Posted 01/22/2020

Nicholas Financial Corporation (NICK)

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Quality

Nicholas Financial is a strong regional bank trading at a substantial discount to its peers. This opportunity exists not only because it is at a trough valuation, but also because there is a large defined benefit plan limiting future earnings growth for several years coming online, which will drive the company's valuation. As such, we feel NICK offers a compelling risk versa trade for the thesis it owns a franchise based financial institution. However, one of the real benefits of shorting NICK is theemen part where both NICK and peers trade at a significant premium to their regional peers (and the extreme valuation gap in general), which should dissipate as the US and European housing markets harden and the company shows substantial progress in the achievement of an attractive regional banking franchise.

I believe NICK is an outstanding bank trading at just 5.2X tangible book value of 21.18 (P/TBV of .83), which is likely 3-5 turns conservative on the hefty .32 slightly dilutive book. This bumps NICK's earnings to an attractive .60 which yields a 2.74% book and values the $3.60 stock at about 20x which is about 7x where its peers currently trade at comparable valuation.

Thesis: Market Concerns are Distorting Electronic Payment Transactions (EPGT), which should benefit NICK for a multi-year period (2014 to mid-2016) with its strong and improving underwriting and bookings growth, yet valuation penalizes the bank for a business that is clearly improving at a rapid pace. Improving lump sum payments markets are currently in a dearth so NICK can profitably acquire conforming EPP portfolios and use these as raw material to produce credit and EPGT transactions at much higher transaction levels. Once the underwriting and growth issues proven, NICK can trade at a growth multiple of 8-10x, as it has over the last decade, while still trading at 2.2X tangible book. This for a regionally healthy (premium plus retained capital ratio 28% vs. 11% since 2003) and continuing footprint that protects against significant industry fluctuations.

Near term catalysts include:

1) transparent and improving earning and earnings momentum;

2) progress in implementing and funding the targeted $3bn capital plan;

3) improved lump sum payment rates;

4) recovery in GHP payments and

5) market realization of NICK's powerful deposit franchise that will soon be recognized for what it is: a free cash flow generator.

Short interest is modest at 0.4%; share price would be 10/8. From January 2008 to December 2013, Nicholas Financial (NICK) was an underperform bulge bracket bank whose book value per share declined from $17.90 to $12.47 over a period of 20 months. Over the same period, NICK's stock price increased from $2.55 to $14.90 reflecting several factors. Short Form 10 filings showed high short interest from 2010 until the end of this year at 28%. NICK will be spun off from larger rival and long-time competitor Nicholas Financial Corp (NFC) this Wednesday, January 17th after it reports Q1 earnings. I believe when the latter quarter's numbers come out, it will serve as a wake-up call to the market that NICK is better equipped to prosper as the prior generation of bank has struggled to generate a competitive moat against market leader and nearly bankrupt Bank of America.

I value NICK conservatively, using a conservative collection of hypothetical scenarios, or spending a week in the tax counsel's office. I'm forecasting a 5% decline in EBIT and $0.12 annual EPS for 2015. Take a 25% discount for tax purposes and the total change is $0.21. At the current price of $6.73 with dividends and assumed share count of 105mm, that is a $7.89 stock price with annual dividends growing to 35mm and the stock trading at 12.2 times 2015 earnings and 9.9 times EBIT.

I believe NICK is worth at least $14.77 (20x $0.46 in dividends) once it fully recovers from the shock of the 2009 credit crisis and the paper business improves its profitability.