OppFi stock: facing the specter of a recession (NYSE: OPFI)

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OpFi (NYSE: OPFI) is a rare free cash flow generating company in a sea of ​​loss-making fintechs. That didn’t stop the Chicago-based subprime lender from being dragged into the market rout that sent valuations plummeting and reduced the common stock price of some previously high-flying stocks to pennies. The company is facing the headwinds of regulation and recession, two factors that threaten to undo management’s efforts to improve OppFi’s operational efficiency.

Management has tightened OppFi’s lending model, reducing its rating metrics to shift its customer base to people with higher credit ratings. This was in response to increasing write-offs that threatened the previous mode of operation and forced the company to charge steep interest rates on its final receivables just to break even. Those rates have left the company vulnerable to regulatory action, including by California’s consumer credit regulator, which has accused the fintech of predatory lending practices and filed lawsuits because OppFi has apparently overcharged 38,000 Californians since the start of the pandemic.

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That didn’t help the stock price drop 70% from its 52-week highs, although it was up from lows of $2.56 in May. Therefore, the continued creation of shareholder value will hinge on the ability of the company’s updated lending standards to reduce charges and weather a potential downturn.

The economic model is not inherently revolutionary. There will always be a segment of the American population at large unable to obtain traditional credit due to their lower quality financial situation. This has and will continue to drive demand for subprime loans. Some OppFi bulls argue that a recessionary environment rather than acting as a barrier to growth would actually accelerate lending. Indeed, management in its first quarter fiscal 2022 earnings call said the current macroeconomic conditions of multi-decade spikes in inflation and rising interest rates are fueling demand for their products.

Sound finances despite deteriorating macroeconomic conditions

OppFi last reported results for its first quarter of fiscal 2022, which saw revenue of $100.7 million, a 19.5% increase from the reporting period. previous year, but a $5.38 million shortfall on consensus estimates. The company reported core EPS of $0.08, a significant overshoot from estimates of negative EPS of $0.03. This was driven by net issuance of $162.8 million, down sequentially from $186.7 million in the prior quarter, but up 63% from $99.8 million in the comparable quarter. of the previous year.

The company’s net write-off rates increased in the quarter, with write-offs as a percentage of average receivables increasing to 56% from 53% in the fourth quarter of 2021, compared to 30% in the prior year quarter. While management said this increase in net charges was due to now-discontinued segments, there was no idea how much of loan origination growth was driven by these segments. We could therefore see a significant slowdown in loan originations in the coming quarters as a result of a reduction in the scope of loans. Free cash flow in the quarter was $41 million, down from $42.4 million in the prior year quarter.

OppFi reaffirmed its guidance for fiscal 2022 revenue growth of between 20% and 25% and an adjusted net margin of 8% to 12%. At a minimum, that would put OppFi’s fiscal year 2022 revenue at $418.8 million with net income of $33.5 million. This direction could be derailed by further deterioration in the economy. A number of economic forecasts, at best, point to strong stagnation in the US economy this year. This likely prompted management to preempt what could be even higher charge rates by discounting loans to riskier individuals. A move that could also help defend against the current regulatory backlash.

The company’s valuation currently stands at $366 million, which puts its price to FY2022 revenue multiple at 0.87x. A sub-1x multiple reflects how much investor sentiment towards OppFi has fallen.

The future and the recession

The most relevant concern I would have against a position in OppFi remains the risk posed by a possible recession in the subprime consumer loan market. The macroeconomic environment is rapidly characterized by declining consumer confidence and sluggish economic growth, conditions that are not conducive to loan repayments.

While the share buyback program and recent inclusion in the Russell 2000 Index could act as a stimulus for a short-term increase in its common stock, the company’s long-term outlook will be fundamentally determined by the stringency of its new lending standards. are against what could quickly become unsustainable imputations. This low earnings multiple provides a margin of safety if the company is able to maintain earnings growth with tighter lending standards, so the stock could be a good addition for more risk-seeking investors. .

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