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Cash Store lends credibility to payday loan industry

No one knows more about a business than the CEO - except the CEO who owns a lot of the stock. Gordon Reykdal is one.

Mr. Reykdal founded and runs Cash Store Financial , a gem of a business. He also owns about a quarter of the stock, and it shows. Talk to him for a few minutes and it soon becomes obvious that he knows every wrinkle about his company, which offers payday loans to a growing base of consumers that big banks want nothing to do with.

I wrote about this stock in December of 2008. It was $6 then, which I thought was very cheap. Mr. Reykdal agreed, because he was in the process of buying back a lot of it through another issuer bid. Those buybacks - 20 per cent of the shares outstanding - look like a great investment today: The stock is about $17.

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I met up with the CEO recently to find out if the stock - which I own - was still attractive after tripling - and through a recession no less. I think it is for five reasons.

The first is that Cash Store has finally cleared the legal air. Payday loans were a controversial subject. Cash Store ran afoul of the vague usury rules and paid a penalty in the form of civil litigation. But Mr. Reykdal also got governments to clarify the laws. Today, both issues - the law and the lawsuits - are pretty much behind him. Rules are in place or will soon be in all provinces except Quebec, where these loans are not allowed.

As a result, the industry is gaining respect, and why not? It clearly provides an important service. Payday loans are short term and high interest rate. Some think they prey on the poor but consumers obviously appreciate the service since Cash Store has a customer base of more than two million with about a tenth of that using its services at any given time. These lenders charge high interest rates because they have to; default rates are higher.

Cash Store knows an awful lot about its customers - it has to in order to assess their credit risk and keep track of them. Mr. Reykdal is using that knowledge to add banking services such as taking deposits.

I think investors will come to accept this. There's little institutional ownership in the stock but I suspect that will change in time.

Another source of growth is that the company generates a lot of free cash that it plans to use to make loans. Cash Store is a loan broker, sourcing its funds from third parties. That's expensive. Using its own balance sheet will improve earnings in a meaningful way.

Third is new services. Cash Store knows an awful lot about its customers - it has to in order to assess their credit risk and keep track of them. Mr. Reykdal is using that knowledge to add banking services such as taking deposits. The company is outsourcing its banking and sharing revenues. But by using its existing infrastructure these revenues pay very high margins and no credit risk.

Fourth, the market in Canada is still very fragmented. Mr. Reykdal has clawed his way to top spot in terms of market share with 34 per cent, in part organically and in part by acquisition. But there are more branches to open - the ratio of population to branches in Canada compared to the U.S. is 2.5 times higher, implying more than 100-per-cent growth in total branches, all else being equal.

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A related point is that new branches take time to mature. Only about a third of the branches are mature now. The most recently opened branches are doing about a third the business of branches that have been open for eight years. They may never make as much money as older ones but they should improve over time.

Finally there's the possibility of international growth. Mr. Reykdal has no plans to make a foray south of the border - "way too competitive" he says. But his company owns about 20 per cent of Cash Store Australia which is doing Down Under what the parent company did here 10 years ago. And it's experimenting with stores in Britain, which has a favourably legal regime and a fragmented market.

Now the stats: Cash Store's earnings per share compounded at 58 per cent from 2007 to 2009. Its return on capital invested went from 16 per cent to 41 per cent in that period of time. The branch count is set to rise about 20 per cent this year. It pays a growing dividend.

And for all that I'd guess the stock is trading at about 10 times forward earnings. That seems cheap given the above, especially knowing you're investing alongside a CEO who has lots of skin in the game.

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About the Author
Investment Columnist

Fabrice Taylor, CFA, publishes the President’s Club investment letter, for which he and The Globe and Mail have a distribution agreement. More

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