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Ugly Duckling Down 11% On Sector Woes, Accounting Decision
By JANET MORRISSEY
Dow Jones Newswires
NEW YORK -- Ugly Duckling Corp. (UGLY) shares slipped nearly 11% Friday,
reaching a 52-week low, as the market appeared to react to blowouts
taken by other companies in the sub-prime lending arena in recent weeks
and to the company's pending decision on an accounting change, analysts
said.
"The whole group has been weak," said analyst William Gibson from
Cruttenden Roth Inc., who cited National Auto Credit Inc. (NAK), First
Merchant Acceptance Corp., Mercury Finance Co. (MFN) and Jayhawk
Acceptance Corp. (JACCQ) as examples of companies swept up in
financially troubling circumstances.
National Auto Credit's auditors resigned last week, saying they could no
longer rely on management's representations, and a special committee is
investigating concerns about potentially "improper" activities related
to the company's accounting records. Adding to the company's troubles
further is speculation it may be in default of loan covenants at fiscal
year-end.
Both First Merchant Acceptance and Jayhawk Acceptance are in the midst
of reorganizations after filing for Chapter 11 bankruptcy protection.
Mercury Finance has been struggling to recover from accounting
irregularities uncovered in 1996, a 1997 third-quarter loss and auditors
questioning the company's ability to stay in business. It recently
unveiled plans to shut down 70 of its 262 branches.
It is these unsettling events that have frightened investors in the
sector, said Gibson.
Although these companies are all in the business of indirectly lending
money to used-car buyers with poor credit, Gibson said Ugly Duckling
stands alone in that it also owns and operates dealerships that sell the
cars. "They own the paper," he said, while the other companies get the
paper from other dealers.
But it's the "gain on sale" accounting method that has shaken investor
confidence in Ugly Duckling, said Gibson, noting that many of the
troubled companies practice this controversial accounting formula. The
method requires that many assumptions be made in estimating how much the
company expects to make from a particular portfolio of loans. The
projection is made and accounted for upfront, and if the loan defaults
or prepayments exceed estimates, charges are taken in subsequent
quarters. The method has left market watchers frustrated and skeptical
about projected numbers.
Ugly Duckling shares fell to a 52-week low of 5 5/8 Friday, passing the
low of 6 15/16 set Thursday. The shares closed at 6 5/16, off 3/4, or
10.6%, on Nasdaq volume of 1.3 million, compared with average daily
volume of 267,000.
Ugly Duckling is now considering switching its accounting method to a
more conservative "on balance sheet" form of accounting, in which income
is recorded when it is received. This allows the company to adjust for
changes in chargeoffs or prepayments over the life of the portfolio,
making it easier for analysts to track and project earnings estimates.
Cruttenden Roth's Gibson hailed the accounting change as a move that
would breathe renewed investor confidence into the company. It would
boost the company's credibility, he said.
On the downside, however, the change would likely result in lower
earnings for 12 to 14 months while the company builds up its portfolio.
But Gibson dismissed this concern as a short-term blip that will resound
into gains in the long term.
The Phoenix company is expected to announce its decision on whether it
will proceed with this accounting change when it reports its
fourth-quarter 1997 and 1997 year-end results Feb. 9.
Gibson added that Ugly Duckling is also considering the sale or spinoff
of its Champion Financial Services operations, which buys financial
contracts from independent auto dealers. A decision is expected later in
the year. Disposing of the unit would allow Ugly Duckling to focus on
its core business and accelerate expansion of its car dealers.
At the end of 1997, the company operated 42 lots, and analysts expect
that number to grow to at least 55 in 1998. Gibson predicted the
expansion would translate into significant earnings growth for the
company. Bullish on the company's prospects, Gibson praised Ugly
Duckling for its high-profile television ads and incentive programs that
encourage low-income or credit-troubled people not to default on loans.
Gibson cited the troubled companies in the sector and the pending
accounting change for the stock's decline Friday. "Its symbol (UGLY)
describes it," he said, adding that he believes the market overreacted
when it came to Ugly Duckling.
Steven Darak, chief financial officer of Ugly Duckling, said he's
comfortable with Wall Street estimates for 1997 of 94 cents a share. The
company earned 60 cents a share in the year-ago period.
-Janet Morrissey; 201-938-5400 |
