One
my all time favorite small caps is NICK, Nicholas Financial and it's on sale.

I wrote up a posting at my blog (http://stock-notes.blogspot.com/)
that goes into more detail about it. I'd love to hear some critical
viewpoints as it's a very important position for me. Here is the first
paragraph which I think pretty much summarizes my opinion.

"How much would you pay for a company that's grown same quarter
revenues and earnings for 65 out of it's last 66 quarters? That's
grown EPS from 12 cents per share to $1.08 per share over the last ten
years (23.6% annualized). A quality company with solid financials
built solely through organic growth, (no rollup), with at least
another decade of strong growth ahead in the U.S. market along. I
understand, you're a bargain type guy, and you don't like to overpay
for anything, even your wife's engagement present. So how about if Mr.
Market puts this hot little number on sale, just for a short time, at
a little less than 11 times reported TTM earnings? Not interesting
enough? What if earnings may be substantially understated?"

http://stock-notes.blogspot.com/

5 stars in motley fool CAPS. Looks good from here! And great write-up, btw.

James

Good info desert, thanks!

I am not surprised the stock has sold off. I am somewhat surprised it has not sold off more. The credit trends are quite scary in the Q from what I read.

This, in particular, looks bad - I know its hard to read here, but its page 20 of the 10Q, and the key is to look at the percentages, which are increasing right to left (last yr to this year). THese are large increases. In a finance company, this is quite a big deal.

The provision for credit losses increased from approximately $832,000 for the three months ended September 30, 2005 to $852,000 for the three months ended September 30, 2006. The provision for credit losses increased from approximately $1,260,000 for the six months ended September 30, 2005 to $1,662,000 for the six months ended September 30, 2006. The Company’s losses as a percentage of liquidation increased from 6.48% for the three months ended September 30, 2005 to 7.65% for the three months ended September 30, 2006. The Company’s losses as a percentage of liquidation increased from 5.77% for the six months ended September 30, 2005 to 6.37% for the six months ended September 30, 2006. The Company anticipates losses as a percentage of liquidation will be in the 6-9% range during the remainder of the current fiscal year. The longer term outlook for portfolio performance will depend on the overall economic conditions, the unemployment rate and the Company’s ability to monitor, manage and implement its underwriting philosophy in additional geographic areas as it strives to continue its expansion. The Company does not believe there have been any significant changes in loan concentrations, terms or quality of Contracts purchased during the three or six months ended September 30, 2006 that would have contributed to the increase in losses.

Recoveries as a percentage of charge-offs were 13% and 16% for the three months ended September 30, 2006 and 2005, respectively. Recoveries as a percentage of charge-offs were 15% and 18% for the six months ended September 30, 2006 and 2005, respectively. The Company believes that as it continues to expand its operations, it will become more difficult to implement its loss recovery model in geographic areas further away from its Corporate headquarters, and as a result, the Company will likely experience declining recovery rates over the long term.

The Company believes there is a correlation between the unemployment rate and future portfolio performance. The Company does not expect the U.S. unemployment rate to rise or fall significantly in the foreseeable future. Therefore the Company does not plan on increasing or decreasing reserves based on the current U.S. unemployment rate. The number of bankruptcy filings by customers during the three and six months ended September 30, 2006 remained consistent with recent reporting periods.

The following tables present certain information regarding the delinquency rates experienced by the Company with respect to Contracts and under its direct consumer loan program:



At September 30, 2006 At September 30, 2005

Contracts


Gross balance outstanding
$ 227,429,864 $ 194,489,189



Delinquencies


30 to 59 days
$ 4,167,057 1.83 % $ 2,793,371 1.44 %

60 to 89 days
1,465,884 0.64 % 707,902 0.36 %

90 + days
563,469 0.25 % 375,156 0.19 %


Total delinquencies
$ 6,196,410 2.72 % $ 3,876,429 1.99 %


Direct Loans


Gross balance outstanding
$ 9,724,049 $ 7,077,542



Delinquencies


30 to 59 days
$ 162,706 1.67 % $ 42,556 0.60 %

60 to 89 days
26,303 0.27 % 21,067 0.30 %

90 + days
25,178 0.26 % 28,138 0.40 %


Total delinquencies
$ 214,187 2.20 % $ 91,761 1.30 %


The delinquency percentage for Contracts more than thirty days past at September 30, 2006 was 2.72% as compared to 1.99% at September 30, 2005. The delinquency percentage for direct loans more than thirty days past due at September 30, 2006 was 2.20% as compared to 1.30% at September 30, 2005.

