By Michael Kim
READ THE FULL CPSS RESEARCH REPORT
After the market closed on 10/31/24, Consumer Portfolio Services (NASDAQ:CPSS) reported 3Q24 earnings results. For the quarter, CPSS reported net income of $4.8 million, or $0.20 per share – a penny shy of our $0.21 EPS estimate. Relative to our model, despite more favorable revenues, the EPS miss was mostly a function of higher expenses.
After updating our model for 3Q24 actuals, we are trimming our 2024 and 2025 EPS estimates from $0.90/$3.06 to $0.85/$2.66. Despite a more favorable revenue outlook, our lower earnings estimates primarily reflect the 3Q24 EPS miss, combined with higher interest expense going forward.
Turning to valuation, despite strong outperformance since we initiated coverage in mid-August, we see further upside for stock. Our model forecasts CPSS’s book value per diluted share to reach $14.81 by the end of next year, with ROEs rising from a nadir of 6.6% in 1Q24 to a more “normalized” 20% in 2025 largely reflecting reaccelerating growth in loan originations and related finance receivables, as well as lower cost of funds and credit losses. As the “Street” increasingly recognizes the company’s growth trajectory and underlying earnings power, we look for a meaningful upward revaluation for the stock, particularly given relative multiples. To be sure, Price-to-Tangible Book Value and Price-to-Earnings multiples remain meaningfully higher across a subset of public companies with sizeable auto finance businesses. Our $18 price target assumes the stock trades at ~1.5x current book value of $11.80.
We highlight the following key takeaways from 3Q24 results:
1. Accelerating balance sheet growth: Total receivables ended the third quarter of 2024 at $3.3 billion, up 4.9% on a sequential basis and 13.1% compared to $2.9 billion as of September 30, 2023. Much of the growth can be linked to accelerating loan originations. To the point, CPSS purchased $446 million of new auto installment sales contracts in 3Q24 compared to $432 million in 2Q24 and $322 million in 3Q23. Looking ahead, lead indicators for continued volume growth remain favorable around rising demand/applications and approval rates (while remaining disciplined on pricing and underwriting). Furthermore, management continues to add sales representatives (+17 in 3Q24) to support the company’s approved network of 12,000+ dealers across 47 states in the U.S., with the recent integration of Informed.IQ’s Dealer Verify tool likely further enhancing loan origination efficiencies. Turning to funding, CPSS recently completed the company’s 53rd securitization (and fourth thus far in 2024) by selling $417 million of asset-backed notes, with a weighted-average yield on the notes of approximately 5.52% (down from 6.69% and 6.56% for securitizations completed in April and June of this year, respectively).
2. Improving (relative) credit trends: At first glance, CPSS’s credit metrics weakened a touch in the third quarter. More specifically, annualized net charge-offs represented 7.32% of CPSS’s average portfolio balance for 3Q24, up 46 bps from 6.86% in 3Q23. Delinquencies greater than 30 days (including repossession inventory) accounted for 14.04% of the total portfolio balance as of September 30, 2024, up from 13.31% as of September 30, 2023. Stepping back, credit trends for 2022 vintages (and 1H23 loans to a lesser extent) have weakened across the industry reflecting stepped up competition at the time of origination, less favorable pricing/spreads, financing at peak valuations, and rising consumer debt levels more broadly. That said, CPSS maintains strong relative performance track records across cycles, with problematic loans down to less than 33% of the total portfolio, and newer paper continuing to perform significantly better. Much of the improved performance can be tied to modest unemployment rates, an enhanced AI-driven underwriting model, and lower Loan-to-Values (LTVs). Key differentiating factors for CPSS include the management team’s tenure, a broad spectrum of credit programs, and the company’s long operating history.
3. Building earnings power: We look for CPSS’s earnings to step function higher in 2025 and beyond reflecting a few powerful drivers. First, we forecast the pace of new loan originations to continue to ramp up, thereby driving higher portfolio balances and rising interest income, with APRs (~20%) and risk-adjusted yields (~11.5%) likely remaining generally consistent with current run-rates. Second, though essentially flat quarter-to-quarter, we expect CPSS’s risk-adjusted Net Interest Margin (NIM) to expand from 6.3% in 3Q24 and approach 7.5% in 2025, with further gains looking out to 2026. Much of our thinking reflects lower cost of funds, as the Fed continues to cut interest rates. Our model calls for CPSS’s cost of funds to trend down to the company’s historical average of around 4.5% looking out to the second half of 2025. Moreover, we look for improving credit trends, as 2021/2022 vintages continue to mature and newer/higher-quality loans increasingly come on the books. Third, we expect CPSS’s earnings profile to increasingly reflect rising operating leverage, as the loan book continues to scale. Much of the operating leverage can be tied to CPSS’s predominantly fixed cost base, limited headcount model, existing infrastructure, and management’s ongoing focus on expense management. To the point, we forecast ROA to trend higher from 0.8% in 3Q24 to ~2.5% in 2025.
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