Our recent assessment of Credit Corp’s (ASX:CCP) fundamentals, following the release of interim results confirmed that there are tailwinds for its three core segments. The Company’s strong track record of upgrading guidance and discipline has earned the shares a premium rating and trading CCP shares on a dip has typically proven to be a successful strategy. Accordingly, we consider whether the current market volatility presents an entry opportunity.
About Credit Corp
The Company has two main business segments. The major contributor to group profit is the purchase of debt ledgers (PDL) from banks, financial institutions, telecommunications and utility companies in Australian and NZ. CCP is the largest player in the domestic PDL market. The debt purchasing segment has also includes debt purchasing operations in the US and financial results for the US business are reported separately. The Company recently expanded its debt purchasing and agency operations in Australia and NZ following the acquisition of Baycorp in August 2019.
The second business segment in which CCP operates is consumer lending, with the majority of the Company’s loan book derived from the Wallet Wizard product, which is a low-cost online provider of loans up to $5,000.
Why Guidance May Be Conservative
At the interim results release, the Company retained FY20 net profit guidance of $81-83m, which was upgraded in August 2019 following the acquisition of Baycorp. We highlight some factors underpinning our view that that this guidance is likely to be conservative:
1. In comparison to PDL acquisition guidance of $310-320m, CCP had $298m of PDL contracted as at the end of January. The targets imply uncontracted PDL acquisitions in FY20 of only $0-5m in Australia/NZ and $12-17m in the US.
2. The Company indicated that it expects market share gains in Australian PDLs to continue to improve following industry consolidation, ongoing operational/regulatory issues for competitors in the domestic PDL market, and the expected return of a large issuer to the debt sale market in the coming months. Market share gains in Australia & NZ are supported by compliance performance & funding capacity, which has seen exclusion of some competitors by issuers.
The market has provided PDL guidance for Australia/NZ of ~$140m. The above factors support a further uplift in PDL activity in FY21 in the core Australia/NZ market (i.e. excluding Baycorp), potentially to ~$200m. There is upside risk to the latter figure, given the potential for further sales of PDLs (such as the Baycorp transaction) and the fact that the return on investment for current PDL acquisitions have improved after a period of inflated prices for debt purchases. In context, CCP’s core domestic buying has reduced from $200m in FY16, primarily as a result of market share losses to competitors.
Other Key Fundamental Drivers
Baycorp Acquisition Strategically Sound and On Track
CCP has a stable core debt purchasing business in Australia and NZ, which has potential upside from industry consolidation and a more stable market structure following CCP’s acquisition of Baycorp (which was a competitor).
In addition to Baycorp having an attractive PDL book, the acquisition of Baycorp provides CCP with an opportunity to create a large and successful agency business. The integration is progressing well and, to date, has entailed the merger of Baycorp’s PDL collection platform with CCP’s existing Australian and NZ debt buying business.
At the 1H20 results release, the Company commented that the acquisition on track for full year NPAT of $6m, with integration progressing ahead of schedule.
Consumer Lending Offering Remains Highly Compelling
CCP’s consumer lending book currently stands at $230m of which $210m relates to the Wallet Wizard product. The yield generated is highly attractive, at 46.5%.
The Company remains confident that it can lift the gross loan book for Wallet Wizard alone to over $230m. We consider that this target is likely to be highly conservative in light of the recent growth profile.
Investing for Long-Term Growth in US
The longer-term opportunity in the US market is underpinned by the fact that:
i. The Company has a small, but growing share of the US financial services PDL market, which is currently ~3.5%. Staff numbers are set to grow a further ~65% over the next 18 months as CCP attempts to build market share. Further, CCP has diversified purchasing relationships across six credit issuers.
ii. At full headcount capacity (700 staff), CCP expects to be able to purchase ~$130-140m of PDL’s. Sustaining this level of purchasing is expected to generate NPAT of ~$30m. This figure compares with the targeted NPAT of $8-9m for FY20.
Although CCP has retraced in line with broader market weakness, the shares are currently trading on a 1-year forward P/E multiple of ~22x. This is still a premium multiple and reflects some very solid fundamentals, in particular:
i. A high degree of earnings certainty, giving rise to a defensive profile,
ii. Balance sheet flexibility, with gearing currently below the covenant level of 60% and debt capacity ($170m) well under its $375m debt facility limit
iii. Potential for FY20 guidance to be conservative (as it typically has been in recent years).
iv. Longer-term growth potential in the US business, with the market becoming increasingly confident that management can execute on its US strategy. To this end, the Company has a strong track record of execution and discipline.
Investors considering investing/trading in CCP should also note that trading in CCP shares is usually illiquid.
CCP has been in a strong uptrend for a number of years now. Most recently, there was some resistance in the mid $33’s but it managed to break free of that at the end of January. Since then it has traded strongly, mostly closing near its highs and on high volume. At the moment though it is coming back with the rest of the market. As it eases off, we need to see the shares hold support between about $32 – $33.50 in order for the longer-term uptrend to remain intact. If that were to occur, it would provide a better entry point from a risk/reward perspective. However, with the market looking weak overall, it is worth bearing in mind that CCP is illiquid. This means that any pullback in the market shorter term could see the shares drop substantially. At the end of the day, CCP is a stock that is likely to be trading at lower levels and investors can therefore be patient.
Michael Gable is managing director of Fairmont Equities.
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