Summery
This company has only one pretty simple business: Credit Card. However, it is not very simple when around 4/5 of their credit card receivable were packaged and sold to other party. I spent quite a lot of time try to understand how this ABS is issued. Until now I can not understand it thoroughly. But I also found what I understood is enough to draw a conclusion.
This company is well running for many years. I found there is only one thing that should be figure out: how charge off rate will affect their earning? The charge off is lost of credit card receivables when card holder failed to pay it. This rate is vary from year to year. A slight change in this rate will affect their earning significantly.
Facts:
1.Their average charge off rate is (2002 to 2007) (7.92%+7.42%+6.38%+5.37%+3.17%+3.19%)/6=5.58%
2. In their 2007 Q3 report, it mentioned that if current lost rate increased by 10%, it will decrease their net income by $5.91m.
3. The estimate current year earning is $1.90 pre share. Shares outstanding 41.1m.
4. The average earning pre share is $1.30 for the last 6 years(2002 to 2007).
5. Book value (591m -(218mx73%))/41.1 = $10.51 ( I charge off 73% on their subprime investment)
Analysis:
You can see the main reason the company has been doing quite well since 2002 is the charge off rate keep decreasing. Last year(2006) their lost rate is in the lowest. This year it keep increasing. And it will be going higher next year as a result of current credit crisis.
Let's take the average charge off rate as their future lost rate:
Then it means their lost will increase by ( 5.58-3.19)/3.19 = 75%.
Their future lost will be 5.91x(75%/10%)=44.3m.
Pre share lost will be 44.3/41.1=$1.08.
Future pre share earning might be $1.90-$1.08=$0.82.
This number is much lower than their average pre share earning $1.30. The reason for this is during the past several years, their get quite a lot income from two discontinued operations and other stuff. I don't even bother to calc those stuff.
Risk:
1. Charge off rate increase, already included in above. In a long run, the rate should be medium number, not high as 2002 or low as 2006.
2. They have 4/5 of their receivables are packaged as ABS. In those ABS structure, they may have problem to issue the B, C, D class(lower credit). Which will make themselves to bear more charge off loses. This is very possible as current subprime crisis is getting worse. However, in a long run, it should not be a problem since the underlying product is good.
3. Fed rate increase or LIBOR rate increase. They benefit from rate cut while lose from rate increase. In a long run, it is not a problem.
Conclusion:
At price (0.82x15)x60% = 7.38. It s a bargain. Since they have two share class A & class B. Their weight is 1:2. Their price difference is around $0.78. So the bargain price for A share is 7.38-(0.78*2/3)=$6.86. B share is 7.38+(0.78*1/3)=$7.64. They are quite lower than their current market price. Let's wait to next year.
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Updated:
Mar. 04, 2008
The new Q4 2007 data has been released for a while. Finally got some time to take a look.
Facts:
1. Q4 earning is $0.17 per share. Including $0.39 charge off based on credit trend. $0.11 charge on litigation and $0.05 gain on selling master card share. Whole year earning $1.61 pre share.
2. New charge off rate for 2006 is 3.48%. New charge off rate for 2007 is 3.79%
3. By Q4 2007, when charge off rate increase by 10%. Lost will be 6.51m. For 2006, when charge off rate increase by 10%. Lost will be 4.23m.
4. Share outstanding 42.5m.
Analysis:
1. If take off all the extra items. Earning in 2007 is 1.61+0.39+0.11-0.05 = $2.06. It is 0.16 higher than previous estimation.
2. Q4 charge of rate 4.13%, Q3 charge of rate 3.87%. Based on my calc, the lost in Q4 caused by charge off should be 5.91x((4.13%-3.87%)/3.87/10%)/4 = 0.99 million. Around 2.5c pre share.
3. In my previous analysis, charge off rates of 2006 and 2007 are 3.17% and 3.19%. These changes in rate will result one time write off of ((3.48-3.17)/3.17/10%)x4.23 + ((3.79-3.19)/3.19)/10%)x6.51 = 4.14 +12.24 = 16.4m.
4. Now take a look at the 0.39 pre share charge off in Q4 2007. It is 0.39x42.5m = 16.6m. It is close to the 16.4m calculated in 3. Basically that is what this charge off come from.
5. New average charge off rate is (2002 to 2007): (7.92%+7.42%+6.38%+5.37%+3.48%+3.79%)/6=5.73%
6. Take off the 12.24m charge off in 3. Real earning in 2007 is 2.06-(12.24/42.5) = $1.77.
7. Estimate future earning based on average charge off: 1.77 - (((5.73-3.79)/3.79/10%)x6.51)/42.5 = $0.99. It is 0.17 cents higher than previous estimation. If I use 1.90 instead of 2.06 in 6. I will get $0.83. Almost the same as previous estimation.
