PORTFOLIO POINT: Capable management and strong business economics have helped Credit Corp grow.
Credit Corp operates within the Australian receivables management industry (debt collection). It was formed in 1992 with a focus on personal and commercial loans, including credit cards and trade receivables.
A call from Credit Corp means you have defaulted on a debt repayment of some description, more likely than not defaulted on your credit card or personal loan and are 180 days in arrears. The phone call is something nobody wants, but is something at which Credit Corp excels.
We must be a little bonkers. While most of the population would do anything and everything to avoid having contact with a debt collection business, Clime Asset Management has spent quite a lot of time getting to know the intricacies of Geoff Lucas’ collection machine.
A superficial comparison with competitors Collection House (CLH), RMG Limited, Dun & Amp; Bradstreet, Baycorp Advantage (BCA) – now VEA and Repcol (RPC), before it went into liquidation, provides confirmation that there is something special about this business.
The company’s main operations include the provision of outsourced debt collection, consulting, legal support, trade and commercial recovery, ledger management, government recovery, process serving and debt purchasing services for companies. Credit Corp specialises in the latter, purchasing and managing debt ledgers (portfolios of debt) from a broad range of clients across the banking and finance, insurance, legal, telecommunications, government and commercial sectors.
This specialisation is enhanced and supported through the operation of several aligned businesses. The recently purchased Pioneer Credit Management Services (one of the pre-eminent consumer receivables management agencies in Malaysia) and Legal Force provide high quality local government, trade, and banking and finance mercantile recoveries. Wise McGrath provides field services and Certus Partners is the in-house legal practice of the group.
Combined, these business units complement each other and serve to put Credit Corp in an industry leading position. In turn, this is reflected in the fundamentals of the business and Clime Asset Management’s forecast estimates of performance for the coming year.
Business performance
The following table provides an insight into the past and potential performance of this business as a consolidated entity and why, at Clime, we continue to be comfortable with holding a position that represents a meaningful portion of our current investment portfolio.
Take a step back in time and focus on the start of 2003-04, when the share price was 89¢. We can see that the business began the year with $10.3 million in opening shareholder’s equity (blue box). Over the following year, the employment of that capital generated $3.3 million in after-tax profits, with $700,000 being paid to shareholders in fully franked dividends (red box). This equated to a return on equity of 38.8% using our in-house measure of owner’s earnings.
Since 2003, shareholders equity has grown from $10.3 million to $42.6 million through the retention of profits and new ordinary share capital, an increase of about 313%. While equity in the business has grown rapidly, it is refreshing to see that profitability has also followed a similar path. Indeed, return on incremental capital is rising.
After-tax profits have grown from $3.3 million to a forecast of $19 million in 2007 using the company’s actual guidance for the full year (which may even be conservative given management’s past history of understating performance) – an increase over the same period of 476%. Shareholders are currently receiving fully franked dividend cheques 12 times larger than those being paid in 2003. Return on owners’ equity has increased to 47.1%.
The performance chart reveals this performance trend by plotting return on equity. The blue bars represent the reinvestment of profits and new ordinary share capital back into the business; the red bars depict the annual distributions or dividends being paid to shareholders each year.
Only great businesses have the ability to redeploy such a large proportion of profits and additional raised capital in the business at superior returns on equity. A combination of capable management and truly wonderful business economics has allowed a greater level of assets to be employed at increasing rates of return.
As investors in businesses, these are the fundamentals Clime searches for.
Think for a moment like a business owner. If you started this business in 2003 with $10.3 million of your own capital and five years later, after injecting an additional $30 million, the business has earned $50 million in profits and paid you $30 million in dividends pre tax and is even more profitable, few would find it hard to argue that your investment in capital, time and effort was not beneficial.
These facts clearly have not escaped the attention of sharemarket investors. Shares were trading for 89¢ at the start of 2003. Today they are more than $11. This represents annual compounded returns of 65.3% over our review period, excluding the fully franked dividends!
