Credit Corp (ASX:CCP) shares achieved an all-time high at the end of May. They have since fallen back quite dramatically. We assess whether it is a stock worth holding and at what point would there be an entry point.

Our previous assessment of CCP was following the release of interim results in February this year. We felt that further upside in the CCP share price was hampered by the prospect of increased competitive pressures in the domestic Purchased Debt Ledger (PDL) segment and regulatory risks from the Royal Commission and Senate Enquiry report.

While the regulatory risks from the latter two events have since abated, the Company’s recent equity raising (announced in April 2019) has opened the potential for expansion in the US PDL market and/or increased domestic PDL purchases. Both factors are likely to offset the challenges faced by the domestic PDL business.

About Credit Corp

The Company has two main business segments. The major contributor to group profit is the purchase of debt from banks, financial institutions, telecommunications and utility companies in Australian and NZ. The debt purchasing segment has also includes debt purchasing operations in the US and its financial results are reported separately. The other business segment in which CCP operates is consumer lending. With this, the majority of the Company’s loan book derived from the Wallet Wizard product. This is a low-cost online provider of loans up to $5,000.

Why the Equity Raising is Significant

1. Gearing Levels Fall Below Target Level

Proceeds from the equity raising will be used to reduce debt. As a result, gearing will reduce to ~20% and is likely to remain below the stated target range of 25% to 30%.

2. Increased Capacity to Pursue Acquisitions and/or Expansion

In addition to completing an equity raising, CCP increased and extended the maturity on its debt facility limit. So, when coupled with the equity raising, the Company now has over $250m of overall funding capacity to pursue acquisitions and/or expansion.

The key area of focus in relation to potential acquisitions is the US PDL market. While CCP has a very small, but growing share in the US PDL market, the Company has been increasing its investment levels (additional facilities, headcount) as a result of improving market conditions. Credit Corp’s increased level of investment, assisted by additional balance sheet capacity, is expected to position US business for stronger profit growth beyond FY20.

In the event that suitable acquisitions cannot be secured, CCP may elect to increase its domestic PDL acquisitions in FY20/21, as capital constraints limit competitors. In context, CCP’s level of debt purchasing has been subdued since 2H17, given that competitive market conditions have inflated PDL prices and the Company’s response to this has been to not pay up for debt purchases.

3. Better Allocation of Capital

Notwithstanding the dilution from the additional shares on issue, ROE is expected to remain comfortably above the 16-18% target range. Going forward, the expanded funding capacity provides the Company with scope to allocate capital across all of its business lines. This is provided it meets the targeted ROE of 16-18%.

Fundamental View of Credit Corp

CCP has strong fundamentals, in particular:

• A strong balance sheet offering capacity for growth
• Highly regarded and stable management with a track record of execution and discipline
• A market leadership position in the domestic PDL market
• Long-term earnings growth potential in the US PDL market, and
• A strong consumer lending product offering.

With the shares now trading on a 1-year forward P/E multiple of ~14.5x and above the medium-term 1-year forward P/E average of ~13x, the market is clearly factoring in the potential upside in earnings. In particular, the deployment of surplus capital is the key upside risk to earnings over the next 18-24 months. This is given that the Company has a high level of return on invested capital (~20% over the past three years).

Given the often impulsive and large swings in the share price, we would still prefer to wait for any share price weakness from current levels before taking a position, as the shares have historically recovered well after periods of weakness.

Charting View of CCP

For the last year and a half, CCP had been trading in a range between about $18 and $24. It broke free at the end of May but it was then sold down heavily. It now looks as though that breakout was a “false break” with CCP now trading back in the old range. This is a short term negative and implies that CCP would head lower from here. It may not head as low as $18 again, but there is intermediate support near $21. However, if CCP can quickly get above $24 in the next few days then we may have to view the recent sell-off as an aberration and that would make us positive on the stock again. For now, it is one for the watchlist.

 

Michael Gable is managing director of Fairmont Equities.

 

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