Most every day at 802 Southeast Plaza Avenue in Bentonville, Arkansas appears to be a pretty good one.
That’s because that address houses the headquarters of Americas Car-Mart, an auto retailer that has found the sweet spot, the intersection where a corporation’s business model meets consumer demand and the net income flows like cool, clear water.
Focusing exclusively on the sub-prime auto-buyer, their clean and efficiently-organized used-car lots throughout the south-central and southwest regions offer a stark contrast to the traditionally dodgy experience of buying a used-car; no one at any Americas Car-Mart locale is likely to be mistaken for the Kurt Russell character in Used Cars. The staff is friendly and well-turned out, there is a wide variety of cars, trucks and vans to choose from, the business offices are clean and air-conditioned and, perhaps best of all, the word “no” just doesn’t appear to be used all that often.
From an analytical standpoint, the business model appears to be simplicity itself.
If you want to buy something, no matter what your economic status is, they can make a deal. This isn’t just some local car-dealer slogan: they will indeed sell you a car even if you have very little business buying anything on credit. If you have about $600 in cash (insert link to 2Q10 CC, page 2), you are good to go. Don’t have that much cash? America’s Car-Mart instantly becomes a publicly-traded pawn shop and you have only to put up that home computer, hunting rifle or set of golf clubs as collateral. Perhaps one way of looking at this model is that in religiously being willing to sell most anyone a car, a sort of loyalty has developed to the company from a segment of the auto-buying public (presumably the segment of the market that is willing to pawn its personal possessions to buy a car.) Indeed, there is a testimonial page on the company’s website that has a multi-cultural cross-section of people describing how impressed they are with the company and their gratitude for getting a chance to buy a car. There are very few companies serving that customer base that could have a testimonial page at all.
In short, it works. Especially for Americas Car-Mart’s investors who have been raking in the gains over the past several months. The stock is at $23.63, giving it a market cap has grown to over a quarter-billion dollars.
The stock price boost isn’t a flash in the pan either. Net income grew 17% from April 2008 to April 2009—a point where from an economic perspective, it looked like western civilization was ending— to $27.96-million from $23.16-million. Throughout last year and into this year, healthy gains were the norm in operating income — though it was essentially flat the last two quarters — and the company’s balance sheet has only $35.12-million in long-term debt , so no reckoning is likely with banks or bondholders.
It only seems to get sunnier, in fact. This week the company reported healthy improvements in net income for the year to $26.8-million from $17.9-million and a 13.4% increase in revenues to $339-million.
So from the surface, it truly does appear that Americas Car-Mart has indeed discovered the proverbial “secret sauce,” the way to make real money without accounting sleight-of-hand and the preposterous growth schemes embraced by larger companies.
As long as the company can continue to bring in a customer that cannot or will not look too closely at what they are getting into, things should be fine for Americas Car-Mart’s and its investors. The minute they do, however, things are likely to get very different rather quickly in Bentonville.
Based on an analysis of bankruptcy filings from its core market in the southern states (most of which are available on PACER), Americas Car-Mart makes its money from financing the car sale to its customers at an average of between three and four-times the Kelly Blue Book value and then tacking on interest rates that at first pass seem pretty reasonable.
Another, more blunt, way of framing the business model is that they are grossing up the sticker price to navigate state usury laws. So if the company can sell a customer in Alabama an auto with a Blue Book value of $3,000 for $8,000 and they finance $7,500 at an 8% interest-rate, the buyer is (presumably) inclined to think the annual interest cost is a manageable $600, a far cry from the 20% and above rates that credit cards often bear. But the true interest rate—that is, the cost to borrow the money on the real value of what they are purchasing— is indeed 20% ($600 divided by $3,000), sharply above Alabama’s usury laws and in line with the sub-prime credit card issuers. (I created a spreadsheet with about 30 randomly selected company creditors to illustrate this.)
There are two ways of looking at how Americas Car-Mart makes its money.
Seen the way the company’s filings and marketing material would have it, their internal finance arm, Colonial Auto Finance, acts like the old Drexel Burnham, underwriting customers who are often shut out of the traditional financing markets, providing an opportunity to own a vehicle in a part of America where public transportation is almost non-existent.
The other way of looking at it is that the company is acting like the old Drexel Burnham, underwriting nearly anything without regard to credit quality, and along the way, as defaults bloom, enabling a class of customer that would be better served making buying decisions without credit being involved.
With average loan rates of 12.8% and Arkansas loans (where about half the loans are originated) carrying an interest rate of 12%–when 36-month used-car loans generally go for appreciably less —their strategy is similar to that of a high-yield bond fund manager: Betting that the higher-yields compensate for credit losses that the company itself says easily run to 20% of sales and often higher.
America’s Car-Mart’s business practices have garnered some amount of attention in the past from regulators. In a 2008 consent decree—where guilt was neither admitted nor denied— a Kansas District Attorney listed a series of violations of the Kansas Consumer Protection Act, including noting that the car was sold at 3.5-times N.A.D.A (the National Automobile Dealers Association) retail value with a 19% interest rate attached.
The settlement and fine amounted to an inconsequential $25,000. More importantly, after the Kansas suit (which was never disclosed in any SEC filings), the company quickly and quietly left the Kansas market, costing them about $375,000, noting only that “The market wasn’t suitable for us.” That Kansas isn’t a suitable business climate for the company is odd: There are long-standing dealerships in bordering Missouri and Oklahoma, so the demographics are likely fertile enough and the state’s maximum interest rate on consumer loans is 14.45%, sharply higher than many of the markets it operates in.