Future prospects
Unlike some competitors such as Repcol, which focuses on cost-cutting initiatives and outsources many of its debt-collection services to India, Credit Corp continues to focus on developing an environment that fosters mutually rewarding, long-term partnerships with its clients.
Dedication to providing a first-rate service within Australia, a proven track record of delivering results and an offering that gives our leading intermediaries the confidence they are dealing with a reputable service provider committed to protecting reputations and corporate profiles, puts Geoff Lucas and his team in the driver’s seat as the preferred purchaser of consumer loans that have been written off by the banks.
An industry leading profile, a very strict practice of not overpaying for debt ledgers (management is skilled at correctly pricing acquired ledgers against the probability/risk of recoverability) and the lack of credible competition almost hands Credit Corp a monopoly in this industry.
Recent significant investment in a deeper management team and improved technology will allow Credit Corp to better assess potential purchases and recently acquired debt portfolios against historical recovery rates. This should underpin current recovery rates and improve performance monitoring (better efficiency). The use of advanced technologies in debt-collection activities, including an internally developed work flow management system called Debtrak, also allows Credit Corp to customise recovery programs to each debt type and specific client requirement.
These practices should go a long way to ensuring management continues to generate a high rate of return on shareholders’ investment capital.
In what is clearly a margin business, debt portfolios are bought for as little as 15-20¢ in the dollar with the aim of realising 60-70¢ (hopefully more). We estimate that Credit Corp derives a collection margin of about 40¢ to the dollar from its extremely strict and stringent purchasing practices.
Now if the past is anything to go by, with management flagging about $100 million of investment over each of the next few years, the ability to scale already efficient practices should see more of the same. Management has also indicated that they would be “disappointed” if they were not able to acquire $130 million a year of debt by 2009. A strong growth profile.
The recent purchase of Repcol’s estimated $620 million debt portfolio for a shade under $14 million, expansion overseas through the recent purchase of Pioneer Credit Management and increasing opportunities to acquire debt ledgers through forward flow agreements established with the major banks, are all positive initiatives.
Another positive comes from increased debt portfolio investment. Once the debt ledgers are bought, Credit Corp will increase its recurring revenue stream, which will improve earnings consistency. This is because all the debt within the portfolio is still accruing interest; Credit Corp is entitled to 100% of that interest income. Personal debt, housing loans, credit card debts, etc, will all continue to accrue interest on the balance outstanding. This point has been lost on many analysts and investors.
The longer a client takes to pay, the more compound interest revenue is earned, although in the end, of course, not all debts will be collected.
The importance of this recurring revenue is forecast to increase over time. This will help in mitigating a high gearing ratio as interest earned on the portfolio will offset the interest expense associated with servicing that debt.
Business valuation
The current share price of $11.46 reflects the market fairly valuing this wonderful business. Having said this, one should also should consider that there are many inferior businesses listed on the ASX that trade substantially above their value. StockVal values the business at $11.22, as indicated on the graph below. This valuation is based on equity per share of $1.50, forecast return on equity of 47.1% and an investor’s pre-tax required return of 14%. Think about it like this: if you invest $1.50 into a business and it generates 47.1% annually and you are happy with 14%, you can pay 7.5 times equity for that $1.50 based on StockVal’s proprietary intrinsic valuation formula, or $11.22.
Despite a very strong economy, we continue to believe that Credit Corp is very well placed to benefit from a fractured, inefficient debt recovery market. With upward pressure on interest rates, high levels of household and personal debt, and with our leading financial institutions recently announcing higher anticipated loan amortisation rates (bad debts) in their half-yearly reports, the supply of debt looks very positive.
Investors in Credit Corp gain exposure to an industry that is defensive. When interest rates are on an upward march and other sectors suffer as a result, greater amortisation of loan books by the banks will in turn lead to larger purchases. An increase in debt ledger purchases and maintenance of current efficiency and margin levels should result in Credit Corp maintaining its benchmark status in this industry.
Russell Muldoon is a senior analyst at the Clime Asset Management group: website, www.stockval.com.au
CCP Price at posting:
0.0¢ Sentiment: Buy Disclosure: Held
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