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Get Into The Debt Collection Business
When times are tough there are always certain companies that thrive based on their business model. Some of the more popular areas that investors turn to include "dollar stores" or "consumer staples". One niche sector that is overlooked is the debt collection business.
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During the recession the debt collection firms were in high demand as the default percentage on loans surged. On the flip side, the same firms had more difficulty collecting the debts. Now that the U.S. is pulling out of the recession, the default percent is dropping and therefore the collections are increasing. Everything from auto loans to home mortgage default rates have been improving this year, but still remain well below where they need to be in a healthy environment. As the improvement continues it should be a boom to the debt collection business. (For related reading, check out The Dark Side Of Debt Collection.)
Collecting Consumer Receivables
Portfolio Recovery Associates (NASDAQ:PRAA) is engaged in the business of purchasing, managing, and collecting portfolios of defaulted consumer receivables. During its most recent quarter the company reported earnings of 91 cents per share, which was above analyst's estimates and showed an increase of 38% from a year earlier. Revenue for the quarter rose 22%. The First Call estimate for 2010 has earnings coming in at $3.72 per share and rising to $4.60 in 2011. Looking ahead two years, the 2012 earnings estimate jumps to $5.50 per share. Considering that earnings per share came in at $2.87 in 2009, the three-year projected growth rate is 24.3% per year.
The company is currently trading with a P/E ratio of 17.2 based on 2010 earnings estimates and as low as 13.9 based on 2011 estimates. Using the 24.3% growth rate and a PEG ratio of 1.0, the fair valuation of PRAA in 2010 is $90.40/share. In 2011 the fair value of the stock jumps to $111.78/share. Based on the current price of $64.11, the stock is trading at a 41% discount to the 2010 fair value.
Deep Discount Debt
Encore Capital Group (Nasdaq:ECPG) is a company that specializes in the collection, restructuring and resale of debt it acquires at deep discounts. The company's first-quarter earnings saw revenue from receivable portfolios increase by 15% and net income jump 16% to 44 cents per share from 38 cents. The numbers are not mind blowing, however the future looks very promising. Based on First Call estimates, ECPG is expected to generate $1.74 per share in earnings in 2010, a 27% increase from the prior year. In 2011 the estimate jumps another 19% to $2.07 per share.
Based on the 2010 estimate the stock is currently trading with a P/E ratio of 11.9, and if you want to look ahead to 2011 the P/E drops to 10.0. Either way you look at it the stock is very attractive fundamentally. Using a PEG ratio of 1.0 based on earnings growth of 19% puts the fair valuation in 2010 at $33.06 per share - a gain of 60% from the current price.
Low and Medium Success
Asset Acceptance Capital (Nasdaq:AACC) has not enjoyed the same success as PRAA and ECPG. When the company reported earnings in late April it earned one penny per share versus 15 cents the year earlier. Revenue also fell by 9% and both numbers were below analysts' expectations.
A company falling in the middle of AACC and the two leaders (PRAA and ECPG) is Asta Funding (Nasdaq:ASFI), a company that is considered a consumer receivable asset management firm. During the first quarter of 2010 the company reported diluted earnings of 20 cents versus a loss of 37 cents one year earlier. The negative in the report was the 30.4% decrease in net cash collections.
Bottom Line
There is no doubt I am a fan of the debt collection sector. The key comes down to individual stock picking. The first two companies mentioned, PRAA and ECPG, are clearly the best positioned companies based on both the fundamentals and technicals. AACC is a stock I would steer clear of and ASFI does not offer the same attractive reward-to-risk opportunity as the two leaders. (For related reading, see Debt Collection: Know Your Rights.)
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During the recession the debt collection firms were in high demand as the default percentage on loans surged. On the flip side, the same firms had more difficulty collecting the debts. Now that the U.S. is pulling out of the recession, the default percent is dropping and therefore the collections are increasing. Everything from auto loans to home mortgage default rates have been improving this year, but still remain well below where they need to be in a healthy environment. As the improvement continues it should be a boom to the debt collection business. (For related reading, check out The Dark Side Of Debt Collection.)
Collecting Consumer Receivables
Portfolio Recovery Associates (NASDAQ:PRAA) is engaged in the business of purchasing, managing, and collecting portfolios of defaulted consumer receivables. During its most recent quarter the company reported earnings of 91 cents per share, which was above analyst's estimates and showed an increase of 38% from a year earlier. Revenue for the quarter rose 22%. The First Call estimate for 2010 has earnings coming in at $3.72 per share and rising to $4.60 in 2011. Looking ahead two years, the 2012 earnings estimate jumps to $5.50 per share. Considering that earnings per share came in at $2.87 in 2009, the three-year projected growth rate is 24.3% per year.
The company is currently trading with a P/E ratio of 17.2 based on 2010 earnings estimates and as low as 13.9 based on 2011 estimates. Using the 24.3% growth rate and a PEG ratio of 1.0, the fair valuation of PRAA in 2010 is $90.40/share. In 2011 the fair value of the stock jumps to $111.78/share. Based on the current price of $64.11, the stock is trading at a 41% discount to the 2010 fair value.
Deep Discount Debt
Encore Capital Group (Nasdaq:ECPG) is a company that specializes in the collection, restructuring and resale of debt it acquires at deep discounts. The company's first-quarter earnings saw revenue from receivable portfolios increase by 15% and net income jump 16% to 44 cents per share from 38 cents. The numbers are not mind blowing, however the future looks very promising. Based on First Call estimates, ECPG is expected to generate $1.74 per share in earnings in 2010, a 27% increase from the prior year. In 2011 the estimate jumps another 19% to $2.07 per share.
Low and Medium Success
Asset Acceptance Capital (Nasdaq:AACC) has not enjoyed the same success as PRAA and ECPG. When the company reported earnings in late April it earned one penny per share versus 15 cents the year earlier. Revenue also fell by 9% and both numbers were below analysts' expectations.
A company falling in the middle of AACC and the two leaders (PRAA and ECPG) is Asta Funding (Nasdaq:ASFI), a company that is considered a consumer receivable asset management firm. During the first quarter of 2010 the company reported diluted earnings of 20 cents versus a loss of 37 cents one year earlier. The negative in the report was the 30.4% decrease in net cash collections.
Bottom Line
There is no doubt I am a fan of the debt collection sector. The key comes down to individual stock picking. The first two companies mentioned, PRAA and ECPG, are clearly the best positioned companies based on both the fundamentals and technicals. AACC is a stock I would steer clear of and ASFI does not offer the same attractive reward-to-risk opportunity as the two leaders. (For related reading, see Debt Collection: Know Your Rights.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
by
Matthew McCall
Matthew McCall is the president of Penn Financial Group, LLC, a registered investment advisor. He also publishes two newsletters, The ETF Bulletin and The PFG Letter as well as other educational material. As a registered investment advisor, he manages clients' investments based on their specific goals and objectives.
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