The Company does not give significant consideration to short-term trends in delinquency percentages when evaluating reserve levels. However, the Company believes delinquency trends over several reporting periods are more useful in estimating future losses and overall portfolio performance. The Company also estimates future portfolio performance by considering various factors, the most significant of which are described as follows. The Company analyzes historical static pool performance for each branch location when determining appropriate reserve levels. The Company utilizes internal branch audits as an indication of future static pool performance. The Company also considers such things as the current unemployment rate in markets the Company operates in, the percentage of voluntary repossessions as compared to prior periods, the percentage of bankruptcy filings as compared to prior periods and other leading economic indicators.

In addition, this is bad at least at first glance...it means the comps are worse than they look- it was 5% of operating earnings in the Q...

The provision increased from approximately $832,000 for the three-month period ended September 30, 2005 to $852,000 for the corresponding period ended September 30, 2006 for credit losses. The increase in the provision is net of provisions reversed for the three-month period ended September 30, 2006, which totaled approximately $201,000. No provisions were reversed during the three months ended September 30, 2005. The reversal of provisions previously recorded was due to the charge-off performance of static pools originated from April 2005 thru September 2005.

The net portfolio yield increased from 22.17% for the six-month period ended September 30, 2005 to 22.22% for the corresponding period ended September 30, 2006. The net portfolio yield increased due to the above factors, net of additional provisions for credit losses required for the change in the recognition of interest (see discussion under “Analysis of Credit Losses” below) and the resulting affect on the provision for credit losses. The provision increased from approximately $1,260,000 for the six-month period ended September 30, 2005 to $1,662,000 for the corresponding period ended September 30, 2006 for credit losses. The increase in the provision is net of provisions reversed for the six-month period ended September 30, 2006, which totaled approximately $617,000. No provisions were reversed during the six months ended September 30, 2005. The reversal of provisions previously recorded was due to the charge-off performance of static pools originated from April 2005 thru September 2005.


This is not good either:
The average dealer discount associated with new volume for the three months ended September 30, 2006 and 2005 were 8.32% and 8.71%, respectively. The average dealer discount associated with new volume for the six months ended September 30, 2006 and 2005 were 8.43% and 8.63%, respectively. The Company believes the average dealer discount may continue to decrease as the result of competition in the markets the Company is currently operating in.

A little OT: DC, are you going to be posting regularly in your blog? I'd be very interested in reading.

Thanks for the write up Cat. BTW, I am also heavily into Kaiser and have gained respect for you by seeing you have a position in it. However, FYI, Tennenbaum and family want to keep the company together (against the wishes of most investors) and try to repeat something along the lines of what they did in CO. I think the dividend is just something done to appese investors since they have been sitting on the money for a long time. Here's to hoping they either give up and liquidate or launch into a successful ventor soon. The good news is that I think that if they are successful in securing another deal like in CO, I think there is immediate value in their ability to gain such deals for the company that is probably around 4-5$ per share.

These are all reasons why NICK is on sale. It's also a concern that they've had increased chargeoffs/writeoffs in a period where unemployment hasn't risen.

Why am I not concerned? Because they've been through it before. These delinquency rates flunctuate, and last year they were the lowest in the history of NICK. So the comps were unrealistic, and it's not surprising they'd increase this year. But if you think this is a trend that will continue, it's silly to buy now as you'll likely get a better price following more bad news.

I'm fully invested here, so I don't think much about timing the best purchase price based on a bad quarter or two. My bigger concern is, has something bad happened to their business model that damages the intrinsic value of the investment?

