Why Credit Corp's numbers stack up

PORTFOLIO POINT: Strong debt recovery systems have put Credit Corp in a good position, and any share price weakness is a signal to potentially buy more.

This month I bring to your attention a business that is both relatively easy to understand and also currently enjoying compelling fundamentals. Those fundamentals are the main reason why the company has been held in The Montgomery Private Fund since its inception. And when we launch our retail fund in August, I suspect it will be keenly watched there too.

Credit Corporation’s (ASX: CCP, Skaffold Quality Score A2) is a relatively uncomplicated debt collection business. Notwithstanding a deterioration in business conditions – in particular rising unemployment – the easier a business is to grasp, the fewer the risks of an unforeseen 'event’.

Few businesses have the specialised skills or teams required to deal with large numbers of customers in arrears, so CCP provides an 'out’. CCP acquires these ledgers and then educates and manages the underlying accounts to ensure payments are brought back on track.

The ledgers are simply thousands of credit card, gas, electricity and mobile phone customers who have not kept up with their payments, purchased from the credit card, telecommunication or utility companies.

In CCP’s case, management, current led by Thomas Beregi (who has done an excellent job at turning around the business’ fortunes since 2008), have to get only two things right.

Because the main asset on the balance sheet is purchased debt ledgers (PDLs), the first thing to get right is rationally forecasting the returns that each ledger will generate to ensure the company does not overpay. Remember, the higher price you pay, the lower your return.

Secondly, in order to hit the return forecasts, collections must be efficient. As Figure 1 shows, this has been the case in recent years.

Figure 1

Over a number of years, the business has efficiently built market leading systems and processes with sufficient levels of full-time equivalent trained staff and senior personnel (731 in total) to deliver consistent collection and scalable business outcomes.

Happily, 71% of all PDL collectables are on regular payment arrangements, creating meaningful recurring revenues and cash flows. These characteristics enable CCP to generate almost double the level of return on equity with half the gearing levels of its listed competitor, Collection House (ASX: CLH).

Figure 2

Credit Corp is an A2 ranked company – the second-highest score - and as the business has grown and economies of scale have developed, returns have increased. This is a rare achievement in practice and a development that creates significant value for shareholders.

Figure 3

If you were a part owner of the business in 2008, your shares would have grown steadily in value (not share price) from $1.06 to $6.15. 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.

Provided you can see which businesses are able to increase their per share intrinsic value, there is no longer any need to try and predict share prices! Simply buy high-quality businesses – with rising intrinsic values – at discounts to that intrinsic value.

Credit Corp, however, cannot grow forever and we expect CCP will limit its bank debt ledger purchases to $80-90 million, which is about 25% of the market. To grow further it will need to focus on overseas (it’s tentatively expanding into the US where department store arrears is big business) as well as other lines such as phone/data (now 15% of its book) and utility receivables. CCP has also commenced a new business line providing personal loans to customers with a reasonable credit history. The typical loan is $3,500 and the company has built a $6 million book funded from its own cash flow and earning 40% interest rates and just 10% defaults.

So until our view changes, which of course can occur at any time, CCP remains a business that is quietly doing what it does best, a business that I will happily hold in the Montgomery Private Fund and a business for whom any share price weakness (provided intrinsic value’s remain unchanged) is a potential signal to accumulate more.

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