you shouldn't buy a business unless you understand it, right? Well if you are thinking of buying CCP, here is a bit of summary of what it does and an OLD valuation by Huntley. He says buy under $8.10 and accumulate under $10. This would make CCP the buy of the year wouldn't it? This valuation, however is under review. So be careful!
Investment Thesis
CCP is the largest and most successful Australian listed debt acquirer. The business model is vertically integrated with backup legal services and process serving functions all performed within the group. Operations have evolved from a sole agency collection business into an aggressive acquirer of delinquent debt portfolios. Previously, banks and other credit providers outsourced debt collection needs to agents, paying them commissions. Delinquent loans usually remained on balance sheet for a year or two before being written off.
As consumer credit and household debt levels exploded, credit providers began writing off and selling delinquent debt earlier in the recovery cycle. The salvage value from selling the loans was higher relative to agency returns. CCP exploited its agency relationships to tender for ledgers and secure forward flow agreements. Debt acquisitions grew from $33m in FY05 to $120m in FY07, reflecting higher supply of delinquent debt being offloaded by credit providers.
Delinquent debts are purchased at a proportion of their face value with price determined by a number of factors, including the period of delinquency and balance outstanding. CCP prefers to purchase credit card or personal loans which have been delinquent for six months and hold an average balance near $5000.
Competitive advantage comes through strong relationships with domestic credit providers, and a large database of debtors which improves analysis needed in tender pricing ledgers. Banks are conscious about brand, therefore reluctant and unlikely to sell debts to less experienced third parties who have a reputation for ruining customer relationships. CCP’s reputation and forward flow purchasing agreements are valuable to any private group seeking exposure or in any industry wide consolidation.
Profit comes from the spread between what is collected and what is paid for the debt, less any other collection expenses. Ledger prices have recently increased as the industry gains profile, causing aggressive underpricing. Anecdotal evidence and feedback from industry sources suggests ample supply will come on to the market in the near term, however CCP will eventually need to participate in offshore acquisitions to maintain superior returns. Most front end collection functions are carried out domestically with staff costs dependent on the local labour market. Low unemployment and rising staff costs makes offshore outsourcing attractive, particularly for backend and support functions. Management is exploring the possibility of moving into either India or the Philippines.
We think the current macro environment is positive for the collections industry and see employment levels as the single most important factor impacting collection volumes and loan repayments. Low unemployment means debtors have the capacity to pay off outstanding balances. CCP negotiates payment terms with each individual customer based on their circumstances with payments made over a period of time accruing interest revenue. Our main concerns are the highly geared business model, pricing pressure and disclosure issues. Asset revaluation and impairment are set at management’s discretion under AIFRS. The degree of leverage also means that one bad acquisition has the potential to write off a large proportion of annual profits - unlikely given recent performance but definitely worth considering.
Valuation
Our FY08 NPAT and EPS forecasts are revised to $24.3m and 55.9 cps respectively. In FY09 we expect NPAT of $28.5 on EPS of 64.8 cps. Our DCF valuation implies a fair value of $10.45, yielding an FY08 PER of 18.7x. We forecast compound annual revenue growth averaging 19.5% of the next five years, mainly driven by aggressive investment in debt ledgers. Our forecasts assume EBIT margins are held steady with some upside towards the end of our five year forecast period from offshore outsourcing.
($millions) FY07(a) FY08(e) FY09(e)
Revenue 135.0 180.3 218.6
Impairment Expense (52.1) (72.1) (87.4)
EBIT 36.4 45.4 54.5
We assume a long term impairment rate of 40% which is below that used in FY07 but in line with the historic average. Our DCF is based on a terminal growth rate of 2.5% and 9.8% cost of capital. Lowering the cost of capital by 0.5% sees our DCF valuation rise to $12.05. Future acquisitions are likely to be debt funded by the current debt facility capped at $160m, with interest charged at a 0.95% spread to the 180 day bank bill rate. We don’t see any immediate reason to buy the stock at current prices and prefer to Accumulate below $10, reflecting an FY08 PER of 18x.
CCP Price at posting:
0.0¢ Sentiment: Buy Disclosure: Not Held
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