Credit Corp Group – Giving Credit where it is due!

Current Price: $5.86

Fair Value: $8.70

Credit Corp Group (ASX code: CCP) is Australia’s largest receivable management company with 25% market share and specialises in debt purchase and debt collection services. They purchase consumer and small business debts from Australian and New Zealand banks, finance companies and telecommunication companies. In the bank and finance sector, charged-off debts are typically unsecured credit card and personal loans that have passed the 180-day past due mark. The group uses call centres located in Australia and the Philippines. Around 70% of Credit Corp Groups debtor receipts come from debtors where repayment plans have been established.

It is no secret the issues the company went through during the GFC. Numerous profit warnings and allegations against key management behaviour called many to question the viability of the group. With these negative memories still fresh in our minds, we felt it important to determine whether the current management was transparent and had the required skills to drive future performance. The opportunity to speak with Chief Executive Officer (CEO) Thomas Beregi and Chief Financial Officer (CFO) Michael Eadie provided some comfort around these concerns.

Management Overview

Mr Beregi joined the company on 3rd September 2007 as the CFO and subsequently appointed CEO in October 2008. Prior to this, he was the COO of Jones Lang LaSalle Australia. Meanwhile, Mr Eadie joined the company in May 2009 as Finance Manager and was appointed CFO in November 2010. He had previously held senior finance roles within various financial service organisations, including Macquarie Bank. Meanwhile the head of analytics comes from an insurance background whilst the head of operations has lengthy experience in the collections business.

Although the backgrounds are not all tied to the debt business, there are some benefits which Mr Beregi highlighted. Their decision is purely fact-based, which as an investor is precisely what you want to hear. This analytical approach means emotions play almost no part and therefore the risk of over confidence, whereby management over-estimate their own knowledge but under-estimate the risk, is significantly reduced. In the current environment where the purchasing of PDLs is becoming more competitive and expensive, we think an appropriate analytical approach is desirable.

Results & Guidance

The group released impressive 1H12 financial results in November 2011. Top line growth advanced 12% on the back of increased PDL collections and fee income. Net Profit after Tax (NPAT) subsequently increased 23%, leading the company to increase its dividend payment by 30%. At the time, the company provided FY12 PDL acquisitions guidance of $50-65 million, NPAT of $23-25 million and EPS of $0.50-0.55.

Fig.1 – H112 Results and FY12 Guidance

Source: Company Presentation

This week the company released a market update on their progress during the first 10 months of FY12. Yet again, the numbers were impressive with PDL acquisitions already exceeding the lower end of the previous forecast. NPAT of $22 million has also been achieved, which equates to almost 85% of the mid-range forecast. $0.48 of EPS has been recognised, which is 84% of the mid-range.

Fig.2 – Market update to April (10 months)

Source: Company Presentation

The level of transparency from the company is commendable and it was further encouraging that the group confirmed NPAT and EPS should come in at the higher end of guidance.

Fig.3 – Updated FY12 Guidance

Source: Company Presentation

A major distraction has now also been removed with the conditional settlement of the long-running shareholder litigation for $6.5 million, stemming from the GFC issues we mentioned earlier. The group outlined that the majority of this fee will be covered by the company insurer and that the company’s contribution to the settlement will not have a material impact on either reported profit or operating cash flow for FY12.

Growth Prospects

The group continues to drive collections from older PDLs (Fig.4) whilst maintaining collection efficiency. (Fig.5). Although efficiency declined from 2010/2011, this was caused by the locating of their call centre to the Philippines to deal primarily with collections in the Telecommunication space. Mr Beregi confirmed to us that whilst the Philippines operation is effective, it is not yet as efficient as their Australian operations. However, he is confident this will gradually improve. Excluding the Philippines operations, efficiency increased almost 12% in 2011/2012.

Fig.4 – PDL Collections

Source: Company Presentation

Fig.5 – Collection Efficiency

Source: Company Presentation

The company continues to target what it believes is an underserved market, consumers with impaired credit records. They launched two products in 1H12, an instalment loan capped at $5,000 and a debt consolidation loan offering. The current loan book has increased to A$4.0 million as per the groups update this week, from the previous 1H12 figure of A$2.5 million. Arrears remain within expectations and there are further product launches in the pipeline over the coming months.

