Credit Corp’s (ASX:CCP) share price has weakened since the release of its interim results in February. One of the key factors underpinning the weakness being the potential regulatory risk arising from the Company’s acquisition of Collection House’s PDL book in late December 2020.
As such, we recently revisited CCP to assess the validity of these regulatory concerns, as well as any factors supporting a recovery on the shares, namely the growth opportunity for the US PDL business.
About Credit Corp Group
Credit Corp Group has two main business segments. The major contributor to group profit is the purchase of debt ledgers (or ‘PDLs’) from banks, financial institutions, telecommunications and utility companies in Australia and New Zealand.
The debt purchasing segment has also includes debt purchasing operations in the US and financial results for the US business are reported separately.
The second business segment in which CCP operates is consumer lending. The majority of the Company’s loan book is derived from the Wallet Wizard product, which is a low-cost online provider of loans up to $5,000.
Key Fundamental Considerations
Regulatory Concerns Appear Unfounded
The potential regulatory risk arising from the acquisition is that CCP could face regulatory review by the Australian Competition and Consumer Commission (ACCC) on the basis that its market share post-acquisition was about 70%.
However, we note that there are a number of factors indicating that a regulatory review would not have a material impact. In particular, the definition of “market share” for the purposes of a regulatory review comprise two distinct elements: i) Back books and existing arrangements and ii) Forward flows & future PDL arrangements. As evidenced by CCP’s acquisition of Collection House’s PDL book, no ongoing contracts with PDL vendors (i.e. future market share) were part of the sale, as the majority of the purchase related to existing arrangements.
As such, we would argue that the acquisition would not result in a substantial lessening of competition for future PDL purchases – as the real benefit to CCP from the acquisition of Collection House’s PDL book is being able to leverage its more productive collection practices in order to recover the outstanding debt balances. Further, the acquisition would make no difference to whether the Company is successful in winning future PDL volumes.
Strong Domestic PDL Market Position Likely to Be Strengthened
A number of factors underpin CCP’s strong position in the domestic PDL market, which is expected to increase meaningfully over the next 1-2 years:
i. The Company has the highest asset turnover and lowest cost-to-collect ratio.
ii. The acquisition of Collection House’s PDL book, as well as the prior acquisition of Baycorp in August 2019, has significantly increased CCP’s scale and collection platform.
iii. CCP has access to substantial debt market liquidity at a material cost advantage to its competitors. This is largely driven by the Company’s ability to navigate PDL pricing in prior years and redirecting capital across the consumer lending and US debt purchasing businesses should PDL purchases not result in the Company achieving its targeted ROE.
iv. CCP’s market share of PDL forward flows in Australia is expected to continue growing, as some competitors have mis-managed their businesses by either through poor collections practices and reputational damage and/or paying higher prices for PDLs in prior years. As a result, competitors are constrained as a result of capital and/or compliance factors. As at 1H21, CCP also has no adverse compliance orders or undertakings and a low dispute rate.
Material Growth Opportunity in the US
The Company has a small, but growing share of the US financial services PDL market, which was ~3.5% in FY20. CCP is a top 6 US debt buyer and has diversified purchasing relationships across six credit issuers.
CCP have stated they have the infrastructure that would enable them to increase its market share from ~3.5% in FY20 to ~7% and would only require the group to scale up headcount to ~600 (from 354 currently). This scale-up in the US would be significantly incremental to earnings.
Factors such as market pricing, sale volumes, as well as absolute and relative levels of CCP collection efficiency are considered key factors as to whether CCP is able to execute on the growth opportunity in the US.
Based on lower pricing of US PDL acquisitions for its competitors, US PDL pricing appears to be at a level CCP is willing to target increased PDL acquisition activity. In terms of volumes, CCP has increased volumes in the US despite the overall level of weakness.
Despite CCP’s PDL acquisitions in the US being materially below the US levels of competitors, CCP is able to leverage its fixed cost base across its Australian and US business, supporting efficiency levels. As such, operating leverage is likely to continue as the level of PDL acquisitions increase in the US.
Net Cash Balance Sheet Position Expected to Continue
The balance sheet moved into a net cash position as at 30 June 2020 ($26.2m) following an equity raising on April 2020. Despite the large acquisition of Collection House’s PDL book at the end of December, the Company remained in a net cash position of $16.2m as at 31 December 2020.
In recent years the Company has been comfortable carrying gearing at around 40%, implying there remains significant capital to be deployed. CCP is expected to remain in a net cash position in FY22/23 and has ample capacity to scale up PDL investment quickly if volume becomes available.
CCP is supported by very solid fundamentals that underpin earnings upside over the medium-to-longer term. In particular:
• Further acquisitions and an acceleration of US investment provide upside risk to earnings in FY22/23, especially given CCP’s net cash level and strong capital position. To this end, given the Company has a strong track record of execution and discipline, we remain confident that management can execute on its planned growth in the US.
• The Consumer Lending business is recovering well after a COVID-19-affected period. The outlook for this segment is supported by a progressive wind-down of various government stimulus initiatives, which should drive further appetite for consumer loans. Further, CCP has re-instated its car lending product (a smaller contributor to the Consumer Lending segment’s revenue), which pre-COVID-19 was starting to gain traction and improving confidence the product could contribute to earnings growth longer-term (+FY23).
• The significance here is that with all three operating segments demonstrating growth potential as well as increased balance sheet flexibility, the Company can now allocate capital across all three operating segments in order to drive earnings growth.
Since mid last year, CCP had been trending very well, bouncing impulsively then consolidating sideways each time before breaking higher again. The share price had been building up nicely. Recently, however, we have seen the share price fall back fairly sharply. In the last several days we have seen the volume tick up on the way down, and two weeks ago it had broken the previous low near $28, which was major support. For the uptrend to remain in place, we needed CCP to stay above $28. With CCP remaining below $28 for the time being, there is a strong chance that we should see lower levels in the short-medium term.
Potential investors can therefore be patient here and look to obtain CCP at lower levels.
Michael Gable is managing director of Fairmont Equities.
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