Sold my holdings on the day of the results. Like @lankypom, I’ve held for an extended period of time since Nov 2010. I also held it in a previous stint from Sep 2004 to Nov 2007.

Consumer Lending did a lot of heavily lifting in the result. The EBITDA return on the carry value of the three main segments - Consumer lending, ANZ PDLs, and US PDLs were 33%, 15.7% and 8.8%. Who would have thought 10 years ago that Consumer Lending would be the division that would be wildly more profitable than the core PDL businesses.

My main concern is the ballooning carry value of the PDL assets on the balance sheet.

Collections have been declining in the past 3 halves, yet the PDL carry value has been increasing. If one thinks that an asset is increasing in value, should it be yielding less? This doesn’t make a whole lot of sense, and shows that management have had a shift away from their ultra conservative accounting practices.

The ANZ PDL business is currently in run off as its not able to get the supply necessary to grow collections. The business collected $141m in 2H. Just for comparison, this is very similar to the collection level the group had in FY15 which was $288m for the full year. To highlight the shift in the company’s conservativeness, the carry values for FY15 vs Today is $164m vs $297m.

I’m harping on about PDL carry values because the amortisation of it affects every number from the revenue down. Revenue is in fact Collections minus PDL amortisation. And the shift to a less conservative stance has benefited the bottom line over the past couple of years.

In absolute terms, Credit Corp’s PDL carry value is still conservative vs its competitors. But that’s not saying much in an industry littered with blowups.

The US PDL carry value is the one I’m most concerned about. They’re carrying A$465m on the books, and collecting about $200m a year. Having seen repayment plan delinquencies creep up in Q4, collections have started to flatten after heavy investments PDL and big headcount increases. The carry value seems bloated and the Amortisation vs Carry Value ratio for the US business is at PNC’s levels of 0.21, having consistently trended down over the past few years.

I’m concerned about write downs. If not write downs, then the headwind the relaxation of the amortisation policy will have on the profits in future years.

I’m actually surprised by the share price action post 1H FY23 Results. The market seems to have taken notice of the medium-long term improvements and discounted the short-term pain and what on the surface looks to be a terrible result.

The Bad

• Revenue for 1H FY23 is up 8% but NPAT is down 30% pcp and the dividend payout is down a whopping 40%.
• Aus/NZ PDL collections are in run off mode because Australian PDL supply is currently 60% lower than pre-covid. There’s just not enough debt to buy.
• US collections is slower than expectations due to the big influx in new staff and the ramp up time required. Management is probably 6-12 months behind where they expected to be on this front.

The Good

• Consumer lending book has grown rapidly - 66% over the past year. Some might view this as a negative going into a recessionary environment. However loss rates are still below pro-forma and pre-covid levels, and the loans are mostly short-term in duration so management believe expansion is currently the correct move. A larger lending book will post higher interest revenue into the future.
• US PDL supply is increasing significantly, and management believe the prices will moderate as a result. They’ll be letting all the forward-flow agreements lapse this financial year, keeping some dry powder and hopefully scooping up PDLs at lower prices.

The Nuance

• When the company writes a loan, it takes an upfront ~20% provision expense to anticipate the potential of future losses. However loss rates are currently only running at ~13% I believe. When these loans are completed, the difference is written back as profit. You have an interesting dynamic where the faster the company grows the loan book in a given period, the worse the statutory NPAT will be. This was a major reason the NPAT result for the half was poor. NPAT will rebound strongly next half as lending abates (demand peaks leading into Christmas).
• The management team is very savvy financially (as you need be in this business), and also very conservative. $3m in project costs for new consumer lending products was incurred in this half (will be piloted in 2H), but they don’t capitalise it or provide any adjusted numbers with this backed out. The CLH acquisition incurred $5m of restructuring cost this half, which they also didn’t call out. The company takes provisions (estimated future expenses that are expensed immediately) for the integration costs of the Baycorp and Collection House acquisitions. After 3 years (as of FY22 report), there’s still $5m of provisions on the balance sheet for the former. For whatever reason, Credit Corp has a propensity to take expenses early, and thereby downplaying the current level of success. This is a rarity in small cap land, and in particular the areas of debt buying and consumer lending - where adjusted EBITDA-alphabet-soup metrics are pushed to the limits.

I’ve had a long history with Credit Corp. It was my first ever purchase of my own volition all the way back in 2004. Back then, I liked the revenue growth, the ROE, and its P/E ratio at around 20 was reasonable. In retrospect, I had no clue what I was doing. And every year, I’m more and more of the opinion that financial services is an area that new comers should avoid completely.

Revenues, profits, and many of the conventional fundamental metrics are meaningless without understanding how loss rates or amortisation rates are calculated. And knowing the relative comparison with peers is not enough, but one needs to understand how it sits at an absolute level. For example Credit Corp was always much more conservative with amortisation vs its peers, but all its peers turned out to be abject failures - Repcol, Baycorp, Collection House, Pioneer Credit. So maybe CCP was not “conservative” at an absolute level, but just more “correct”.