We spoke with Mr Beregi and Mr Eadie specifically on the recently started US debt purchasing operations to get a better understanding on both the opportunities and challenges associated with a region outside of Australia. With regards to the challenges, they confirmed it always comes down to getting the licences. Rather than being difficult, it is merely a timing issue due to the mechanical process. The US operations are about half the size of the Australian business but the sheer size and partnerships they are developing there are encouraging. Furthermore, the privacy laws are not as restrictive in the US making it easier to find people. We found it interesting that whilst 2% of funds are received from suing people in Australia, the figure is more like 30-40% in the US, suggesting some legal challenges lie in wait for the company. However, it is a challenge they are aware of and are preparing accordingly for.

Risks

Regulation is undoubtedly an ongoing risk. Mr Beregi outlined his view that the government is guilty of regulation overkill. He does not think there has been irresponsible lending in Australia, yet the industry is being treated as though there has. Regardless, he believes that as the largest player, any regulatory issues will have less of an impact on them compared to their competitors. We would tend to agree with Mr Beregi and we find it reassuring that the company has reduced its gearing significantly below that of its competitors.

With competition increasing, it is critical that companies such as Credit Corp Group remain diligent in their acquisition of PDLs. Mr Beregi confirmed as much when we spoke, reiterating that their analytical process ensures that the risk of over-confidence or making decisions on gut-feelings is mitigated. We applaud management for their discipline but caution investors to continually monitor that these standards are not being lowered in the search for increased growth.

Donnelly Outlook and Valuation

The GFC issues have been well documented and it is understandable why investors might treat a company such as Credit Corp Group with caution. However, it would seem to us the company has undergone some significant changes and we are impressed by their level of transparency, not only when we spoke with them but also with their market updates.

The business is clearly reaping the rewards with revenue, earnings and free cash -flow all growing at impressive levels in an industry which is far from saturated in our opinion. The balance sheet is rock solid and we like the fact that the large cash balance allows the company to test potential growth opportunities such as the call centre in the Philippines and the expansion into the US. Although some investors might suggest this cash should be returned to shareholders, we are comfortable so long as the company continues to generate returns on this capital.  This has been the case  in recent years and reflects well on the direction management has taken and indeed, of management itself. Furthermore, despite this deployment of cash to fund growth, the company still pays a credible dividend with a current yield of 5.6% and growing.

Our FY12 earnings forecast is A$0.54, which is conservative considering the company outlook for A$0.57-59. Based on the current price of $5.86, the company trades on 10.9x P/E. We believe the recent strategies employed by the company will lead to continued growth over the coming years and forecast FY14 EPS of $0.67. Having come through our quality model in particularly impressive fashion, we deem the company warrants a P/E of 13x, suggesting a fair value in the region of $8.70. Combined with our expectation for a continuation of the current dividend payout ratio, our forecasted 3-year return for Credit Corp Group is 67%.

From a timing perspective, the company is currently overbought, recent momentum looks to have flattened out and the share price recently failed to break through its 52 week highs.  Therefore, a correction cannot be ruled out. However, any such pullback toward the 50-week moving average at $4.73 would present a compelling buying opportunity. Based on our current FY14 forecast, such a level would suggest a forward P/E of only 7x.

In conclusion, we believe Credit Corp Group is a good company in an interesting industry. We are impressed by the turn-around efforts being made by current management and applaud what we deem to be a high level of transparency to investors. Whilst it has enjoyed a strong run of late and is perhaps subject to a pullback, current valuations are not demanding and we believe shareholders will be rewarded over the 3-year time horizon we base our investment decisions on. Lastly, never one to run with the herd for the sake of it, we like the fact that the company is largely under the radar of the large brokerage houses. If our thesis and outlook on the company play out, it will only be a matter of time before the brokers come to join the party.

Any recommendations given in this document is General Advice only. We have not considered clients’ personal or individual circumstances. All clients and readers should seek professional advice before acting on any recommendation. You should also obtain a copy of and consider the Product Disclosure Statements for any product discussed before making any decision.

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James is a senior investment analyst at Donnelly Wealth Management. To contact James, e-mail james@donnellywealth.com.

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