Some companies just can't take a trick. Just look at pawn shop operator and pay-day lender, Cash Converters (ASX: CCV).
No sooner did they bring a class action against them in NSW to a close — after a $20 million out of court settlement — than another one is launched in Queensland.
To add insult to injury, it looks likely that their lender, Westpac (ASX: WBC), with which Cash Converters has a $70 million funding facility, may pull that funding (less than 6 months after increasing it!).
And sitting ominously on the horizon is a Government Review into the legislation governing pay-day lending. It's little wonder shares are down 43% since the start of the year!
Untouchable?
Of course, those who see the business as one that preys on the financially vulnerable could argue that they are simply getting what they deserve.
Others take the stance that this is a misunderstood company, operating in an industry that has been tainted by a small number of rogue operators, and that provides an important service for those that have no other options.
It's a divisive issue. Everyone has a different ethical framework, and if an investment in Cash Converters goes against that, far be it for me to argue otherwise.
But even if we put ethical considerations to one side, the investment case remains prickly.
Choppy waters ahead
On one hand, the business has been a wonderful creator of wealth for its long term shareholders. Strong sales and profit growth has helped underpin a 16% average annual increase in dividends over the past ten years. Despite the recent slump in the share price, a $10,000 investment in Cash Converters in 2005 is today (with dividends reinvested) worth almost $48,000.
And, should regulatory and legal conditions allow, the business is set to continue generating solid returns for many years to come. A termination of certain license fees, a fast growing online portal, a new venture into automotive leasing and a joint venture into Latin America are but some of the reasons to expect earnings to grow strongly in the years ahead.
Thanks to the recent share price decline, exposure to that growth is the cheapest it's been in roughly 4 years and — assuming dividends can be maintained — investors can expect a fully franked yield of nearly 7%.
But, on the other hand, the risks facing Cash Converters are serious. It is largely thanks only to the good grace of Government that they can operate at all, at least under the present financial framework. If the rules change significantly enough, the company's prospects could look very different indeed.
The bulls will argue that Government risks a host of undesirable unintended consequences if they regulate too hard — merely pushing much lending into the shadows where no regulatory oversight exists at all. Further, those that are most susceptible to any punitive changes are the smaller operators that do not enjoy the scale advantages that Cash Converters possesses. As such, there is real potential that any adverse changes, while impacting the business short term, could ultimately be a positive as smaller rivals leave the industry and allow Cash Converters to gain a greater market share.
The bears will argue that things could get a lot worse before they get better, if indeed they improve at all. The profit potential, though attractive, they argue, is simply not enough to compensate for the downside risks. Besides, there's certainly no shame in throwing the whole thing in the 'too hard basket', which is usually the best approach when you can't form a firm conviction.
