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2 Consumer Loan Stocks Overcoming Tough Industry Backdrop

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The Zacks Consumer Loans industry continues to bear the brunt of falling consumer sentiments, mainly attributable to inflation, geopolitical matters and recessionary fears. This will, therefore, gradually dampen the demand for consumer loans and hurt top-line growth. Weakening asset quality as the economic growth continues to slowdown remains a key near-term concern.

Nonetheless, easing lending standards, which have increased the number of clients eligible for consumer loans and digitization of operations, will keep benefiting industry players. Hence, companies like Credit Acceptance Corporation CACC and Encore Capital Group, Inc. ECPG are worth considering for the near term.

About the Industry

The Zacks Consumer Loans industry comprises companies that provide mortgages, refinancing, home equity lines of credit, credit card loans, automobile loans, education/student loans and personal loans, among others. These help the industry players generate net interest income (NII), which forms the most important part of total revenues. Prospects of the companies in this industry are highly sensitive to the nation’s overall economic condition and consumer sentiments. In addition to offering the above-mentioned products and services, many consumer loan providers are involved in other businesses like commercial lending, insurance, loan servicing and asset recovery. These support the companies in generating fee revenues. Furthermore, this helps the firms diversify revenue sources and be less dependent on the vagaries of the economy.

3 Themes Shaping Consumer Loan Industry's Future

Sagging Consumer Sentiments: The ongoing Russia-Ukraine conflict, supply-chain woes and raging inflation (persistently being above 8%) continue to weigh heavily on the consumer sentiments. Due to these factors, the Conference Board Consumer Confidence Index fell to a 16-month low of 98.7 in June. Also, the Expectations Index — which shows a six-month outlook – fell to 66.4 this month (the lowest level since March 2013) as consumers become more downbeat regarding the outlook for the economy, labor market and incomes.

Lynn Franco, senior director of economic indicators at The Conference Board, said “Consumers’ grimmer outlook was driven by increasing concerns about inflation, in particular rising gas and food prices. Expectations have now fallen well below a reading of 80, suggesting weaker growth in the second half of 2022 as well as growing risk of recession by yearend.” So, consumer spending is likely to face headwinds from inflation and rising interest rates during the second half of the year. This will thereby result in lower demand for consumer loans. Thus, growth in net interest margin (NIM) and NII for consumer loan companies is likely to be hampered.

Credit Quality May Worsen: Since March 2020, the U.S. administration has provided substantial financial assistance to individuals through various packages to overcome pandemic-related challenges. However, with the stimulus packages gradually stopping and the Federal Reserve signaling continued monetary policy tightening ahead to tame inflation, there is a strong likelihood that the U.S. economy might be slipping into a recession in the next six-nine months.

Also, going by the central bank’s latest Summary of Economic Projections, the U.S. economy will grow 1.7% in both 2022 and 2023, down from the prior projection of 2.8% for 2022 and 2.2% for 2023. These factors may severely curtail the consumers’ ability to pay back loans. Thus, consumer loan providers will likely have to build additional reserves to tide over unexpected defaults and payment delays owing to the economic slowdown. This will, thereby, lead to deterioration in industry player’ asset quality going forward.

Easing Lending Standards: With the nation’s big credit reporting agencies removing all tax liens from consumer credit reports since 2018, several consumers' credit scores have improved. This has raised the number of consumers for the industry participants. Further, easing credit lending standards are helping consumer loan providers to meet loan demand.

Zacks Industry Rank Reflects Muted Prospects

The Zacks Consumer Loans industry is a 17-stock group within the broader Zacks Finance sector. The industry currently carries a Zacks Industry Rank #211, which places it at the bottom 16% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates underperformance in the near term. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of a disappointing earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since April 2022-end, the industry’s earnings estimates for the current year have moved 1.3% lower.

Before we present a few stocks that you may want to add to your portfolio despite industry challenges, let’s take a look at the industry’s recent stock market performance and valuation picture.

Industry vs. Broader Market

The Zacks Consumer Loans industry has underperformed both the Zacks S&P 500 composite and its own sector over the past year.

The stocks in this industry have collectively lost 28% over this period while the Zacks S&P 500 composite and Zacks Finance sector have declined 12% and 13.5%, respectively.

One-Year Price Performance

Industry's Current Valuation

On the basis of price-to-tangible book (P/TBV), which is commonly used for valuing consumer loan providers because of large variations in their results from one quarter to the next, the industry currently trades at 1.03X. The highest level of 1.54X and a median of 1.21X are recorded over the past five years.

This compares with the S&P 500’s trailing 12-month P/TBV of 13.32X, as the chart below shows.

Price-to-Tangible Book Ratio (TTM)


As finance stocks typically have a lower P/TBV, comparing consumer loan providers with the S&P 500 may not make sense to many investors. But a comparison of the group’s P/TBV ratio with that of its broader sector ensures that the group is trading at a decent discount. The Zacks Finance sector’s trailing 12-month P/TBV of 3.92X for the same period is way above the Zacks Consumer Loan industry’s ratio, as the chart below shows.

Price-to-Tangible Book Ratio (TTM)

2 Consumer Loan Stocks Braving the Industry Challenges

Credit Acceptance Corporation: Headquartered in Southfield, MI, CACC offers financing programs and related products and services to automobile dealers across the United States, enabling them to sell vehicles to consumers irrespective of their credit history. Further, it is engaged in the business of reinsuring coverage under vehicle service contracts sold to consumers by dealers on vehicles financed by the company.

Revenue growth remains a major positive for Credit Acceptance, with the same witnessing a five-year (2017-2021) CAGR of 13.7%. Growth is primarily attributable to a steady rise in finance charges, which is also the main revenue component. Finance charges are likely to continue improving as the demand for auto loans steadily rises, driven by solid economic growth. A decent rise in dealer enrolments and active dealers is also expected to aid the company’s revenues.

Credit Acceptance believes in returning capital to shareholders through stock repurchases instead of paying dividends. In September 2021, it authorized additional 2 million shares to be repurchased. As of Mar 31, 2022, the company had 0.36 million shares left to be repurchased. Despite having a substantial debt burden, its high cash flow generating business model and low capital expenditures are likely to help sustain share buybacks.

The company’s earnings are expected to decline 11.1% for 2022. Shares of this Zacks Rank #2 (Buy) firm have lost 14.4% over the past three months.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price and Consensus: CACC

Encore Capital: Based in San Diego, CA, ECPG offers debt recovery solutions and other related services for consumers across financial assets globally. The company also provides debt servicing and other portfolio management services to credit originators for non-performing loans in Europe.

Encore Capital primarily focuses on portfolio purchasing and recovery business in the United States and Europe. It plans to leverage its leadership position in portfolio purchasing and recovery as well as credit management services to bolster market share worldwide.

Organic growth remains solid for ECPG. Over the last three years (ended 2021), revenues recorded a CAGR of 7.2%. A gradual rise in portfolio purchases will help the company’s revenue growth.

Similar to Credit Acceptance, ECPG believes in returning capital to shareholders through stock repurchases. In May 2021, it authorized an additional $250 million for share buyback. As of Mar 31, 2022, the company had $153.2 million authorization remaining. Despite having a huge debt burden, its high cash flow generating business model is likely to help sustain share buybacks.

This Zacks Rank #2 stock has lost 8.2% over the past three months. ECPG’s earnings are expected to increase 14.4% for this year.

Price and Consensus: ECPG

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