Triumph Financial - TFIN

A Non-traditional Commercial Bank

Triumph Financial - TFIN, a Dallas-based non-traditional commercial bank, operates beyond traditional banking services by maintaining a sizable factoring division focused on the trucking industry and fostering a scalable payments network specifically tailored to trucking businesses.

Under the visionary leadership of Aaron Graft, a highly respected CEO in the banking industry, Triumph Financial emerged from a bold decision made during the 2007/08 financial crisis. With a seemingly audacious plan to acquire a struggling bank, Graft transformed it into the thriving financial institution that stands today.

Triumph has established itself as a leading player in the transportation industry by transforming a small factoring business that handled $40 million worth of invoices per month into a much larger operation that now processes over $1 billion. The trucking industry, comprising over 250,000 companies, is largely driven by small businesses, many of which are owned by single-truck operators. In the United States alone, there are approximately 3.5 million drivers and half of them rely on freight factoring to manage their cash flow. Triumph typically charges a 1.5% fee for invoices purchased from its over 5,000 clients. This translates to roughly $30-40 per invoice, which averages around $2,000. Large-scale factoring is a labor-intensive process due to the risk of fraudulent invoices, which can be difficult to identify. This is one reason why commercial banks have traditionally avoided factoring, but Triumph has embraced it with open arms.

Factoring is a financial practice where a business sells its accounts receivable (unpaid invoices) to a third party, known as a factor, at a discount. This allows the business to receive immediate cash instead of waiting for the customer payments. The factor then collects payments directly from the customers. Factoring helps companies manage cash flow by converting invoices into immediate funds, although at a reduced amount due to the discount.

Fun Fact: factoring as a payment strategy predates lending as the oldest form of finance. Historical records can be traced back to ancient civilizations throughout the Middle East and around the Mediterranean coast. As early as 3000 B.C., merchants and traders engaged in factoring transactions to receive payment upfront for their goods and services, enabling them to continue making purchases for subsequent trades.

TriumphPay

After the success with the factoring business, which remains the primary driver of Triumph's profits, Aaron has shifted his focus to developing a payment network tailored to the trucking industry. By charging small fees and fostering network effects across the industry, the goal is to collect very tiny fees that eventually scale up, similar to the Visa and MasterCard models.

This undertaking is significantly more manageable when you have a profitable entity like Triumph's factoring business, which can provide the necessary funding. The fact that TriumphPay is approaching profitability and experiencing significant quarter-over-quarter growth suggests that this strategy is sound.

During our two years of following TFIN, we have come across at least three independent sources, in addition to the CEO, who claim that TriumphPay's value exceeds Triumph's current market capitalization. The CEO has also stated:

"We firmly believe that the enterprise value of TriumphPay alone at that 2024 target is greater than our entire market cap right now. And not to mention, we have a very profitable community bank with excellent deposit quality and a factoring company that, despite headwinds, will generate 3% to 6% pretax ROAs at scale. There just aren't many other companies that can achieve this level of success."

Repurchasing shares might appear to be a logical strategy in this situation, and Triumph has indeed been actively buying its own shares. We view it as further evidence of the management team's astute capital allocation skills. The recent tender offer to purchase $100 million worth of shares at a price of $51-$58 per share, in a "Dutch auction" with possibility to repurchase 7-8% of the total shares outstanding, resulted in only 1.7% of shares being tendered. This relatively low tender participation suggests that investors recognize the company's intrinsic value and are not willing to sell their shares at a significant discount. As Aaron has stated,

"The ability to buy back our own shares if the market values the intrinsic value of TriumphPay at 0, that's a pretty simple analysis for us."

This sentiment reflects the management team's confidence in the company's long-term prospects and their willingness to capitalize on undervalued shares. The buyback program is a testament to their commitment to maximizing shareholder value.

In the realm of consumer transactions, processing payments is a seamless and almost instantaneous process. With a swipe of a card, the availability of funds is verified, and the transaction is either approved or denied. This seemingly invisible service incurs a fee of around 2%, which is distributed among the various players in the payment network, with the largest share going to card issuers like Visa or Mastercard.

However, the factoring payments in the trucking industry remain antiquated and inefficient. The process is significantly slower, lacking the instantaneous verification of funds that characterizes consumer transactions. This complexity opens the door for fraudulent activities, such as fake invoices, exposing factoring companies to substantial losses. The overall process is time-consuming and ripe for modernization.

The adoption of a credit card-like network for trucking payments could revolutionize the industry, streamlining the process and bringing it into the 21st century. This is where TriumphPay enters the picture. Their network has the potential to benefit all stakeholders in the industry, including factoring companies, carriers, and brokers.

