed remains accommodated, the gap between the market’s fears about the subprime lending space and fundamental reality at companies like CURO has grown too wide.
CURO is performing better on risk as well as growth front, its customers are acting responsibly towards maintaining credit rating, the company is benefiting from the Canadian market performing better than expectations, and Katapult is a major beneficiary of changes in customer purchasing behavior during the pandemic.
Subprime lending space
Unlike previous downturns, customers have paid off loans instead of drawing limits, highlighting a shift in credit culture and growing awareness about financial responsibility. Yes, stimulus package also played a role but the change in consumer behavior is visible in other developed countries as well.
The result of which is that loan volume as well as delinquencies remained low, a combination that led to better demand for US subprime bonds and tighter spreads between subprime and treasuries, e.g. triple-A-rated subprime auto ABS pricing at 1.2 percentage points above Treasuries, higher than 0.5 percentage points at the start of the year but significantly lower than 4.25 percentage points in March.
CURO holding up better than Bears think
Revenue declined 31% during the second quarter, but other than that almost every other metric is showing improvement, including the forward indicators like weekly application volume and all-important risk measures like delinquency rates.
Besides the changing consumer behavior towards credit, two major explanations are attributed towards this all-round improvement, the stimulus package in the US and TINA (There Is No Alternative) factor, i.e. shrinking options for subprime borrowers is forcing customers to act responsibly and saving credit limit for rainy days.
As the chart above shows, the count of companies catering to the sub-700 FICO score market is shrinking.
Of course, with tighter spreads and responsible customers, lenders like CURO are also open to providing relief to customers at risk.
Ok survived well, but can the business grow again?
Yes, besides the macro tailwinds for credit demand from the economy opening up, there are four major easily identifiable growth catalysts specific to CURO,
- Canadian market
- Stride Bank relationship
- Cash, the dry powder
- Stimulus package
Canadian business, 1/3rd the size of the US business, holds promise. The open-ended balance products are growing fast and there is significant potential for online adoption in the market given just 35% of the total transactions conducted online during the second quarter compared to 66% in the US. Almost 70% of the CURO’s debt is with prime-tier customers in the Canadian market and there are primarily two major competitors of the company in the market.
Fast expanding relationships with Stride Bank can be another growth catalyst for the company. The bank is providing help in underwriting, origination, and servicing to generate online installment loans. Stride is expected to offer loans in 19 states by the end of the current quarter, up from 10 states at the end of the second quarter.
With $269 million in cash and $363 million of liquidity, including undrawn capacity on the revolving credit facilities, at the end of the last quarter, CURO’s balance sheet is strong. The virus has ended up being a source of liquidity rather than use of liquidity.
This additional liquidity should help spur growth in the coming months. Seasonally, application volumes increase during the second half and the company has also started to loosen credit criteria since July, after tightening in early March, the combination should lead to growth in lending activities during the coming months.
The second stimulus package, when cleared, should drive another wave of economic growth and a resulting improvement in credit demand.
Katapult, the underappreciated growth rocket within
CURO has 43% ownership in Katapult, a fast-growing online lease-to-own platform focused on the non-prime market segment. The company grew at 250% during the first half, thanks to an aggressive partnership building program with retailers and brands. Since CURO books income from its minority ownership with a two-month lag, its second-half results should benefit from the same.
Now that Katapult has achieved scale, almost $100 million of leases during the first half, which may lead to profitability soon, the market may finally wake up to this underappreciated asset soon, whether or not CURO increases its stake above 50%.
Operational improvements and margins
Even though the market is least bothered about margins right now, recent cost reduction programs have surpassed expectations and when the topline turns the corner, earnings growth may convert even the staunchest Bears.
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