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More than a year ago, I recommended taking profits on Credit Acceptance Corporation (NASDAQ:CACC) due to the steep rally of the stock and its resultant rich valuation. Since my article, the stock has shed 24% due to some business headwinds and the ongoing bear market of the broad market. The stock is currently trading at a price-to-earnings ratio of 9.6. As the current headwinds are likely to subside in the upcoming years, the stock has become interesting from a long-term point of view.
Business overview
Credit Acceptance has a mundane business model and thus it passes under the radar of most investors. It offers financing programs that help automobile dealers sell vehicles to customers who cannot buy a vehicle via the traditional bank channels. In other words, the company appeals to consumers with a relatively poor financial status.
Credit Acceptance is facing a strong business headwind this year due to the surge of inflation to a 40-year high. First of all, inflation has caused many consumers to struggle to pay for their living expenses. Consequently, most consumers have reduced their discretionary spending. This trend is negative for Credit Acceptance, as fewer consumers are likely to apply for an auto loan.
In addition, the Fed has raised interest rates aggressively in order to restore inflation to its long-term target of about 2%. Rising interest rates make loans less appealing to consumers. Indeed, a recent survey reported that U.S. consumers are less likely to apply for auto loans due to rising interest rates. In fact, this is the exact reason behind the aggressive interest rate hikes implemented by the Fed. The central bank aims to cool the economy in order to lead inflation to lower levels.
As the economy continues to slow down, more consumers are likely to struggle to service their loans and thus Credit Acceptance may face higher delinquency rates in the upcoming quarters. Overall, the surge of inflation has multiple effects on the business of Credit Acceptance. This helps explain why analysts expect the earnings per share of the company to decrease 6% next year and remain flat in 2024.
However, Credit Acceptance has an exceptional performance record and continues to perform well, even in the adverse business environment prevailing right now. In the third quarter, its adjusted earnings per share decreased only 3.5%, from $13.84 to $13.36, primarily due to a decrease in the forecast of the company about its future collection rates. Nevertheless, Credit Acceptance maintained strong loan growth, with 29% growth of loans over the prior year’s quarter. As a result, its earnings per share exceeded the analysts’ estimates by $0.43. The company has exceeded the analysts’ estimates by a wide margin for 12 consecutive quarters. This is a testament to the strength of its business model and its solid execution.
Moreover, Credit Acceptance has an admirable record of forecasting its collection rates.
|
Loan Assignment Year |
Initial Forecast for Collection Rate |
Current Forecast for Collection Rate |
|
2013 |
72.0% |
73.4% |
|
2014 |
71.8% |
71.7% |
|
2015 |
67.7% |
65.2% |
|
2016 |
65.4% |
63.8% |
|
2017 |
64.0% |
64.6% |
|
2018 |
63.6% |
65.1% |
|
2019 |
64.0% |
66.5% |
|
2020 |
63.4% |
67.9% |
|
2021 |
66.3% |
66.8% |
|
2022 |
67.4% |
66.5% |
As shown in the table above, Credit Acceptance has forecast its collection rates with a high degree of precision year after year. In most years, its actual collection rates have exceeded its initial forecast. Such a consistent performance record confirms the prudent management of the financial services provider.
It is also important to note the exceptional growth record of Credit Acceptance. Since 2012, the company has grown its earnings per share in every single year, apart from 2020 due to the pandemic, at a 24% average annual rate. A consistent growth record is paramount when deciding whether a stock is worth considering for an investment.
Investors should also realize that Inflation is likely to moderate in the upcoming quarters. The Fed has clearly stated that it has prioritized restoring inflation towards 2%. Thanks to its drastic interest rate hikes, the central bank will almost certainly achieve its goal sooner or later. When inflation moderates, consumers will see the real purchasing power of their income increase and thus they will feel more confident for applying for an auto loan. As a result, the business of Credit Acceptance is likely to recover whenever inflation subsides.
Valuation – Share repurchases
Credit Acceptance is currently trading at a price-to-earnings ratio of 9.6. This is certainly an attractive valuation level, especially given the exceptional performance record of the company and its expected recovery whenever inflation moderates.
Even better, Credit Acceptance has an excellent record of enhancing shareholder value via meaningful share repurchases. During the last decade, the company has reduced its share count by 45%. In addition, the markedly low price-to-earnings ratio of the stock greatly enhances the efficiency of share repurchases. At its current valuation, the company can reduce its share count by 10% per year without the use of debt. As long as the stock remains cheaply valued, its share repurchases are likely to greatly enhance value for long-term shareholders.
Risk
There are essentially two risk factors related to Credit Acceptance. The first one is the adverse scenario of persistently high inflation for several years. In such a case, the company may face weak demand for its auto loans for years and thus it may offer lackluster returns to its shareholders. However, as the Fed has prioritized restoring inflation towards 2%, such an adverse scenario is highly unlikely.
The other risk facing Credit Acceptance is its regulatory risk. The company charges exceptionally high interest rates to its customers, who cannot borrow funds from the traditional bank channels. As a result, the market has always been afraid that regulatory authorities may force Credit Acceptance to lower its interest rates. This risk factor has always been in place but it has never materialized. There are currently no signs on the horizon that regulators may impose limits on Credit Acceptance, though no-one can be sure about the long run.
Final thoughts
Credit Acceptance has outperformed the S&P 500 in the long run. During the last decade, the stock has rallied 390%, much more than the 177% rally of the S&P 500. Whenever Credit Acceptance has gone through a period of consolidation or correction, it has always rewarded investors excessively afterwards. Nevertheless, as Credit Acceptance is currently facing some business headwinds, patience is required. Only the investors with a long-term perspective should consider purchasing Credit Acceptance during the ongoing downturn in its business.
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