Credit Corp Limited Downgrade Neutral Previous Rating: Overweight A Deferral of Growth or Indication of a Fundamentally Flawed Industry? A$10.59 07 November 2007 Price Target: A$7.45 Australia Emerging Companies Richard AmlandAC (61-2) 9220-1589 [email protected] Alexander Mees (61-2) 9220-1939 [email protected] Bryan Alfred Johnson (61-2) 9220-1927 [email protected] 7 9 11 13 A$ Nov-06 Feb-07 May-07 Aug-07 Nov-07 Price Performance CCP.AX share price (A$) ASX100 (rebased) YTD -1M -3M -12M Absolute 31.2% -1.3% 4.5% 33.8% Relative 14.4% -0.6% -7.7% 12.4% Source: RIMES, Reuters. Credit Corp Limited (Reuters: CCP.AX, Bloomberg: CCP AU) Year-end Jun (A$) FY07A FY08E FY09E FY10E Total Revenue (A$ mn) 135 184 231 268 EBITDA (A$ mn) 89.2 116.3 147.7 172.8 Net profit after tax (A$ mn) 19.63 18.50 24.84 29.78 EPS (A$) 0.456 0.422 0.567 0.680 P/E (x) 23.2 25.1 18.7 15.6 EV/EBITDA 6.90 5.29 4.17 3.56 Dividend (A$) 0.23 0.21 0.29 0.34 Net Yield (%) 2.2% 2.0% 2.7% 3.3% Normalised* EPS (A$) 0.456 0.422 0.567 0.680 EPS growth (%) 29.0% -7.4% 34.3% 19.9% Normalised* P/E (x) 23.2 25.1 18.7 15.6 Relative P/E (%) 114.0% 137.9% 112.2% 102.9% Company Data 52-week range (A$) 12.99 - 7.45 Market capitalisation (A$ bn) 0.46 Market capitalisation ($ bn) 0.43 Fiscal Year End Jun Price (A$) 10.59 Date Of Price 07 Nov 07 Avg daily t/over (12m) (mn) 1 Shares outstanding (mn) 43.5 ASX100 5,385.8 ASX200-Ind 9,640.1 NTA/Sh^ 1.64 Net Debt^ (A$ bn) 0.16 Source: Company data, Reuters, JPMorgan estimates. ^ Next forecast FY. * Normalisation excludes goodwill, P&L on FX movements, asset disposal and some non-operational items. www.morganmarkets.com J.P. Morgan Securities Australia Limited See page 6 for analyst certification and important disclosures, including investment banking relationships. JPMorgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. The analysts listed above are employees of either J.P. Morgan Securities Australia Limited or another non- US affiliate of JPMSI, and are not registered/qualified as research analysts under NYSE/NASD rules, unless otherwise noted. • Credit Corp reduced its FY08 NPAT guidance to $17.0-19.0 million, 20-30% lower than its previous guidance of $24.0 million. Management did not provide much clarity to the downgrade, and we will look for additional information following the company’s conference call Thursday morning, November 8, 2007. • The key question at this time is, “is this downgrade a deferral of growth while the company absorbs a 50% increase in employees, or is this downgrade a sign the industry is fundamentally flawed?” • Management cited two broad drivers of the profit downgrade: 1) rapid business expansion driving higher costs combined with lower productivity from new hires, and 2) shifts in asset purchase mix due to competitive pricing tension and associated declines in near term collection performance. • We can accept the challenges of maintaining margins while going through a period of rapid expansion. However, we previously believed management would slow the expansion rather than sacrifice the firm’s profitability. We are more concerned about implications of pricing tensions forcing Credit Corp to change its competitive behaviour and negatively impacting its profitability. • We are reducing our FY08 NPAT forecast by 23.5% and our FY09 NPAT forecast by 14.9%. Our earnings revisions assume the downgrade is a one-off impact from growing beyond management's capability to handle. Our new FY09 forecast is essentially in line with our previous FY08 forecast. Thus, we assume the firm’s earnings growth has been pushed out a year. 2 Asia Pacific Equity Research 07 November 2007 Richard Amland (61-2) 9220-1589 [email protected] Fast business growth brings rapid expense uplift Credit Corp pointed to a substantial increase in operating expenses as one contributor to its earnings downgrade. The company made substantial expansions to its Queensland and Parramatta sites recently. The increased site costs are complemented by expectations of FTE headcount rising to 620 by the end of FY08 from 405 FTE at the end of FY07. The new employees are less productive than experienced collection veterans, and the firm is also incurring higher than ordinary training expenses. However, we thought management would have worked to deliver more manageable growth rather than putting itself in the position of a downgrade of this magnitude. Is the market structure different than we believed? Credit Corp indicates pricing tension is forcing the firm to move away from at least one sector of the ledger purchase market. Furthermore, the company indicated this move will negatively impact its short term profit performance. This announcement came as a surprise on both accounts. In our view, the Australian debt collection market is so fragmented that most competitors lack the capital to match the volume of purchases the Credit Corp’s balance sheet enables. We believe Credit Corp can undertake forward flow agreements and substantial ad hoc ledger purchases that are beyond the capital and operational capacity of other industry players. Based on this, we believed Credit Corp was not facing pricing tension in its acquisitions. This has been a cornerstone argument to our positive investment thesis. If this proves to be incorrect, it carries materially negative implications for our view of the company. Earnings revisions We are reducing our FY08 NPAT forecast by 23.5% and our FY09 NPAT forecast by 14.9%. Implicit in our forecast is the assumption that the company is able to absorb its growing pains in FY08 and return to earnings expansion and positive operating leverage in FY09. Our principal changes are around a reduced collection rate in FY08 and faster-than-expected growth in the firm’s operating expenses. Table 1: Credit Corp Earnings Revisions Current FY08 estimates Prior FY08 estimates % change Current FY09 estimates Prior FY09 estimates % change EBIT $m 37.6 45.5 (17.4) 49.0 54.7 (10.4) NPAT $m 18.5 24.2 (23.5) 24.8 29.2 (14.9) EPS cps 42.2 55.3 (23.6) 56.7 66.6 (14.8) Source: Company reports and JPMorgan estimates. Price target and valuation We are reducing our June 2008 price target to $7.45 from $12.00, previously. Our price target is the weighted average of trading multiples and our DCF valuation. Our price target implies a FY09 P/E of 13.1x, a FY09 dividend yield of 3.9%, and a FY09 EV/EBIT multiple of 10.3x. Given the debt collection sector's poor track record with public companies, we do not believe Credit Corp will be able to sustain a premium valuation until it reestablishes investor confidence around the earnings growth sustainability. 3 Asia Pacific Equity Research 07 November 2007 Richard Amland (61-2) 9220-1589 [email protected] Risks The primary risks to our price target include a strategic shift in the banks to take collections back in house, a rise in the unemployment rate negatively impacting consumers’ ability to service their debt, paying too much for ledger acquisitions, and profitability declines as a result of growing too fast, and the emergence of a viable competitor. 4 Profitability declines as a result of growing to fast. says it all Over 50% increase in staff in one year. That is huge. They obviously have the volume of work to require the staff.That interferes with a lot of experienced old hands trying to train them. Its such a people intensive job. RAB
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