8. Need to figure out why there is 0.16 cents difference in 1.
Conclusion:
At the end of the analysis, I was trying to figure out how this 0.16 cents difference was created since they are not getting better. Then I realize it is a mistake to invest this company. Not because I found something bad about it. But I found I am not really understand their finance statement. I also found I might better keep away from any financial stock for now because my accounting knowledge is not enough for understanding them.
Will sell it in a appropriate time.
Q1 2008 data has been released.
Mar. 04, 2008
The new Q4 2007 data has been released for a while. Finally got some time to take a look.
Facts:
1. Q4 earning is $0.17 per share. Including $0.39 charge off based on credit trend. $0.11 charge on litigation and $0.05 gain on selling master card share. Whole year earning $1.61 pre share.
2. New charge off rate for 2006 is 3.48%. New charge off rate for 2007 is 3.79%
3. By Q4 2007, when charge off rate increase by 10%. Lost will be 6.51m. For 2006, when charge off rate increase by 10%. Lost will be 4.23m.
4. Share outstanding 42.5m.
Analysis:
1. If take off all the extra items. Earning in 2007 is 1.61+0.39+0.11-0.05 = $2.06. It is 0.16 higher than previous estimation.
2. Q4 charge of rate 4.13%, Q3 charge of rate 3.87%. Based on my calc, the lost in Q4 caused by charge off should be 5.91x((4.13%-3.87%)/3.87/10%)/4 = 0.99 million. Around 2.5c pre share.
3. In my previous analysis, charge off rates of 2006 and 2007 are 3.17% and 3.19%. These changes in rate will result one time write off of ((3.48-3.17)/3.17/10%)x4.23 + ((3.79-3.19)/3.19)/10%)x6.51 = 4.14 +12.24 = 16.4m.
4. Now take a look at the 0.39 pre share charge off in Q4 2007. It is 0.39x42.5m = 16.6m. It is close to the 16.4m calculated in 3. Basically that is what this charge off come from.
5. New average charge off rate is (2002 to 2007): (7.92%+7.42%+6.38%+5.37%+3.48%+3.79%)/6=5.73%
6. Take off the 12.24m charge off in 3. Real earning in 2007 is 2.06-(12.24/42.5) = $1.77.
7. Estimate future earning based on average charge off: 1.77 - (((5.73-3.79)/3.79/10%)x6.51)/42.5 = $0.99. It is 0.17 cents higher than previous estimation. If I use 1.90 instead of 2.06 in 6. I will get $0.83. Almost the same as previous estimation.
8. Need to figure out why there is 0.16 cents difference in 1.
Conclusion:
At the end of the analysis, I was trying to figure out how this 0.16 cents difference was created since they are not getting better. Then I realize it is a mistake to invest this company. Not because I found something bad about it. But I found I am not really understand their finance statement. I also found I might better keep away from any financial stock for now because my accounting knowledge is not enough for understanding them.
Will sell it in a appropriate time.
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Updated:
Apr. 08, 2008
After listen to its Q4 conference call and read its annual report more carefully. More information about the mis 0.16 cents:
Analysis:
1. Extra-odinary items in Q4:
(1) Pretax charge of 10m( 0.14/share) for owned receivables.
(2) Pretax charge of 17.2m (0.25/share) for securitized receivables.
(3) Pretax charge of 7.8m(0.11/share) for litigation related with Visa.
(4) Pretax gain of 3.3m( 0.05/share) for selling master card share.
2. Compare of Q4 2007 and Q3 2007 income
Q4 Q3
Securitization Income 10.4m 22.4m (2)
Servicing revenues 25.3m 24.2m
Other revenues 9.9m 8.6m (4)
After listen to its Q4 conference call and read its annual report more carefully. More information about the mis 0.16 cents:
Analysis:
1. Extra-odinary items in Q4:
(1) Pretax charge of 10m( 0.14/share) for owned receivables.
(2) Pretax charge of 17.2m (0.25/share) for securitized receivables.
(3) Pretax charge of 7.8m(0.11/share) for litigation related with Visa.
(4) Pretax gain of 3.3m( 0.05/share) for selling master card share.