In a recent Baby Giants episode, Claude spoke about how Redbubble, to some extent, can choose its sales number by its allocation on ad spend. I really like the comment because I feel lots of companies are in this position, but it’s not spoken about much. This is even more the case for debt buyers and consumer lenders. Debt buyers can buy more debt by bidding higher, and consumer lenders and lend more by relaxing lending standards. Both are not good things. I cringe whenever I hear these companies boasting about “gaining market share” with no reference to the trade-offs made. It’s like someone boasting about buying the most houses in Australia this week (“I’m taking market share”).

If you got down this far. Thanks for reading :D

Encore Capital (NASDAQ: ECPG) has been looking for a buyer of Baycorp for several months now. This is to exit AU/NZ and focus on the USA and UK where pricing is currently more favourable.

On Friday they agreed to sell Baycorp to Credit Corp for AU$65m. According to Encore and the WSJ, the sale price was under book value of ~$80m. Credit Corp will seek to integrate everything to their core business swiftly, while maintaining and improving the NZ agency business.

With how it sounds, it feels like a fire sale purchase of some cheap PDLs. What Baycorp pricing the assets at $80m for the cost of $65m... and with a substantial agency  business thrown in as a sweetener.

PDL purchase guidance has been uplifted by the acquired PDL book value - $80m. And NPAT, EPS guidance has been given a kick along also.

Market likes this because:

• It's a fire sale. Cheap is good.
• Utilises the spare capacity from the capital raising, so it's not too much of an EPS drag
• Most were expecting AU/NZ PDLs to be a slight drag over the next few years. This reframes the narrative significantly.

Encore and Credit Corp agree on one thing. The pricing and opportunities are currently substantially more favourable in the US. And that's where the next battles will be - on Encore's home court.

The biggest question that investors need to determine when investing in debt collection companies is: "Are they accounting correctly?"

I've done a bit of back-solving of results over the past few years to get an approximate of the PDL numbers on the AU/NZ division segment.

If collections are not growing, you should expect the PDL carry value on the balance sheet to also remain flat. Be wary and ask questions if a black box tells you otherwise.

Credit Corp's PDL carry value for the AU/NZ is likely to have declined over the last couple of years on flat collections. It's a tick from me.

Disclaimer: These are my figures, they might be completely wrong. Please do you own research, etc.

True to form, Credit Corp once again led the reporting season by releasing the FY19 results in late July.

There was a negative reaction, with the share price diving by several percentage points on the day. The main concerns appear to be EPS dilution from the $140m capital raising in April 2019, and the subdued FY20 forecasts. The latter, avid followers would know is a trademark of the management team which tend to revise these as the year unfolds.

EPS dilution, FY20 guidance - these are near term factors. Focusing on them may distract from what I believe to be 4-5 years of moderate earnings growth that has a high probability of unfolding.  So lets zoom out  a little ...

• Growth Engine - USA PDL Purchasing
  • 10x the market of AU/NZ, better pricing, and the company is going hell for leather on expanding PDL purchasing and employee count, while having the lower cost-to-collect among listed US peers. Employee ramp up is the limiting factor for further increases in purchasing at this stage.
  • Currently doing AU$85m of PDL purchasing, and with 363 employees (up 70% from FY18).  Targeting 550 employees by the end of FY20, and with an office space capacity of 700. Management stated 700 employees can sustain AU$150-200m of PDL purchasing per annum - which is similar in size to the AU/NZ core operation.
  • It's easy to envisage the US operation reaching AU/NZ purchasing levels in 2 years time.
  • Assuming it takes a further 2 years after that to reach AU/NZ profitability, the US division will add $50m to NPAT over 4 years at a CAGR to Group NPAT of 14% pa. I don't think I'm stretching the bow too far here. At Year 4 I'd expect the US division to be purchasing substantially more than AU/NZ.
• Added Kick - Consumer Lending and AU/NZ PDL division
  • Consumer Lending, which has been the main earnings driver over recent years, continues to grow strongly with lending standards on mainstream products further tightening post Royal Commission.  The company is also likely to be making a play in auto-lending, with a good chance of moving out of pilot stage during the year.
  • AU/NZ PDL purchasing - After a couple of subdued years, purchasing grew slightly in FY19 and will likely again in FY20. NPAT contribution likely to be flat without once-off opportunities that arise.
• X-factor
  • Management have alluded to things rumbling in the AU/NZ PDL market, which may reveal once-off opportunities that could involve deploying most of the capital raised ($140m). One would expect opportunities such as these would have ROEs rates that are materially higher than standard purchases.

Bottom Line

This year has been the first time the company has raised capital in over a decade. 14% dilution is going to subdue EPS figures in FY20. However it's not difficult to see 15% NPAT growth over the next 4 years, with potential to surprise on the upside. The US PDL market is huge, and even when the US division overtakes AU/NZ, they'll still be a small time player with ~5% marketshare and plenty of room to grow.

The US opportunity is clicking into gear, and I believe is being undersold by those without a long-term mandate.

$125m capital raising plus ~$10m SPP with plans to take advantage of market opportunities and accelerate USA push. This is after no capital raising for over 10 years and sustained organic growth. 

My read on management’s message: “We foresee, now and the near future, amble opportunity to deploy capital at and above our 16-18% ROE hurdle”. 

Most bullish stance that I’ve seen from management for at least the past 5 years.