There are two further related points that I would like to add to my previous post.
- Because CCP tends to be conservative in its accounting, which lowers its NPAT and its recording of income-generating assets, management has latitude to ensure that reported EPS does not drop below what management wants it to be. This removes the EPS volatility that would occur if management always maximised reported NPAT, and thus let normal vagaries manifest themselves. Over provisioning of the Loan Book, and over amortising of PDLs are the most significant areas of management's discretion to keep reported NPAT steady.
- In respect to Point 1, there must come a time when a reckoning occurs. Consequently, CCP's EPS improvement may exceed the 10% that has applied in recent years. To this must be added the benefits of taking the Unsecured Loan business past the critical-mass point, which means the average profit increases. As an aside, the "time of reckoning" also applies if one inflates NPAT and over values assets, which may explain CLH's projected hiatus for FY2016, although, because I have not scrutinised CLH's numbers, and I have no need to do so, I am uncertain of this suspicion.
If you look at CCP's NPAT and EPS for FY2014 and FY2015, you will see that they grew about 10% in FY2015. If you accept the top-of-range guidance numbers to estimate FY2016, you would be estimating NPAT and EPS to grow by about 14.5%. For the reasons at Point 2, this should not be a surprise. Also, CCP has flagged that it is withdrawing from the SACC (small amount credit contracts) business, which because of 20% bad-debt provisioning of SACCs, would tend to boost short-term profit. Management may wish to downplay a sudden increase in NPAT, and hence EPS, so a smaller-than-14.5% increase may be the end result, but that does not detract from the underlying performance.
On reflection, I'll make a third point in relation to steadiness of performance. There is one thing that CCP cannot control, and that is the supply side of PDLs. However, profit can be steadied for a few years by switching collection emphasis to older PDLs, and by deploying the money not spent acquiring PDLs into funding the Loan Book, reducing debt, and if necessary, buying back shares. Management could also think longer term, and use cash flow to fund selected initiatives, as it did when it entered the unsecured loan business recently. Encore Capital has mitigated the PDL-supply shortage in the USA by expanding into other geographies to allow funds to be profitably deployed – an option that CCP has not succeeded in opening so far.
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