Pawn Shop Power Plays

By Matthew McCall | February 10, 2010 AAA

Typically someone visits a pawn shop when they are desperate for money and the only way to get their hands on cash is to sell valuables, including electronics, jewelry and anything else that was once worth something to the seller of the item. As you can imagine, during tough economic times this type of business will benefit from people in need of cash to pay bills and feed their family.

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Even though pawn shops are known for being the middle man between sellers and buyers in hard times, they also have another lucrative business - payday lending. Payday lenders make small, short-term loans against the borrower's paycheck. This allows the borrower to have cash quicker than going to a traditional bank, depositing the funds and waiting for the cash to become available. And, of course, the pawn shop charges a hefty fee for the benefit of the "cash advance".

Beating Expectations
With over 500 stores in the U.S. and another 112 in Mexico, Cash America International (NYSE:CSH) is well-positioned to provide instant cash. Fundamentally, the company has been impressing investors lately. The company reported Q4 earnings in late January and revenue grew by 16% as net income more than doubled to $1.09 per share, well above analysts' expectations of 98 cents per share. On the conference call the company boosted earnings guidance for Q1 to a range of 89 cents to 98 cents per share.

Annual Service Charges Mean Earnings
First Cash Financial Services (Nasdaq:FCFS) is based in Texas, where it has a stronghold on the pawn shop and cash advance business, but also has operations in a dozen other states and Mexico. The over 500 shops FCFS operates offer the traditional pawn shop services and their customers may be charged an annual service charge of up to 240%. (For related reading, check out Should You Pawn Your Valuables?)

That enormous number is what led to the company's strong earnings in Q4. The company reported record revenue, net income for both the fourth quarter and full year 2009. Revenue and net income for the quarter both rose 26% on strong pawn services.

The company provided guidance for 2010 and expects earnings per share in the range of $1.53 to $1.59, giving the stock a current P/E ratio of 13.5 based on 2010 earnings. Considering growth will be approximately 15% in 2010 based on estimates, FCFS looks to be undervalued at $21 per share. (For more, check out Getting On The Right Side Of The P/E Ratio Trend.)

Demand - And Net Income - Take Off
Another Texas based pawn shop and check casher, EZCORP (Nasdaq:EZPW) is similar to its competitors in that the fourth quarter was a profitable three months. The majority of the company's operations are in Texas and Mexico, obviously a hotbed for pawn services and loans. Revenues in the fourth quarter were up 44% as net income surged 73%. The CEO noted strong demand for loans in all of the company's businesses. For the full year 2010 the company expects earnings per share of $1.81 and based on the current price of the stock that would put the P/E ratio under 10.

The Bottom Line
There is no arguing there is value in the three pawn shop/lenders mentioned above. The question is whether the demand for their services will continue if the economy continues to improve in the United States. One way to gauge the potential for the pawn shop stocks is to watch the unemployment rate. With 9.7% unemployment in January, a large number of people remain out of work and will likely seek out the assistance of the pawn shops during tough times.

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