The upwards trajectory of the personal bankruptcy filings in which America’s Car-Mart is listed as a creditor suggests an obvious point: Its shareholders may be benefitting, but as these charts show, a fair amount of its customers have had a hard time meeting their obligations in this economy. Along the way, a study of the filings opens a direct window into both the aspirations and financial failures of the Southern working poor during the credit crisis. One of the Chapter 7 filings from McRae, Arkansas lists an ATV, the mountain-bike of rural mountain life, as having nearly a $1,000 balance left on it. Several filings list either World Acceptance or Heights Finance, two of the more popular short-term household finance lenders for the working poor, as a creditor for essential household furniture and (arguably less-essential) television sets. Many list homes purchased at 2004 and 2005 prices alongside their new, sharply lower valuations, clear enough evidence that loan losses are certain to continue for banks big and small.
It is difficult to see several of the filings as anything but poignant: Tractors and farmland collateralize loans that have RV’s and mobile homes as the primary dwellings. Although a number of the filings are filed under Chapter 13 of the bankruptcy code, indicating that there is potentially enough cash flow to settle the debts fairly while retaining (most) of the assets, the economic news — especially as it pertains to wage growth — is hardly encouraging.
(Tracking down the bankruptcy creditors of Americas Car-Mart for comment is an entirely separate story, rife with canceled phone numbers, sudden moves and numerous address changes. In some cases, relatives of the creditors were begging to be kept informed of their whereabouts, having not seen their family members since the bankruptcy filing. In other cases, relatives and neighbors were decidedly none-too-pleased to be receiving phone calls from creditors—and a reporter—who were betting that sharing the same last name or having once been neighbors with the creditor might lead to some information on their whereabouts. The ones I managed to reach were alternately embarrassed and humiliated and blamed a combination of themselves and sudden job-loss, with the occasional divorce and spendthrift spouse thrown in for good measure.)
The question then becomes whether the spike in bankruptcy filings— there were 331 in 2009 vs. 95 in 2008—is going to test the adequacy of the provision for credit losses. While the two would never be expected to move precisely in tandem, the exponential growth of its customer bankruptcies is certainly forcing credit loss provisions to grow for the first nine-months of this fiscal year, to $46.6-million from $43.87-million.
Above all, the gimlet eyed observer can find one of the classic early warnings signs of a possible slowdown in growth prospects in America’s Car-Mart’s statement of cash-flows. There is a growing disparity between net-income and its cash from operations over the past nine months. A traditional—and highly reliable— red flag, companies can be nicely profitable and still struggle to meet their obligations. So, in a nine-month period when profit grew 35% to $19.6-million from $12.8-million, the company used $750,000 of cash in its operations, versus throwing off almost $8-million for the same nine-month period last year.
One culprit is surely the nearly 12% growth of finance receivable originations, a fancy legal-speak way of saying “the loans we made,” to $212.1-million from $188.5-million over the past nine months. Put even more plainly, a lot of the growth in revenues and net income is because they are still happily lending out plenty of money to a class of consumer that has been through the ringer for the past 18 months and may not be getting out of it any time soon.
If what insiders are doing is any clue, drilling down into what Tilman Falgout, the longtime heart and soul of America’s Car-Mart— As well as its former chief executive and current Chairman and General Counsel—and the second-largest holder of company stock (with 6.7% of its shares) might be telling.
In a word, he has been on a non-stop selling-spree since early 2009 (see this chart.) His discretionary sales, or sales that were not done under the SEC 10b5-1 planned sale rule, amounted to over 197,000 shares since March of last year at a weighted average piece of $22.65. In the same period, he moved another 155,000 shares in planned sales. There’s no panic here to be sure, and Falgout still owns almost 480,000-shares, but the sale of $8.1-million in stock ($4.4-million of which was discretionary) sends a message that the boss is seeing at least a cyclical peak and is taking some profits.
There is nothing wrong in structuring a business around serving the wants of a market segment that others are wary of and the only obvious hedge against a customer base that is seeking bankruptcy protection at triple-digit percentage increases over the past two years is to make a profit when you sell them a car. But America’s Car-Mart isn’t Ralph’s Supermarkets, a West-Coast retailer that has made a point of expanding its full-service food markets in areas that most of its competitors shun. Providing a service that saves its already disadvantaged customers time and money, the company makes money on volume because of both loyalty and the fact that for many years it held a virtual monopoly on the inner-city market. America’s Car-Mart does indeed provide its customers a valuable good, but the cost to its customers is steep and might get steeper.
There is an ample volume of vehicles for sale privately in every market that the company’s customers live, and most every principle of personal finance indicates that they would be vastly better off buying an old clunker for cash rather than financing a nicer vehicle. But they don’t have the cash so they are lured, siren-like, by friendly sales staff who come bearing low-down payments, non-invasive credit-checks and are always happy to use tax-refunds, or any number of other marketing strategies, to put them into the car or truck that seemingly everybody else has. In the battles fought between the principles of saving and debt-avoidance and the world of easy-credit, the forces of debt always have a very, very strong appeal.
America’s Car-Mart may well continue to do just fine no matter what happens with the economy, even if credit losses mount into the 29% of sales range (see page 2 of the 10-K), like they were in 2007. There customers have a sharply less-rosy outlook. If old-fashioned frugality comes back in vogue, the testimonials page might start to look a little thin.