Credit Corp shows debt pays

Shares in Credit Corp surged to a two-week high this morning on a profit upgrade and strong first-half result.

Shares in Credit Corp (CCP) surged to a two-week high this morning on a profit upgrade and strong first-half result.

An 18% jump in the debt collection group’s net profit to $17.2 million on the back of a 25% increase in revenue to $84.1 million for the six months to end December sparked a 5.3% rally in its share price to $9.34 this morning, even as the broader market sank 1%.

The result was comfortably ahead of consensus forecasts for net profit and sales of $16.2 million and $78.2 million, respectively.

What also got investors excited was its full-year guidance. Management lifted its net profit estimates for 2013-14 to between $33 million and $35 million compared with November’s guidance of $31 million to $33 million.

The improved forecast is largely due to more aggressive purchase debt ledger (PDL) acquisitions. Credit Corp buys uncollected debts from companies at a discount and chases debtors for payment, profiting from the difference.

Management has been warning that PDLs are getting more expensive to buy, but this has not stopped the group from growing its debt ledger portfolio. Credit Corp has also expanded into credit impaired consumer lending and is looking to expand its debt collection business in the United States.

These are good growth levers for the group, but the so-called easy-growth options are over and margins are likely to come under sustained pressure.

While Credit Corp made more money in the first half of the current financial year, its net profit margin has shrunk 120 basis points (or 1.2 percentage points) to 20.5% compared with the previous corresponding period.

The fact is, PDLs are getting more expensive to buy both in Australia and in the United States, and this is unlikely to change. Its loans business is expected to deliver a maiden profit sometime in 2015, but that division’s earnings contribution will still be small relative to its core debt collection business.

Margins are probably skinnier than what most analysts are predicting too. Indeed, those polled on Bloomberg are expecting to see margins expand in the coming years with consensus forecast tipping net profit margins to grow to 21.5% in 2014-15 before lifting to 22.6% the year after.

It is not only evidence of margin growth opportunities investors should be keeping an eye on at Credit Corp’s full year result – they also should be scrutinising the group’s cash flow.

The group is not facing any immediate danger of a cash crunch, but the robust increase in half year profit has coincided with a negative operating cash flow of $14.7 million as management significantly increased PDL purchases to chase growth.

Cash on its balance sheet of $4.6 million is largely unchanged at the end of last year compared with December 2012 even as profits improved. It would be pleasing to see a reversal in its operating cash flow position.

Based on management’s guidance, the stock is trading on a 2013-14 estimated price-earnings of around 13 times and yield just north of 4%.

Credit Corp is part of the Uncapped 100.