Digging through the guidance numbers

Credit Corp has lost market ground … but financial archeology points to further growth.

PORTFOLIO POINT: While Credit Corp hits its profit guidance numbers, the company’s shares have dropped. But CCP still has a strong financial record if you dig deep enough.

It is the market’s short termism that is its downfall. As this discussion of a particular aspect of Credit Corp’s reporting style demonstrates, it helps to be a bit of an archeologist.

Credit Corp (ASX: CCP) is a business I was watching closely heading into reporting season and the results, once presented, did little to change my view of the business or its prospects.

All things being equal, this is a business I plan on holding in the Montgomery Private Fund for some time yet.

You can read my discussion on CCP here, which will help in furthering your understanding of what the business does.

In short, I am comfortable that the business remains on track in the fifth year of its turnaround. Thomas Beregi and his team continue to do an excellent job, as reflected by increases in net after-tax profits of 26.7%, earnings per share of 24.5%, free cash flow of 55% and, to top it off, debt was completely repaid and return-on-equity improved to 23.3%.

Although I was chuffed, others clearly were not. The share price has subsequently fallen from $6.80 to $6, (-13.3%). Perhaps the business was expected to deliver results in excess of what was reported, even though management hit their guidance. More likely, however, it appears that the share price fall is based on the company’s forward-looking statements, which were conservative and below expectations.

As provided by CCP:

As you know, most investors take their cues from price. But this is folly. Price movements are a reflection of the manic depressive character of the market and it is our job as value investors to take advantage of price. Taking your cues from price action is lunacy.

As investors and shareholders, the only way to see through the market’s ‘noise’ is to focus on the business rather than the stock, and focus on the value rather than the price.

Anyone who has followed the business knows that current management has been conservative in their guidance at the commencement of each financial year, and below I have reproduced the company’s announced ranges at the start of the past three years. I have also reproduced their regular updates throughout the year and then the actual results. When compared in a single table and with the midpoints of the company guidance at each date, a clear trend emerges.

By focusing on the ‘initial guidance’ provided a company can catch an investor off-guard, both on the positive and negative side. For CCP, three updates have historically occurred in November, February and May in the lead-up to the full-year result, and in each time the initial guidance has been revised higher.

This classic under promise/over deliver attitude is one I like, but just as I get used to it I have to be mindful that a company cannot continue to grow at phenomenal rates forever. But, thus far Thomas B and his team give me little reason not to believe that the estimate provided for the 2013 financial year won’t be revised higher in subsequent quarters. Of course, it will be relatively easy to see if the pattern is broken. Here’s a table for you to pin to your investing calendar.

Management most recently stated that business conditions are tough. Lots of competition and aggressive pricing is making it particularly difficult for CCP. The purchasing outlook for the coming year might be more subdued, but I believe the strong levels of purchasing during 2011 and 2012 along with additional purchased ledgers this financial year of between $80 million-$90m (admittedly versus guidance of $50m-$70m) will continue to contribute to earnings growth in 2013 and produce profits in excess of the 61 cents earnings per share, or a net profit of $28m guided.

Indeed, if the business’s recent momentum continues, the 71% of customer accounts already on recurring revenue payment plans could produce 65 cents in earnings per share, or a net profit after tax of $30m.

And so, while the market has sold down the shares on the back of lower expectations of future growth, Credit Corp remains a highly profitable, debt free, high free cash producing company that is the clear market leader when compared to its listed peer Collection House (ASX: CLH) and unlisted competitors Baycorp and ACM.

I will continue to back management heading into the 2013 calendar for a number of reasons. First, chairman Donald McLay seems to be doing the same by again purchasing shares on-market for $6.53 recently. Second, the company appears to be a high-quality business producing high rates of return on equity with little or no debt and finally, as is illustrated by the chart above.

Skaffold indicates the shares are attractive at the current market price and the prospects for further intrinsic value growth currently appear to be in place. And given, according to Skaffold, there are only a handful of companies that meet all the criteria, I’ll take what I can get.

If the company again produces results that exceed current company guidance, let’s add archeology to the list of skills required to be a successful investor.

Roger Montgomery is an analyst at Montgomery Investment Management and author of Value.able, available exclusively at rogermontgomery.com.

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