So far, I don't think so. They've been through much worse competitive environments and still grown their business through it. I'm trusting management to be very conservative, to not get overly leveraged and not chase bad business (even if it costs growth), which is what they've done in their history. Note how often this management team has over-reserved for potential losses, and how often those reserves end up being reversed into earnings.

Thanks for all the info DC, I am considering opening a position in this company and if at some point you believe there to be more significant news(in either direction) please let us know!

James

I hope so. I just posted a more detailed analysis of Scorpion Man's concerns. To summarize, here is a look at some key metrics from the last 8 years that show this year isn't totally out of whack historically.

All,

This might be the best stock ever and I have no reason to doubt DC's analysis, but never trust anyone and always do your own work. You should never buy anything just because you saw a convincing writeup. What happens if you buy it and it starts to drop? Very tough to buy more if you don't really know anything about it.

On the slim chance you aren't aware, DC, I went to NICK's website and discovered links to some equity research. UPFC is mentioned as a competitor in the first piece I pulled up and its stock has had the [censored] kicked out of it.

Too soon to draw any conclusions, but maybe what's going on with NICK is less company specific and more industry related.

http://www.nicholasfinancial.com/FBWRep042806.pdf

Exactly. If you are interested in NICK you should read all of it's annual reports for the last few years, the last quarterly report, and you should call mgmt with any questions. You should also research competitors by doing the same. If you live in the SE, you might even visit one of their branch offices to doublecheck everything mgmt says. If you are not prepared to do those things, don't buy an individual stock.

This is far from a no-brainer. Remember that my last public pick here was Krispy Kreme puts, most of which have now expired worthless.

Don't delinquencies lead charge offs? That is the worst number to have go out of line and its at multi year highs...and the one that is not subject to "conservative" accounting, like chargeoffs.

To me, you need a good reason to believe that that number is a blip and not a trend to own the stock.

It may mean nothing, but it makes me nervous when highly paid executives exercise options early.

http://www.sec.gov/Archives/edgar/data/1...2906082942-.xml

1999 was the high for delinquencies, chargeoffs the next year went down (and were lower the next two years). So not necessarily.


Sure. My reason is that you see similar blips in their history, and you see this mgmt team work through them with no problems.

He sold about 8% of his holdings at a price 20% higher than todays. He's also in his late 60s and has most of his net worth tied up in NICK. I don't know how good sales are as predictors of a companies future, I've always read that purchases are a better indicator because people sell for lots of reasons (tax planning, diversification home purchases, divorces, pessimism over companies future, etc), but typically only buy for one reasons. They think the company is undervalued.

In this case he could be pessimistic, or buying a big boat, or both. It's not unreasonable to assume he'd like to sell more for diversification purposes, or even try to sell the company at some point. Last summer the CFO mentioned that they had been approached by private equity firms on a regular basis. I'd hate a company sale because I like to think of this as a long term holding, but it could produce a positive short term profit.

I spent a little time going through the 10Q. I agree with Scorpion Man. The credit trends are alarming. Finance receivables increased about 17% year over year but delinquencies increased almost 60%? That's fishy and may indicate a relaxing of underwriting discipline to grow the loan book. The other thing that suggests competitive pressures are increasing, possibly causing management to relax underwriting standards, is that dealer discounts declined several basis points year over year.

What's really spooky is the economy is still perking along at over 2% growth and unemployment is only 4.5%. It seems likely the economy will slow even more over the next few quarters. That should cause the unemployment rate to tick up (which is what the FED wants in order to contain inflation). If unemployment picks up, it's reasonable to expect the credit statistics to get even worse. If I were you, I'd try to get my hands on NICK's credit agreement to understand the covenants and how tight they are. At the end of September, they had a maximum of $13 million of unused capacity on the line (subject to a borrowing base), and you want to be comfortable they have access to it if the credit statistics continue to weaken.

Delinquencies only increased 30%, and are still in the range of historical norms. Remember that the numbers you are using for comparison from last year were low by their historical standards.

It's pretty evident competitive pressures are increasing. That's something that has happened cyclically in the past. And I think it's clear that some new branches did not meet their past underwriting standards this quarter.

