Zacks Small Cap Research – CPSS: INITIATION: Scale-Enabled Auto Finance Company, with Key Catalysts – Technologist

By Michael Kim

NASDAQ:CPSS

READ THE FULL CPSS RESEARCH REPORT

We are initiating coverage of Consumer Portfolio Services, Inc. (NASDAQ:CPSS) with a 12-month price target of $18.00, translating into sizeable upside from the stock’s current price. CPSS purchases and services retail automobile contracts sourced from the company’s broad network of franchised and independent automobile dealers in the United States, thereby providing indirect financing to subprime customers.

Our investment thesis revolves around:

1. Pivoting to growth: As of the end of the second quarter of 2024, the company’s total managed portfolio reached $3.4 billion of contracts. While loan originations slowed from $1.85 billion in 2022 to $1.36 billion in 2023, 2024 is off to a strong start, and we forecast originations to grow by ~30% this year to $1.75 billion. Our estimate is based on: i) rising applications and higher approval rates suggesting underlying demand trends continue to strengthen; ii) CPSS’s expanding dealer network, with the company currently maintaining an approved network of 12,000+ dealers across 47 states in the U.S.; iii) accelerating volumes sourced via strategic partner Ally Financial’s pass-through platform; iv) ABS outperformance driven by the company’s proprietary AI-driven underwriting model; and v) a massive TAM with limited competition – six players have consistently maintained outsized market share, with CPSS amongst the top three or four lenders.

2. Premier ABS issuer: CPSS’s primary source of capital to fund the purchase of auto contracts remains the securitization market. Key differentiating factors for CPSS include the management team’s tenure, a broad spectrum of credit programs, and the company’s long operating history. Since 1994, CPSS has completed 102 term securitizations of ~$20 billion in automobile contracts, with a focus on subprime customers.

Turning to performance, 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 driving less favorable pricing/spreads, financing vehicles at peak valuations, stubborn inflation trends, and rising consumer debt levels more broadly. That said, CPSS maintains strong relative performance track records across cycles. To the point, Cumulative Net Losses (CNLs) are currently running at ~19.5% for CPSS loans originated/securitized in 2022, well below the mid-20% range for most peer ABS vintages. Looking ahead, delinquencies/loss rates on newer paper originated in the back half of 2023 and thus far in 2024 are tracking well below 2022 vintages, with management expecting newer ABS to exhibit CNLs consistent with long-term averages.

3. Increasingly leveraging technology: A key differentiating factor for CPSS remains the company’s longstanding focus and ongoing investments in technology to enhance operations. The company’s tech-savvy management team continues to leverage proprietary systems and data to systematically enhance and automate business functions. As a result of employing Artificial Intelligence (AI) and Machine Learning (ML) across the lending cycle, CPSS originates additional higher-quality loans from better performing dealers, which in turn drives more favorable credit performance, enhanced collection and recovery trends, and ultimately higher earnings/balance sheet growth.

4. Accelerating earnings power: Impressively, CPSS has delivered 51 consecutive quarters of pre-tax profitability dating back to 2011. And while growth is not necessarily management’s primary focus, we believe the stars are aligning for robust growth in revenues, margins, returns, and earnings. More specifically, we forecast 2024 and 2025 EPS estimates of $0.90 and $3.06, respectively, implying 240% growth in 2025. Key modeling inputs include: i) accelerating interest income reflecting a step up in the number of auto contracts purchased, higher portfolio balances, and building risk-adjusted yields (inclusive of loss assumptions); ii) NIM expansion primarily driven by declining NCOs and lower cost of funds (assuming the Fed eventually starts to cut interest rates); and iii) rising operating leverage as the loan book continues to grow given CPSS’s limited headcount model and existing infrastructure.

5. Strong capital position + ongoing share repurchases: Focusing on portfolio financing, CPSS’s asset/liability mix continues to strengthen. As of June 30, 2024, the company held $3.0 billion of finance receivables on the balance sheet versus $2.7 billion of securitization trust debt translating into a 0.9x debt ratio. Stepping back, CPSS maintains a strong balance sheet, with considerable access to capital to fund growth via upsized warehouse lines of credit, residual interest financing debt, and subordinated renewable notes.

From a capital management perspective, management remains committed to buying back stock as the primary lever to return excess capital to shareholders. While SEC rules and quiet periods limit repurchase activity to some degree, management maintains a systematic buyback approach – seemingly eager to repurchase stock up to CPSS’s book value per diluted share ($11.55 as of 6/30/24) – thereby providing support for EPS, as the diluted share count continues to trend down, as well as the stock price.

6. Upward revaluation opportunity: Despite steady growth in book value across cycles, CPSS’s stock price has lagged more recently – perhaps somewhat understandable given the lack of consensus estimates. Our model forecasts CPSS’s book value per share to reach $13.87 by the end of 2024, with ROEs rising from a nadir of 6.6% in 1Q24 to 10.5% in 4Q24 and 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. In our minds, the stock’s more recent underperformance provides investors with an attractive entry point for CPSS, as awareness and appreciation of the company’s business model, growth prospects, competitive positioning, high insider ownership, and valuation disconnect increasingly take hold.

Our report provides a deep dive into Consumer Portfolio Services’ position as a premier ABS issuer. In addition, we present CPSS’s multi-layered growth story, introduce the senior management team, and walk through our financial model and valuation analysis. The final section summarizes what we believe to be key investment risks specific to the macroenomic backdrop and competitive landscape, as well as potential credit and regulatory headwinds.

SUBSCRIBE TO ZACKS SMALL CAP RESEARCH to receive our articles and reports emailed directly to you each morning. Please visit our website for additional information on Zacks SCR. 

DISCLOSURE: Zacks SCR has received compensation from the issuer directly, from an investment manager, or from an investor relations consulting firm, engaged by the issuer, for providing research coverage for a period of no less than one year. Research articles, as seen here, are part of the service Zacks SCR provides and Zacks SCR receives quarterly payments totaling a maximum fee of up to $40,000 annually for these services provided to or regarding the issuer. Full Disclaimer HERE.