Why Spring Has AmeriCredit Blooming

In one of the most startling stock-price moves of the year, AmeriCredit (ACF), which makes auto loans to people with spotty credit records, has soared 67% from its March low.

This is startling for three reasons. First, AmeriCredit is a financial company, and most finance stocks are being hit by fears that the Fed will have to raise interest rates to redouble its fight against inflation. Second, it's a consumer-finance firm that focuses on lower-end borrowers, who still have a bad name after several -- remember Mercury Finance? -- got into serious trouble, or collapsed, a couple of years back. Third, AmeriCredit's stock performance far outshines that of consumer-finance rivals Household International (HI) and Associates First (AFS), which are up 31% and 11%, respectively, over two months.

The Old and the New

The Fort Worth, Texas-based lender's just-released fiscal third-quarter financials were well-nigh perfect, and it's almost impossible to find a single bear on the stock, even among the hyper-critical short-sellers. Of course, monolithic bullishness about a stock is dangerous in itself, as even a speck of bad news can trigger a selloff. But, for the time being at least, the rosy view appears justified.

Beyond that, the company's superior results show how an Old Economy firm can use technology -- AmeriCredit has a sophisticated loan-pricing process -- to produce robust earnings growth, which most New Economy companies can only dream of.

Giving AmeriCredit When It's Due Consumer-finance rivals lag behind AmeriCredit

Source: BigCharts

AmeriCredit slipped 3/16, or 1%, Friday to close at 18 9/16, just off its 52-week high of 21 1/4.

"The fundamentals of this company are extraordinary," says Richard Whitman, a manager at New York-based hedge fund Benchmark Partners, which is long AmeriCredit shares.

In the most recent quarter, net income rose 66% from a year ago, to $32.4 million, while per-share earnings jumped 41%, to 41 cents. AmeriCredit's per-share earnings grew 47% in the last calendar year, and analysts surveyed by First Call/Thomson Financial think they will advance 31% in calendar 2000. Yet, the company trades at only 10.7 times its forecast calendar 2000 earnings of $1.74 per share.

Going With the Flow

AmeriCredit's attractive valuation and strong growth have long been recognized. But this quarter the results effectively blew away skeptics' two biggest doubts, says Todd Pitsinger, analyst at Arlington, Va.-based Friedman Billings & Ramsey. Pitsinger has yet to publish a rating on AmeriCredit, and his firm hasn't done recent underwriting for the company.

For the first time, the company posted positive net operating cash flow. What does that mean? AmeriCredit bundles up its auto loans and sells them as bonds in a practice known as securitization. The company then provides a cash cushion in these bonds to protect the bondholders against bad-loan losses. The net operating cash flow equals the operating cash flow minus the cash cushion. In the first quarter, this calculation was $35.1 million less $30.8 million, or $4.4 million -- reversing the $15.5 million deficit in the year-earlier period. "Based on our predicted growth rate, we will have positive [net] cash flow for this calendar year," says AmeriCredit spokeswoman Kim Pulliam.

Another big hurdle was crossed in the most recent quarter. This period marked the first time that AmeriCredit made higher profits when doing its accounts as a bank-like balance-sheet lender, instead of a securitizing consumer-finance firm. Why the distinction? Most firms that do securitizations have to factor into earnings the estimated future profitability of the securitized loans. They do this themselves, using assumptions about potential prepayment rates and bad-loan levels.

However, investors mistrust this approach, which is known as gain-on-sale accounting. This is because in the past, certain lenders have revised profits downward after they were initially too optimistic in their assumptions. Recognizing this concern, AmeriCredit has for several years also provided a set of accounts that assumes the loans have never been securitized, but rather remained on AmeriCredit's books. According to this method, AmeriCredit made 43 cents a share in the most recent period, vs. the 41 cents using gain-on-sale.

Potential Pitfalls

So, what might trip up AmeriCredit? One analyst who requested anonymity likes AmeriCredit because it apparently hasn't made its loan conditions easier. (His firm has done underwriting for AmeriCredit.) He's watching the auto-loan market closely for any signs that competitors are trying to outprice AmeriCredit.

This threat looks distant. The average interest rate on loans originated in the latest quarter was a 0.7 percentage point above the second-quarter level. Nevertheless, the company managed to lend a record $1.55 billion in the latest quarter, against $981 million in the preceding period, AmeriCredit's Pulliam points out. At $5.6 billion, AmeriCredit's total managed loans (which includes securitizations) are a fraction of the estimated $194 billion in auto loans to impaired borrowers in 1999. This shows that AmeriCredit has room to grow further, says Pulliam, adding that earnings growth could stay at the current rate, even if the Fed hikes rates by another 1.5 percentage points.

Perhaps most surprising, bad loans aren't trending up. If they were, it would signal that the company is lending to too many questionable borrowers in its quest to goose growth. Annualized charge-offs, or bad loans, decreased to a record 3.9% of average managed loans in the fiscal third quarter from 4.1% in the second three months, and they're much lower than the 4.7% in the year-earlier period.

What AmeriCredit fans fear most is a recession, which could scotch loan demand and, more seriously, boost defaults. But, with the economy currently growing at a 5.4% clip, a recession appears very remote.

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