Credit Corp Group – a stock to consider

Founder and Chief Investment Officer of Montgomery Investment Management
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This week I bring to your attention a little business that is both relatively easy to understand and is also currently enjoying a little time in the sun. It is a company we have held since inception. The business is Credit Corporation Limited (CCP).

What does it do?

Irrespective of whether it’s a bank, utility or telecommunications company, a business without the specialised skills or teams required to deal with large numbers of accounts in arrears will turn to a company like CCP to fill the gap.

CCP turns accounts receivable into cash today and reduces the amount ultimately written off as bad debts later.

Problem payers with specific age and maturity profiles, for example accounts that are 180 days in arrears, are rolled into a single vehicle known as a ‘Debt Ledger’. Thousands of credit cards, gas, electricity and mobile phone customers, who have not kept up with their payments, are bundled together and marketed for sale to debt collection businesses.

CCP analyse the ledger, the type of debts, the age and profile of the non-payers and what return they believe they can make by taking it on. Provided their required return can be met, CCP will bid a few cents in the dollar, and if they are selected as the preferred bidder, the newly acquired ledger becomes another part of the core assets of the business, which includes the many ledgers purchased before it.

Known in the company’s language as PDLs or Purchased Debt Ledgers, CCP educate and manage the underlying, newly-acquired accounts to ensure payments are brought back on track. Debt management is what they do best, simple.

Keep it simple

We prefer simple businesses. The easier a business is to grasp, the lower the risk of an unforeseen ‘event’. With that in mind, CCP management really only has to get two things right.

Because the main assets on the balance sheet are PDLs, the first thing to get right is rationally forecasting the returns that each ledger will generate to ensure the company does not overpay/overbid. A general rule in investing is the lower the price you pay, the higher your return. Naturally, therefore, you’d expect management to be as conservative as they can here, but balanced against competitive forces.

Secondly, in order to hit the return target initially forecasted, the business as well as actual collections from the ledgers must be run efficiently. As Fig 1 shows, this has been the case in recent years.

Over a number of years, CCP has built market leading systems and processes, as well as a team of 964 people to help deliver consistent, and importantly, scalable business outcomes. This includes a significant move to ‘offshoring’ collection teams in order to make purchasing lower balance accounts, such as utility and phone bills, economical.

A focus on income

CCP is also lowering their earnings risk by shifting their revenue mix to a ‘recurring’ nature, with 72% of all PDL collectables now on regular payment arrangements. Some of the best investment attributes that spill out from a larger recurring revenue base are business stability, the ability to forecast future cash flows with a greater level of confidence, clarity of the businesses financial metrics and higher returns to shareholders.

Since 2008, CCP’s intrinsic value has grown steadily from $2.33 to our forecast range of $9.50 to $10.00. And if you believe Benjamin Graham’s observation that in the long run, the market is a ‘weighing machine’, then you would agree that prices eventually follow valuations. And indeed, that is precisely what has happened in CCP’s case.

CCP, however, can’t grow forever, and while there is always the temporary risk that rising unemployment could make it harder for the company’s customers to pay back their smaller debts, at some point the business will, more permanently, mature in Australia. When it reaches that point, other growth engines will be needed, and already management is focusing on the future, with two paths to extending the winning streak of shareholder returns.

The future

CCP has commenced a new business line providing personal loans to customers for whom they obviously have detailed knowledge of a reasonable credit history.

The typical loan is $3,500 and the company has built a $20 million book funded from its own cash flow, earning 40% (yes, F-O-R-T-Y) interest rates and below-industry defaults. The potential is a total loan book of $70 million with a target after-tax return on equity of 16%. The incremental profit potential here is therefore approximately $4.2 million.

The other is the business’s expansion overseas into the United States. The US expansion plan is very important, as this would become the business’s next big source of growth. And the opportunity is large.

The US collections market is currently dominated by Managed Investment Schemes (MIS) and private equity players, who are known to purchase books, squeeze them as quickly as possible (collect the easy money) to get their money back, and then flip the remaining books for a riskless profit. It’s estimated that 90% of the market participates in such activities but new legislation has effectively stamped out this practice.

Sellers of PDLs (Citigroup, American Express, JP Morgan, Chase etc.) now have to ensure that books are being sold to reputable organisations that will manage their books and NOT resell. According to CCP, a large portion of the US collection market will be impacted by the structural change to a collection ‘servicing’ model. This appears to play directly into CCP’s strengths and it opens the door to a large opportunity. CCP can take market share while other participants scramble to get their houses in order.

Like any business strategy or investment however, it’s not without its execution risks. While we currently rate CCP management very highly, we are watching this development with interest.

Until our view changes, which of course can occur at any time, the outlook appears to be bright. CCP remains a business that is quietly doing what it does best and a business that we will happily hold in our funds at Montgomery.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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