The purpose of having a banking facility was stated in CCP's FY2014 Annual Report – mainly, using my words, to allow CCP to distribute cash to shareholders, rather than holding cash to buy PDLs if and when they become available at prices consistent with CCP's profitability bench marks, and CCPs ability to collect on the PDLs. Borrowers' loans fall into the same box, but PDLs are the main game, so I'll focus this post on them.
PDL's are sometimes expensive, and CCP then tends to not buy them, as happened in 2012 and 2011, and perhaps earlier, but perhaps that was caused by the need to pay off debt in earlier years, rather than being caused by high PDL prices. What happens when PDL purchases decline is that collections from the stock of PDLs continues to roll in, and CCP tends to have a positive operating cash flow, which is used to reduce debt and distribute dividends to shareholders. NPAT may also hold up in low-buying years, because collecting older debt is profitable (the book value of older debt being low due to generous amortisation).
When PDLs become available at acceptable prices, then CCP may buy up big, and cash flow becomes negative. CCP then eases off on dividends in a relative sense (decreases the payout ratio), but management likes the dividend stream to be reliable, so it does not reduce dividends, but it uses its banking facility to fund the procurement of PDLs. The key to keeping reported NPAT in a steady trend line is the amortisation policy, the PDL-buying discipline, and access to funds when the price of PDLs supports buying them. Obviously, in the long term one can only have a successful PDL-collections business if one has PDLs to collect on. The following table may be of interest:
Column 1
Column 2
Column 3
Column 4
Column 5
Column 6
1
$ million
FY11
FY12
FY13
FY14
FY15
2
Operating cash flow after tax
119.5
136.5
158.2
184.3
189.1
3
PDL acquisitions, lending & capex
-95.7
-99.6
-148.5
-197.3
-191.3
4
Net operating (free) cash flow
23.8
36.9
9.7
-13
-2.2
5
PDL & consumer loan carrying value
147.0
132.7
161.1
203.7
244.3
6
Net bank debt
23.8
-
4.9
35.7
58.5
7
Net debt / carrying value (%)
16.2 %
-
3.0%
17.5%
23.9%
Debt in FY11 was an overhang from high debt when CCP was recovering from its near-death experience caused by a debt-fuelled expansion policy leading up to FY2007 – see figures below:
Column 1
Column 2
Column 3
Column 4
1
$ million
FY08
FY09
FY10
2
Net bank debt
125.0
81.2
42.1
3
Net debt / carrying value (%)
61.5%
47.7%
28.5 %
In CCP's setting, the question is what is currently an appropriate debt level, bearing in mind that the asset values supporting that debt are probably undervalued via over amortisation, debt is now cheap, PDLs are relatively cheap and CCP has a high dividend payout ratio, which it could reduce without reducing the dollars paid as dividends. There are other considerations – e.g., the formulaic manner in which the assets transform into cash flow, which predictability springs from the statistical law of large numbers.
The debt level is a question of balance, and not one that should evince Animal-Farm-style mantras, like “debt is bad” and “no debt is good”, or the reverse thereof – “debt leverage is smart” and “lazy balance sheets indicate poor management”, which was the mindset that got CCP into strife in FY2007 when it grew its business faster than it developed the collection facility to handle the growth.
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