Credit Acceptance Looks Promising as Used Car Drought Eases
Ruane Cuniff & Goldfarb, a guru investment firm followed by GuruFocus, likes what it sees at Credit Acceptance Corp. (NASDAQ:CACC). In the Sequoia Funds fourth-quarter 2022 letter, the firm wrote:
At the current share price, Credit Acceptance trades for approximately 8x expected EPS for 2023. We consider this an attractive price for a business that generates industry-leading returns through conservative underwriting, has reasonable prospects for growth and is run by a highly disciplined and extremely shareholder-friendly management team that has bought back over a third of outstanding shares over the past five years.
About Credit Acceptance
The company offers financing of vehicles through auto dealers, and traditionally has focused on consumers with poor credit ratings (FICO scores below 650). In 2020, Credit Acceptance expanded its market by providing financing to higher-rated consumers. By the end of 2022, these auto buyers made up 15.2% of its sales. The change represents a major expansion of its total addressable market.
Thats some good news for a company that has had a dash of discouraging news. As Ruane Cunniff (Trades, Portfolio) noted, it took a hit in 2022 because of limited supplies of used cars. With dealers selling fewer of them, Credit Acceptances opportunities to finance them also dropped.
In its fourth quarter and full-year 2022 earnings report, the company noted that consolidated net income for the year was $535.8 million, or $39.32 per diluted share, compared with $958.3 million, or $59.52 per diluted share, in 2021.
The used car environment
According to an article at the Kelley Blue Book website, Almost every factor that contributes to car affordability helped shoppers in February, from falling prices to rising incomes. Monthly payments finally began to inch down from an all-time high set last December.
It points to several factors that have affected, and could further affect, the auto industry. First, the shortage of used cars can be traced back to a global shortage of microchips, which slowed or stopped the production of new cars. With fewer new cars available, demand forand the prices ofused cars went up.
Hence, the 2022 shortage of used vehicles, that is now easing. But the article also pointed out several other factors may lead to tightened supplies of used vehicles later this year. These include the fact that automakers now build fewer cars priced at $25,000 or less.
The industry also faces the headwind of uncertainty about interest rates, which makes consumers more hesitant to make purchases.
Ruane, Cunniff on Credit Acceptance
Despite the uncertain environment, the fund remains bullish on Credit Acceptance for several reasons.
First, it noted collections on outstanding loans improved because of low unemployment and cash in consumer pockets because of earlier fiscal stimulus.
Second, it calls the company a disciplined underwriter, one that has maintained its margins by avoiding the temptation to cut prices when business slows.
Third, Auto loan cycles come and go, and Credit Acceptance is expert at navigating them, usually growing market share when other lenders batten down the hatches.
But Ruane Cunniff (Trades, Portfolio) also sees a downside, which reflects the fact Credit Acceptance does most of its business with a vulnerable population. According to the fund letter, the firm has already settled a suit brought by the Massachusetts Attorney General and faces two similar suits. Ruane Cunniff (Trades, Portfolio) added, It is part and parcel of the deep subprime lending business. Our research indicates that Credit Acceptance rigorously follows all existing lending laws, although enforcement agencies may attempt to broaden the interpretation of existing laws through litigation.
Fundamentals
Credit Acceptance enjoys a high GF Score of 92 out of 100. That includes full 10 out of 10 ratings for profitability and growth, while financial strength gets only 3 out of 10. The latters low rank probably reflects a finance companys need to provide funding upfront.
On the profitability scoreboard, it enjoys a net margin of 29.24%, which is above average for the credit services industry. Add to that industry-leading returns on equity (32.73%) and return on invested capital of 7.82%.
Credit Acceptance also receives a high ranking for value, 9 out of 10. That is based on the price-to-GF Value ratio and involves the current April 18 price of $486.21 and the GF Value of $602.19. With the current price below the GF Value estimate, the stock is considered modestly undervalued.
Because the company has a predictability ranking of 5 out of 5 (on watch, though), we can have confidence in the discounted cash flow assessment. On an earnings-based calculation, the DCF is $1,235.13, so the stock looks deeply undervalued. This price would provide a 60.63% margin of safety.
Ruane Cunniff (Trades, Portfolio) also sees value here. As it noted, above, "this an attractive price for a business that generates industry-leading returns.
Gurus
Do other gurus share Ruane Cunniff (Trades, Portfolio)s optimism about Credit Acceptance? Well, at least six of them did at the end of 2022. Still, Ruane Cunniff (Trades, Portfolio) had by far the largest stake with 798,731 shares. The Smead Value Fund (Trades, Portfolio) held 156,500 shares and Jim Simons (Trades, Portfolio)' Renaissance Technologies owned 5,788.
Conclusion
The past year was a tough one for Credit Acceptance. However, I still consider it a growth stock with good possibilities. As we saw, it is growing its total addressable market, the used car shortage situation seems to be easing, it has excellent fundamentals, including those for profitability and growth, it is undervalued to some extent and it has a guru champion.
This article first appeared on GuruFocus.
