The K-Shaped Economy, It’s Tough Out There: EZCORP $EZPW

When the Stock You Love Doesn’t Love You Back

“I’ll have my bond. Speak not against my bond.

I have sworn an oath that I will have my bond.

Thou call’dst me dog before thou hadst a cause,

But since I am a dog, beware my fangs...

I’ll have my bond. I will not hear thee speak.

I’ll have my bond, and therefore speak no more.

I’ll not be made a soft and dull-eyed fool,

To shake the head, relent, and sigh, and yield” - Shylock

Today’s company focuses on two themes, the K-shaped economy, and the rapid economic development of Latin America.  The K-shaped economy is where the upper class is thriving, but the middle class is trading down to join the ranks of the lower class.  Mexico’s GDP per capita at purchasing power parity has grown at a 7% annual rate since the dip in 2020 from the Covid lockdowns.  With labor costs one third of China’s, and piped natural gas from Texas, I think there are good odds that companies with exposure to Mexico will outperform.

For those readers who aren’t familiar with the pawnbroker business model, customers who need a cash loan can bring jewelry or some other type of merchandise with an estimatable resale value to the pawnbroker.  The pawnbroker will make a loan and keep the merchandise as collateral, and as a rule, the loan will only ever be made for 50% of the resale value of the merchandise.  Interest rates tend to be high, between 3% and 10% monthly, but the duration of the loan is expected to be short.  The rate of interest charged by pawnbrokers is less than half of what is charged by payday lending companies for a similar size loan.  If the loan goes into default, the merchandise is placed for sale at the pawnbroker’s shop.  The business is highly regulated, and terms can vary state by state.  In Florida, for example, the pawnbroker has to wait 60 days from the loan default to sell the merchandise.  

EZCORP (EZPW) is a pawnbroker with 1,258 locations as of Q3 2024.  Of those locations, 541 are in the US, 554 are in Mexico, 125 in Guatemala, 18 in El Salvador, and 20 in Honduras.  While the US is 40% of the locations, it currently represents 80% of EBITDA.  The reason for this is that EZCORP’s turnaround efforts started three years ago with the entrance of a concentrated activist hedge fund, Kanen Wealth Management.  While Kanen only controls 4% of the company, EZCORP is about 15% of Kanen’s portfolio.  I have to respect that concentration.  Since the arrival of the new activist, the old management team executed a turnaround strategy that started with the US first, and Latin America second.  But the first uplift in results from Latin America are already starting to arrive.

EZCORP isn’t just a turnaround story, it’s also a growth story.  Store count is up about 5.5% a year for the last four years.  Revenue is growing at about an 8.5% annual rate.  Net Income was negative during the Covid lockdowns, but Gross Profit has been growing at a 16% annual rate off of the Covid lows due to expanding margins from the successful turnaround.  There are still plenty of worlds left to conquer as EZCORP isn’t even in all 50 states, and they only represent about 5% of US pawnbrokers.  

The Incentive alignment of management could be better, the board of directors is a rotation of past CEO’s, many of whom ran the company into the ground.  The executive chairman, Phillip Cohen, acquired EZCORP in 1989, took it public in 1991, and has been milking it ever since, paying himself and hiring his consulting company for over $52 million.  Meanwhile EZCORP has returned only 70% since 2005 while the only other publicly traded pawnbroker, FirstCash (FCFS), returned 648%, and the two companies have almost identical margins.  Capital allocation really does make or break a business, EZCORP has been squandering their earnings on value destroying acquisitions outside of their core competency.  With the same scoundrels still firmly in control of EZCORP, is Kanen’s 4% ownership stake enough to enforce discipline on the company?  The last few years since Kanen’s participation have been very good, but this is a company to be dropped on the first sign that management is back up to their bad habits.

The pawnbroker business in the US is about 60% to 65% jewelry oriented, and the rest is general merchandise.  In Latin America jewelry is only about 30% due to competition from non-profit organizations that specialize in making jewelry loans, but EZCORP is attempting to take market share by using their expertise to make larger loans on the same jewelry.  With the prices of precious metals skyrocketing this year, it’s worth noting that EZCORP, a $632 million market capitalization company has $171 million of inventory, and $218 million in cash.  That inventory is majority jewelry, with a slow turnaround time, and while gold miners can mark their gold inventory to market, it is my understanding that this book value represents the lesser of the price paid initially or the current market value.  Meanwhile gold prices are up 30% in the last 12 months alone.  Rising gold prices should provide an unexpected tailwind to EZCORP as they realize gains when their inventory eventually finds a buyer.

There is an unfortunate amount of convertible debt outstanding, about $300 million, this debt is a holdover from poor decisions in the past, it has been refinanced at least three times since 2014.  If this convertible debt were converted, shares outstanding would be 83 million rather than the 54 million of the current float.  The debt could be repaid with three full years of operating cash flow, but management doesn’t have the right to buy any of it until 2026, and the holder has the right to convert at any time.  Pressure from Kanen has led management to authorize about $55 million in share buybacks over the last couple of years, but despite the low share price, only $3 million was spent on buybacks last quarter. 

The competing public pawnbroker, FCFS, trades at a price to book ratio of 2.37x to EZCORP’s 0.79.  FCFS trades at a price to sales of 1.43x to EZCORP’s 0.86.  All other valuation ratios give a range of FCFS trading at about double or triple the valuation of EZCORP.  If EZCORP continued their current disciplined trajectory of avoiding poor acquisitions, buying back stock, and paying down the convertible debt, and if good behavior caused a multiple rerating, there’s no reason to think that EZCORP couldn’t triple within a few years.  Of course that depends on good behavior from the same people who had behaved badly for so long in the past.

How much shareholder abuse am I willing to tolerate in order to own a growing business trading at less than tangible book, and with exposure to Latin America, rising interest rates, precious metals, and the lower leg of the K-shaped economy?  Unfortunately I am willing to take some management risk in order to buy a bit of EZCORP.  I am also wary that there could be a pullback in the price of the stock after such a strong run up from $4.50 at the start of 2021.  I would be curious to see if any shareholders take profits in January knowing they have the whole year to compound before paying taxes.  EZCORP is an excellent stock for a watchlist, or to slowly average into.