Hock Stocks for Economic Shocks

A recession may be the bane of most businesses, but it's a potential blessing for pawnshops. Tight times mean strapped consumers are more likely to hock Mom's pearls to pay a credit-card bill. With credit harder to come by, more borrowers will see pawnshops as lenders of last resort. And with so many people struggling to make ends meet, they may head to secondhand stores to buy their next TV or diamond ring.

This countercyclical business -- so-called because profitability runs counter to general economic trends, at least to some degree -- holds three major players. We suggest passing on shares of the smallest, First Cash Financial Services (symbol FCFS), which has been having trouble with its "Buy Here/Pay Here" used-car dealerships. First Cash says it expects weak sales and mounting losses from bad auto loans this year, and it has yet to announce any compelling plans for dealing with the problems.

EZCorp has more appeal. The Austin, Tex., company operates 295 EZPawn shops and 380 EZMoney cash-advance stores across 13 states and Mexico. EZPawn accounted for 73% of the $372 million in revenues that the company generated in the fiscal year that ended last September 30. Moreover, EZCorp holds a 29% stake in Albemarle & Bond, a British pawnshop operator and payday lender. "In the U.K., there isn't the stigma about pawn and payday loans that there is in the U.S.," says Elizabeth Pierce, an analyst with Roth Capital Partners.

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EZCorp sees opportunities south of the border. It opened its first Mexican pawnshop in early 2007 and has since added 24, including 20 in a single acquisition. The company plans to add up to nine more pawnshops in Mexico (plus 100 EZMoney stores in the U.S.) in the fiscal year that ends next September. Chief executive Joseph Rotunda says he sees "excellent growth potential" in Mexico, where people generally don't have bank accounts.

The cash-advance business is the weakest link in a deteriorating economy because payday lenders could face a growing number of defaults. The regulatory environment for payday lending is another concern; laws and regulations in the U.S. vary by state and can change quickly.

EZCorp's profits have grown at a 38% annual clip over the past three years, and analysts see earnings rising 11% annually over the next few years. In mid February, the stock (symbol EZPW) traded at $13, or 11 times the $1.14 per share that analysts expect the company to earn in fiscal 2008. EZCorp has a market value of $510 million.

Cash America International is the McDonald's of pawnshops. "The stores are brightly lit and well organized," says Bob Auer, co-manager of the Auer fund. "You wouldn't be intimidated to go into one." The Fort Worth company offers loans in 499 pawnshops, 304 cash-advance outlets and 139 "Mr. Payroll" check-cashing kiosks.

CashNetUSA, the company's Internet-based lending platform, has been growing like kudzu. Revenues last year totaled $185 million (a sixfold increase over the 2006 figure), or 20% of Cash America's total '07 revenues. The online segment operates across 32 states and the U.K., which helps spread the company's regulatory risks.

Cash America's shares are even cheaper than EZCorp's. At its mid-February price of $31, Cash America (CSH) sold for ten times expected 2008 earnings of $2.97 per share. The stock looks awfully cheap for a company whose earnings are expected to grow 16% annually over the next few years. Perhaps you should hock Mom's pearls and buy the stock.