2. Compare of Q4 2007 and Q3 2007 income
Q4 Q3
Interest Income 49.8m 50.0m
Interchange Income 69.3m 62.7mSecuritization Income 10.4m 22.4m (2)
Servicing revenues 25.3m 24.2m
Other revenues 9.9m 8.6m (4)
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Operating expenses 81.0m 68.1m (72.3m) (3)
(1) Pretax charge of 10m( 0.14/share) for owned receivables should be included in "Provision for credit losses". However, the number seems not match.
(2) Pretax charge of 17.2m (0.25/share) for securitized receivables is included in "Securitization Income". However, the number seems not match, they didn't provide detail information in it.
(3) Pretax charge of 7.8m(0.11/share) for litigation related with Visa is included in "Operating expenses". In Q3 it is 4.2m, which shown in the adjusted 72.3m number.
(4) Pretax gain of 3.3m( 0.05/share) for selling master card share is included in "Other revenues". In previous quarter it is 2.9m.
3. But it is not that hard to understand the where 0.16 come from now. Increase in interchange income 6.6m plus 2.2m saved in interest expense should contributed to it. Seems just a seasonal stuff since there are more transaction in Q4, not really important.
Conclusion:
Its financial report is hard to understand. Although I get better idea how their charge off is calculated, but still quite confusing. Need more time to figure it out.
Interest Expense 22.2m 24.4m
Provision for credit losses 21.6m 14.7m (1) Operating expenses 81.0m 68.1m (72.3m) (3)
(1) Pretax charge of 10m( 0.14/share) for owned receivables should be included in "Provision for credit losses". However, the number seems not match.
(2) Pretax charge of 17.2m (0.25/share) for securitized receivables is included in "Securitization Income". However, the number seems not match, they didn't provide detail information in it.
(3) Pretax charge of 7.8m(0.11/share) for litigation related with Visa is included in "Operating expenses". In Q3 it is 4.2m, which shown in the adjusted 72.3m number.
(4) Pretax gain of 3.3m( 0.05/share) for selling master card share is included in "Other revenues". In previous quarter it is 2.9m.
3. But it is not that hard to understand the where 0.16 come from now. Increase in interchange income 6.6m plus 2.2m saved in interest expense should contributed to it. Seems just a seasonal stuff since there are more transaction in Q4, not really important.
Conclusion:
Its financial report is hard to understand. Although I get better idea how their charge off is calculated, but still quite confusing. Need more time to figure it out.
Updated:
May. 02, 2008
1. Charge off rate increased to 6.43%. Real earning 16c pre share.
2. A quick calc using previous quarter's formula estimated yearly earning should be 1.77 - (((6.43-3.79)/3.79/10%)x6.51)/42.5 = $0.70. Not much different from 16c x 4.
3. The charge off rate has increased quite a lot. It is already above the average number 5.73%. I didn't expect it raising so fast. Neither did they.
4. From their conference, Florida and California's lost rate are 1.3 times of other area. Business of these two states are account 24% of total business. This is a important sign that Advanta's business is more connected to housing market than I previous expected.
5. If all other area's lost rate increase to the same lever as in these two states. Their charge off would be 6.43% + (6.43%x0.3x76%) = 7.9% which is the level of 2002. At that level. They will start to loss money. But I am afraid it might getting worse. At 9% lost rate, they will lost around 35c pre share yearly. At 10% lost rate, they will lose 75c pre share yearly.
6. Taking their high book value, those number are not too bad even it did happen like that. Unless this crisis getting very bad and last for long time.
Conclusion:
Somehow I have sold this stock with 16% profit. For holding just four months, I can't complain at all.
1. At my current knowledge level, finance stock is not very suitable target since they are not easy to understand throughly
2. The reward of this stock potentially might be very high. However, it has much bigger risk than my other holdings. I am still quite new to the market. Better keep myself safe.
Nov. 23rd, 2009
I can't tell how lucky I was after the company filed for bankruptcy earlier this month and was delisted from NASDAQ now. There was a time that the company was selling at 20c and I was tempted to buy it back. Fortunately I didn't do it because I missed the right price point I want. Over all, it is so important that I should not get into a business that I can't understand its operation.
1. At my current knowledge level, finance stock is not very suitable target since they are not easy to understand throughly
2. The reward of this stock potentially might be very high. However, it has much bigger risk than my other holdings. I am still quite new to the market. Better keep myself safe.
Nov. 23rd, 2009
I can't tell how lucky I was after the company filed for bankruptcy earlier this month and was delisted from NASDAQ now. There was a time that the company was selling at 20c and I was tempted to buy it back. Fortunately I didn't do it because I missed the right price point I want. Over all, it is so important that I should not get into a business that I can't understand its operation.
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