Creating such a product is a daunting task, requiring years of effort from highly skilled individuals. Additionally, gaining the trust of other industry players, while being one yourself, presents a significant challenge. Triumph's journey to building this network was marked by unwavering dedication, trust-building efforts, and sacrifices. They were fully aware of the short-term impact on profitability but recognized the immense long-term potential in an industry such as trucking that accounts for 8% of the US GDP.

This long-term vision and willingness to embrace short-term pain set Triumph apart. Their existing profitability eliminated the need for external capital, allowing them to focus on developing their network without financial constraints.

To grasp the magnitude of these fees and the challenges in achieving profitability, consider that it takes approximately $75 billion in invoice volume to generate around $100 million in revenue. This translates to a TriumphPay fee of just 0.13%. Despite the trucking market's current downturn cycle, the latest quarterly earnings report revealed an annualized payment volume exceeding $21 billion, demonstrating consistent growth.

While profitability remains distant, profit margins are steadily improving, and management appears well-positioned to deliver. TriumphPay's vision has the potential to transform the trucking industry, bringing efficiency, transparency, and cost savings to all participants.

TriumphPay revolutionizes transportation receivable factoring by eliminating 85% of its associated costs. Its payment network exhibits characteristics of a natural monopoly, enabling the network owner to exert pricing power once everyone is on board. Bank analysts struggle to grasp TriumphPay's value due to their limited understanding of its pricing power and the market's valuation of payment companies. It experienced remarkable growth, expanding over 250% in the past year, and has become the primary clearinghouse for carrier factoring (2022). Carriers, brokers, and factoring firms are gravitating towards the network due to its improved economics and enhanced usability.

To facilitate rapid scaling, TriumphPay is currently charging minimal fees. Over time, it seems reasonable to assume that TBK could raise pricing to 0.35% on network volumes of $150 billion. This fee would still be at the lower end of the spectrum for payment companies. TBK has yet to fully monetize this network, leaving significant untapped potential.

More about the business

The CEO's quarterly letters to shareholders stand out for their exceptional communication. Unlike many annual CEO letters, these quarterly reports offer valuable insights into the business. They display a rational approach and practical insights, often lacking in such corporate communications. The management's focus isn't solely on impressing Wall Street with rapid growth but is oriented towards sustainable, long-term growth for investors. “Anyone can loan money. The trick is to get it back.”

Over the nearly nine years since its public offering, the stock has shown a remarkable 19.2% annual compounding rate. Importantly, this growth trajectory may still hold promise for impressive long-term gains over the next decade.

Currently, Triumph Financial sits at a valuation straddling between that of a traditional bank and a fintech company, leaning toward the higher end. Its shares are valued considerably higher compared to those of conventional banks (at two times Book Value and three times Tangible Book Value per share), emphasizing its unique standing in the market due to its factoring and payment divisions. While its valuation is not as extreme as certain tech businesses, it lies somewhere in the middle. What's compelling to us is the proactive use of profits from profitable divisions to build something potentially highly valuable—a strategy that, once successful, could generate significant returns. With a reliable team behind it, we're inclined to take this calculated risk, seeing a safeguarded downside and an uncertain but promising upside, that improves with every next quarter so far, as TriumphPay adds the biggest brokers to its network.

These are the types of companies that pique our interest for inclusion in our portfolio. If we discover 7-8 similar opportunities with comparable potential, we'd gladly construct our portfolio around them. Although the outcomes might not materialize immediately, we see Triumph Financial as distinctly positioned to seize such opportunities. Waiting too long might make an investment with such potential at a fair valuation challenging.

Hit by a combination of factors such as the economic slowdown, troubles in the trucking industry, and broader banking concerns last year, the share price of Triumph Financial took a significant hit. Amidst this, TriumphPay sustained its momentum, offering an opportunity for value-oriented investors like us to start building a position. Initially, we established a small position in the mid $60s in September 2022, steadily increasing it during the banking turmoil and purchasing shares in the $40s, resulting in an average price of around $50. Presently, the share price has rebounded, and we've gained around 40%, making TFIN nearly 15% of our portfolio. Although we don't anticipate an immediate return to the market highs of nearly $130 in 2021, we remain confident in the company's long-term prospects and foresee reaching that price level within the next 2-3 years.