This is true, and a concern. But it's also reasonable for you to expect management to fix the underperforming branches, so that's going to be a positive on credit statistic trends.

The line of credit was put in place in 2000 when NICK had a debt to equity ratio of 3.3-1. Today it's ratio is 1.4-1. The line has been increased every time they've asked, and I have little doubt they could have it increased substantially now. I believe this risk is very small, but let's explore what happens if it occurs.

Assume the lenders panick and refuse to increase the credit line and NICK can't find another lender who will. Nick can still operate with slow growth generated by internal cash and the remaining credit line. They could also pay out around $1 a year in dividends (8.5% yield). All this assumes the credit problems are manageable.

But in an absolute worst case scenario, the problems aren't manageable, lenders demand repayment and force NICK to liquidate. NICK has $8.70 per share in liabilities, including all debt. It has $23.85 per share in cash+loans+future interest owed. Assume that 40% of the loans default over the liquidation period and average recovery is 50% (partial payments and vehicle recovery). The $23.85 total value of the loans shrinks by 20% to about $19, minus liabilities and 50 cents a share ($5m) in liquidation costs leaves shareholders with around $9.80 per share.

So in a melt down it looks like worse case scenario getting most of my money back over a 4 year period. Of course it can't be that simple. What am I missing here?

The the sake of simplicity, I ignored direct loans in computing the increase in deliquencies. Direct loans are a small portion of the total book and aren't materially different from the contracts.

From page 20 of the 10Q, using contract information:

Contract delinquencies at Sept. 30 2005 were $3,876,429.
Contract delinquencies at Sept. 30 2005 were $6,196,410.

(6,196,410 - 3,876,429)/3.876.429 = 59.8%.

How did you arrive at a 30% increase in delinquencies?

45% of the dollar amount of contracts purchased in the September quarter were in Florida, a state feeling disproportionate pain associated with the housing slowdown. The stuff I'm reading suggests the homebuilders only started laying off construction workers in the past couple of months. I'm guessing some portion of the people willing to pay 24% interest to purchase a used car are day laborers. I feel pretty confident delinquencies are going to increase even more in the months ahead.

That said, your liquidition analysis looks solid.

Ok you were using absolute dollars, I was using delinquencies as a percentage of outstanding contracts, which went from 1.99% to 2.72%, which is an increase of 36.7%, not 30%.

And your observation about florida is likely right on target. I'm seeing similar things from another company I investigated this week, a building supply products company where sales in most of the south are solid, but in Florida sales have been very weak.

Buffett constantly talks about finding businesses that serve a repetitive need and have a durable competitive advantage that will cause the company to produce monopoly like profits in the long run. NICK does serve a repetitive need, buying auto debt, but what is it's durable competitive advantage? If I was a used car dealer and wanted to sell off some outstanding debt I don't see any reason why I would accept a lower bid from NICK than a slightly higher bid from one of NICK's competitors.

My understanding from DC's writeup is that NICK doesn't offer a lower bid to dealers compared to their competetors. They offer the same bid, and gain their advantage by taking a more indepth look at the invididual credit risk.

What I believe to be NICK's competitive barrier is their unique credit scoring and local branch offices. This "hands on" approach allow them to better determine which borrowers are lower risk, and which dealers offer better paper. And they can also do a better job of follow-up with borrowers to minimize the default ratio. Whereas the "big guys" might followup with a call (that you duck) or a letter (that you toss) when a payment is late, the NICK guys know where you work, who your references are, and they'll immediately want to talk to you. The big guys typically outsource vehicle recovery, whereas a NICK manager may do it himself.

This advantage allows NICK to "pay more" for a dealers client knowing that the client is a better risk than traditional scoring indicates, and avoid writing loans to clients who are worse. A dealer may not be able to get anyone to write a loan to a customer except NICK, if their credit scores are too low.

It's not a traditional "moat", but it seems very effective. And it's difficult to duplicate, because competitors don't want to invest the time and capital building their own branch office network. Their approaches are heavy on automation, which produces lower costs, but also higher losses.

Very interesting. I feel like I learned a lot in this thread. Got anymore companies we can look at?