Pawn Shops Benefit From Credit Crunch

| June 11, 2008 | 0 Comments

Last weekend I witnessed a most unusual sight.  I pulled into the parking lot of a small strip mall in Northern Arizona.  I was on a mission to pick up some needed essentials for dinner.  As I got out of my car I noticed people parked in the Ford Explorer right next to me.  They were pulling boxes and a nice looking guitar out of their car.  They then carried these items into one of the stores.

How strange.

I’m used to people carrying boxes out of a store, but not into a store. What really boggled my mind was the steady stream of other individuals. The people parked right next to me weren’t the only ones.  I noticed 3 other people doing the same exact thing.

Returning unwanted items?

I quickly realized that these people weren’t returning defective or unwanted items.  I was witnessing a local pawn shop in action.  Pawn shops are just like local banks.  They provide cash loans to individuals, and they profit from the interest and fees charged.  Pawn shops make their living acting as a financial institution – just like Bank of America or Citibank.

NI bet you never thought of them like that?

Pawn shops just take the collateral idea one step further.  They hold onto the assets as collateral.  It’s like getting a mortgage on your home, but instead of a home, you use tools, musical instruments, or jewelry.

Providing a valuable service.

People in need of short term loans often use pawnshops.  It allows individuals to leverage assets and get much needed spending capital. Now, pawning items is not their only business.  These pawn shops have a number of ways to profit . . . but more on that in a minute.

This isn’t your father’s pawn shop anymore.

Pawn shops used to have a bad reputation.  Now these once seedy shops have become legitimate means of financing for many individuals. The business is run by national companies who own hundreds of stores. They provide safe and clean environments, and locate stores in good neighborhoods.  Some high powered image consultant is truly working wonders.

But that’s not all.

Pawn shops are not just focused on pawning items.  Now they offer a number of other services including short term personal loans, paycheck advances, and lending against automobiles.  This allows pawn shops to expand their product offerings and diversify their revenue.

For pawn shops, recessions are a good thing.  Money’s hard to come by, and credit standards are tightening.  This is when pawn shops do more business.  And more business means more profits.

Think of it this way.  If you’re maxed out on your credit cards and need to buy groceries or make a mortgage payment what do you do?  The bank isn’t going to loan you money.  Good luck with the credit card companies, you’re already tapped out.  And going to friends and family isn’t an option.  To raise the money quickly, you might go to a pawn shop.

What’s really exciting about these companies is the numbers.

Hundreds of thousands of people use pawn shops every year.  According to some statistics I uncovered, the average loan level is around $150. And the fees collected run between 15% and 20% per month.  With more than 70% of those loans repaid, profits are strong.  And when loans aren’t repaid, collateral is sold at retail margins of more than 30 or 40%. To top it off, the industry is showing revenue growth of around 16%.

What’s all this mean to you as an investor?

Profits; pure and simple.  The profit potential of this industry is very exciting, and the growth rate is nothing to sneeze at.

But there are risks.

Like with any investment this business has its own risks.  Normally an investor would identify the biggest risks as competition or collecting overdue loans.  That’s not the case here.  The biggest risk is government intervention.

Some state governments are working to limit the amount of interest that can be charged on payday loans.  Democratic presidential nominee Senator Obama has even proposed a nationwide limit on interest for payday loans.

This has scared many people out of the stocks recently.  The threat of regulation could limit growth rates.  I agree but have a different view on things.  What everyone needs to realize is payday loans are only one part of the pawn shop business.  Would regulation hurt?  Of course, but it won’t bankrupt these companies.

And another thing.

Pawn shops are already highly regulated.  Yet they survive and thrive.  If the government were to regulate another part of their business I have no doubt that these companies will adapt.  They’ll develop profitable business models working with any new regulation . . . if and when it arrives.

The big three of pawn shops.

The industry has three big players, Cash America (CSH), EZcorp (EZPW), and Fist Cash Financial (FCFS).  All three companies have a significant presence in the United States.  EZcorp and First Cash have expanded into Mexico.  And Cash America and First Cash are active in automobile loans.

Diversifying by geography and product insulates these companies from the biggest industry risks.  They all have great business models and can capture significant growth . . . even in a struggling economy.  Best of all they are very profitable.  This might be a great long term investment – especially through the remainder of the recession.

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Category: Stocks

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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