Cash Converters International Ltd: Revenues up but worrying signs

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Cash Converters International Ltd (ASX: CCV) announced its results for the six months to December 2011 on the 15th February 2012. Revenues have increased by 28.2% to $111.7m, but net profit fell by 7.5% to $13.2m.

Cash Converters acts primarily as a pawn-broker, trading in second-hand goods, but has expanded into financial services by providing cash advances and personal loans. Financial services now make up a significant portion of the company's revenues.

Revenue growth has been driven by increases in personal loan income of $14m and an increase in corporate store revenue of $12.5m. Net profits were hit by an increase in overheads to ramp up the company growth. Debt has also increased from $22.6m in June 2011 to $38.2m as at end of December 2011, and has resulted in the business moving from a slight net cash position to a net debt to equity ratio of 10.6%.

Cash Converters currently has a network of over 600 stores operating in 21 countries and has increased the number of stores in the first half by adding nine "greenfield" company-owned stores, with seven in the UK and two in Australia. The company expects to open a further eight new stores in the second half, six in the UK and two in New South Wales.

Credit reform review

In late 2011, the Australian government put forward a proposal to limit the interest rates and fees that can be charged on so-called "pay-day" loans. The parliamentary committee set up to review the reforms concluded that the proposed fee limits were unworkable and recommended that the government revisit key aspects with further industry consultation. This is expected to take place in the first half of 2012.

Despite the committee's conclusion, it's very likely that some limits will be set, and those limits are likely to affect revenues and profits at some stage, which is a cause for concern.

Other concerns

Cash Converters has also raised an additional $91m through the issue of new shares in the last 10 years, with the number of shares on issue growing from 150m to 379m, hence the lack of EPS growth – an outcome that appears to not be particularly shareholder-friendly.

The business also wrote off bad debts of over $10.2m for the six months to December 2011; double that of the prior corresponding period. While the company has stated that bad debts written off as a percentage of principal has improved in Australia to 6.2%; in the UK, that same ratio was over 11% in the first half of 2012.

Lastly, and perhaps most importantly, are the deteriorating financials over the last five years, which look set to continue at least into the 2012 financial year. As you can see from the chart below, return on equity, net profit margin and earnings per share (EPS) growth have all fallen significantly since 2007. Based on my forecasts, 2012 is not likely to show any improvement either.

Source: Company reports, 2007 – 2011, my estimate for 2012 

The Foolish bottom line

While I can see a need for companies like Cash Converters (and also Money3 Corporation Limited (ASX: MNY), FlexiGroup Limited (ASX: FXL) Thorn Group Limited (ASX: TGA), ThinkSmart Limited (ASX: TSM) to provide the services they offer, Cash Converters is not my pick in that sector.

The only bright spot is a potential takeover offer from EZCorp Inc (NASDAQ: EZPW). EZCorp currently owns 30% of the business and withdrew from a plan to take a further equity stake last year, amid uncertainty over the outcome of the credit reforms.

Cash Converters is currently trading on a forecast price/earnings ratio of 7.7 and prospective dividend yield of 6.5%, fully franked, but looks like a classic value trap to me.

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Motley Fool contributor Mike King doesn't own shares in Cash Converters. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Click here to be enlightened by The Motley Fool's disclosure policy

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