champpixs
Introduction
One of the slight improvements that occurred in the last report from Regional Management Corp. (NYSE:RM) was the delinquency rate starting to decline somewhat to 6.9%. This is still quite high in my opinion and investors should be worried about the company acutely losing a significant amount of earnings potential from this.
I think however that they have remained robust otherwise as interest fees have risen and topline growth has been very consistently trending upwards for a long time. What keeps me from making it a buy is the valuation not offering enough of a discount against the risks that are associated with high delinquency rates like that. In the meantime though, investors can be pleased to know that they will continue being able to collect a decent dividend of around 4%, and that shares are also being bought back at a very decent rate historically, and I think it will continue to be like that as well. For me, RM represents a hold right now, with the possibility of being a buy if the price drops to around 6x earnings.
Company Structure
The share price has been performing quite poorly over the last few years for RM as it’s down heavily from the highs of over $60 back in late 2021. This seems to have come from higher interest rates as the potential slowdown in the market was felt throughout a lot of industries, the consumer finance one included. What RM has proven though is that they are capable of growing their asset base efficiently and the top line as well.
RM stands as a diverse consumer finance entity, offering a variety of services and financial products. Operating across a broad expanse of 13 states, the company extends its reach through a network of 350 branches, with over 450,000 customers and clients. Positioned at the forefront of the financial landscape, RM plays a pivotal role by extending loans to a consumer segment that often grapples with limited access to traditional credit sources, such as established banks and credit card companies.
Operating Leverage (Investor Presentation)
The company has over the years done a very good job of properly growing their business and delivering an appealing profit ratio. Operating expenses have been largely maintained by the company over the last couple of years and revenues have further improved which has resulted in the decent bottom line growth seen so far.
P/B Growth (Seeking Alpha)
The valuation of the company has seen a steady decline as I said, and right now the company sits at an earnings discount of close to 20% compared to the sector. I think this is unfortunately not adequate for where I would like to have it. A p/e of 6 would be more intriguing as the high delinquency rate is putting a wrench in the operational performance in my opinion. With a low multiple like that the downside risk would be limited and properly reflect the risks that come along with higher delinquency rates as well. With a high and persistent rate like that, earnings are in danger and therefore the dividend as well. The current payout ratio for RM right now is just under 40%. This isn’t necessarily high and if earnings fall RM could maintain the dividend if they want as the lower payout ratio would allow them to do so. However, with a far higher payout ratio, less capital is available for expansion and customer acquisitions, which could in the future lead to slower earnings growth. But seeing as the value that investors get from the company is in the shape of a dividend, cutting it as earnings decline may face significant pushback. I think RM will most likely try and cruise through these higher delinquency rates and hope it doesn’t exponentially impact the earnings. But I do admit there is a risk of cutting it if the impact is severe enough to leave RM with a negative bottom line. Seeing as the dividend is one of the main appeals of the company, it’s risky to buy right now as a drop or lack of growth will likely result in the share price dropping further.
Earnings Transcript
On August 2, 2023, RM had their most recent earnings call and there are some comments made by the CEO Robert Beck that touch upon some issues and views I have on the company’s performance so far.
“We exceeded our expectations on both the top and bottom lines. We produced $6 million of net income and $0.63 of diluted EPS. Loan demand remained strong in the quarter, allowing us to generate high-quality portfolio growth and near-record quarterly revenue, while simultaneously maintaining a conservative credit posture”.
Seeing strong loan demand I think is great as the market conditions then aren’t as poor as some might have first thought. RM being able to maintain a strong loan portfolio is further solidifying them as a decent opportunity in the space at the right price. What I want to see though for the coming quarters is a further acceleration of the delinquencies rates going lower. That will help ensure that the loan profile and the target base that RM has are actually viable and don’t pose too much unnecessary risk.
Margins (Seeking Alpha)
Looking at the margins of the business they have largely been underperforming over the last 12 months, even as rates have gone up and companies like RM should technically be able to earn more interest. The net margin is a fair bit below that of 12.79% which is the average it has had the last 5 years. Impacting the margins has mostly been the rise of selling general, admin & expenses, and interest expenses have also climbed to the highest level in the company’s history at nearly $60 million. As interest rates go down in 2024 hopefully, I can see the bottom line recovering and margins returning to their 5-year average once again.
Risk Associated
An inherent risk lies in the potential scenario where mounting inflationary pressures and sustained rises in interest rates intersect, potentially triggering an abrupt surge in the delinquency rate. This dynamic could emerge as consumers grapple with cash flow challenges amid the evolving economic landscape. It’s important to note that RM operates within the subprime lending space, boasting a relatively modest loan portfolio and market presence.
Credit Trends (Investor Presentation)
With delinquency rates falling a little bit, it still doesn’t mean that RM is completely out of the clear I think. The rates need to fall further to make the risk profile lower and then a higher valuation makes more sense. Some reasons the company stated regarding the rates are the higher interest rates the Fed has announced over the last 12 months. I think that unfortunately, they will be at an elevated level for quite some time as the aim is made clear by the Fed that they want inflation down to their target of 2%.
Investor Takeaway
I think that RM holds some value still as the dividend yield is appealing to be a part of and benefit from. The earnings are also discounted by nearly 20% compared to the sector, so I think the downside is somewhat limited from here. I said I wanted a P/E of 6 before buying and that is the case if delinquency rates don’t quickly decrease to historical levels of below 4% at least. This all concludes to me right now rating RM a hold rather than a buy.