The CEO, Aaron Graft, expressed his vision for TriumphPay to become synonymous with industry payments, stating:

“As to what happens with Triumph's payment, there are a thousand things that could happen. My job is to run the business with excellence. We're not going to have our heads turned by some offer with a little bit of premium in the short term because if we can do this for a $400 billion dollar market, if we become synonymous with it like Xerox is synonymous with copy machines or Kleenex is synonymous with tissues, then we're going to be in a very good place.“

You can see the full interview over here.

Risks

The Impact of the Trucking Crisis on Factoring

The factoring unit has been a significant source of income for Triumph, but recent challenges in the trucking industry have negatively impacted its performance. This year, profits have fallen considerably compared to the previous year, reflecting the downturn in the trucking sector.

Management has been transparent about this issue, acknowledging that the slowdown is responsible for the substantial decline in earnings. The factoring division has experienced a decrease in invoice volume, average invoice size, and purchased volume. This decline stems from an excess of capacity and insufficient demand within the trucking industry, leading to fewer opportunities to factor invoices.

Despite these challenges, management remains optimistic about TFIN's ability to navigate this cycle and emerge stronger once conditions improve. They view the current downturn as an opportunity to make prudent loans, a strategy that contrasts with their approach during periods of economic growth. Some of the comments they’ve made:

"The freight market has not rebounded, and it could get worse before it gets better."

"We do not wish for a deeper freight recession, but if it comes, I expect we will benefit from it"

Risks related to TriumphPay

The successful implementation of TriumphPay is a key factor in the long-term growth strategy of the company. While TriumphPay has demonstrated resilience even during challenging market conditions, its future profitability and ability to attract large market players remain not fully certain.

As with many nascent payment networks, TriumphPay faces the challenge of balancing rapid growth with financial sustainability. During the growth phase, it is common for payment networks to incur losses due to infrastructure investments, customer acquisition costs, and operational expenses.

Management has expressed optimism about TriumphPay's path to profitability, but critics have raised concerns about the potential impact of declining payment volumes on this goal. A drop in payment volume could hinder TriumphPay's ability to achieve financial stability and could delay its projected breakeven point.

Commercial Real Estate Exposure

The looming commercial real estate crisis in the United States poses a significant risk to the economy, with concerns surrounding the ability of borrowers to repay loans in this sector. While there are early indications of trouble, the situation has not yet escalated to a major crisis. Triumph Financial has exposure to commercial real estate loans, and a downturn in this sector could lead to substantial losses.

Management acknowledges TFIN's exposure to commercial real estate loans but emphasizes that the company avoided making risky loans during the peak period of 2021-2022, when the danger was most apparent. This highlights TFIN's commitment to prioritizing safety and avoiding irrational lending practices. Nonetheless, it is crucial to acknowledge this major risk in our analysis.

Insider Ownership

We generally prefer to invest in companies with a higher level of insider ownership. At the time of writing, Triumph Financial Innovation's (TFIN) CEO owns 0.82% of the company's shares, and the total insider ownership stands at just over 5%. While this level of insider ownership is not insignificant, it is lower than our preference for a higher concentration of insider holdings.

While the following issue is not a specific risk associated with Triumph, we encountered it during our research on the company and believe it is important to inform our readers about the complexities of accounting, particularly in relation to loan losses and charge-offs in financial institutions. This issue dates back to the time when Triumph Financial Innovation (TFIN) was still known as Triumph Bancorp (TBK). You can read the full article here.
The main takeaway is that it emphasizes the distinction between provisions for loan losses and actual charge-offs, illustrating how these distinctions can influence reported earnings. Using TBK as an example, it demonstrates how accounting treatments and the timing of charge-offs can have a significant impact on financial ratios and perceptions. Moreover, it underscores the significance of conducting thorough analysis, going beyond readily available data, and reaching out to companies for clarification, advocating for hands-on research and engagement to fully grasp accounting intricacies and make informed investment decisions.

Some final words

Currently trading around $70, TFIN is close to its 52-week high. While we see the potential for the stock to perform well, even doubling in the next two to three years, we wouldn't make it a major portfolio position at this price. We believe that our downside is limited at a price between $40 and $50, but we hope we never see those price levels again. However, if we do, we'll be buying some more, especially if the price drop is similar to the last time it fell to that level, when it was unrelated to Triumph's performance but due to external market factors.

We hope that you find this write-up informative and insightful. We welcome any input regarding potential downsides or any aspects we might have overlooked in our analysis of Triumph Financial. It's important to emphasize that this report should serve just as a starting point for your research and investment decision-making process. We encourage you to delve deeper, seek additional perspectives, and conduct your own thorough due diligence before making any investment decisions. Your financial well-being is of utmost importance, and we wish you success in your investment endeavors.