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Debt Collectors have the potential to do very, very well in the face of economic calamity, and here in the land down under, their prospects are especially appealing. 

Conventional wisdom says individuals and small businesses get into debt trouble due primarily to some interruption in their income flow.  Layoffs, reduced hours, time off for medical reasons, and marriage or partner breakups are supposedly the key drivers leading to debt problems that can result in bankruptcy.  Conventional wisdom is wrong. 

Check bankruptcy research in Western industrialised countries and you learn total debt and savings are what opens the door for severe debt trouble.  In short, losing your job may push you into a financial abyss but it is high debt and low savings that left you standing at the edge.

Prior to the GFC Australian households had the highest level of debt in the world.  While households in other Western nations have shed debt substantially, we have not.  Take a look at the following graph from the Reserve Bank of Australia:

The best we can say is that here in Australia at least household debt stopped accelerating around 2006-2007, but it hasn’t gone down significantly, remaining close to 150%.  We have done better of late in the second debt driver – lack of savings.  Here is an Australian Bureau of Statistics graph of our Household Net Savings over the last 50 years:

The point to be made here is simple.  All over the world there are people who have suffered some form of income interruption that manage to stay current with their debts.  What separates these people are low debt and high savings.  Considering we have the opposite here, if the mining boom, to cite one example, really has totally collapsed, that will lead to massive income interruption around the country and more opportunity for debt collectors as more and more people sink into the muck.

The Debt Collection Industry in Australia is fragmented, with many smaller names being subsidiaries of the two major publicly traded players in the Australian Credit and Collection Industry.  Here they are:

Company

Code

Market Cap

Share Price

52 Wk Hi

52 Wk Lo

Dividend Yield

Credit Corp Group

CCP

$262M

$5.75

$6.08

$3.55

3.5%

Collection House

CLH

$88M

$0.82

$0.90

$0.62

7.6%

 

Oddly enough, these two companies have different GICS Sub-Industry Classifications, with CCP classed as a Diversified Financials Company while the smaller CLH is classed as a Diversified Commercial and Professional Services Provider.

Although both are in the debt collection business, they are structured slightly differently.  Debt Collection is something of a nasty business so much of the general public and even the investors like you don’t know how the industry operates.  Here is a quick primer.

When a consumer or a small business goes late on any form of unsecured credit payment by 90-120 days, the account usually ends up in “collection.”  The question is where?  The collection process is expensive and lenders proceed in slow orderly steps to minimise their own costs knowing full well they may collect nothing of what they are owed.

Some lenders have in-house collection departments but due to their cost, other lenders choose to hire professional debt collection agencies and larger companies and pay them a commission on what they collect.  Collection House generates part of their revenue from this commission-based debt collection.

Even the most aggressive lender will eventually write off a debt, but they legally still own the debt and are entitled to repayment.  Typically, these bad debts are pooled together and sold off in huge batches to debt collection companies like CCP and CLH.  This is known as Purchased Debt Ledger collection and it is the only way CCP deals with consumer debt and is the main revenue source for CCP.  That company does do commission based debt collection of past due receivables for small businesses.  .

A Purchased Debt Ledger business model is by far the more lucrative as lenders sometimes sell these bad debts for literally pennies on the dollar.  When a debt collector eventually reaches a settlement agreement with the debtor, they can afford to be generous and still make huge profits. 

Credit Corp Group Ltd (CCP)

Let’s start with CCP and see how its share price has performed over 10 years, 5 years, and 1 year against the ASX financial index the XFJ.   Here are the charts:

10 Year Price History

5 Year Price History

1 Year Price History

CCP’s average annual shareholder return (taking dividends into account) over 10 years was 27.1%, -9.1% over 5 years, and 21% over one year.  The company buys consumer debt ledgers from credit card and personal loan issuers as well as telecommunications companies.  Subsidiary companies provide the debt receivables services to small businesses. 

Credit Corp has the advantage of long relationships with the major consumer financial lending institutions in both Australia and New Zealand.  Of greater import is their technological capability and continuing innovation.  While the business model sounds simple and powerful to the novice, not every bad debt they purchase results in a collection.  They have huge databases which not only help them determine a competitive price to pay the lender for the debt, but also to target debts with higher probability of recovery. 

Collection House Ltd (CLH)

Collection House is more diversified and less concentrated on the consumer sector than CCP.  Collection House has four primary business segments – Commission Collections, Receivables Management, Purchased Debt, and Legal and Insolvency Services.  They also have a potpourri of related services including credit management related training services in the collection industry; collections and credit information services; and credit risk assessment and cash flow optimisation services.  Here are their 10, 5, and 1 year share price charts:

10 Year Price History

5 Year Price History

1 Year Price History

CLH’s average annual shareholder return (taking dividends into account) over 10 years was -8.2%, 7.9% over 5 years, and 29.9% over one year.  On the basis of average shareholder return, there is no crystal clear choice between the two.

Considering the uncertainties we face, one could make a strong case for investing in both.  With a P/E of only 7.96 and a fully franked dividend of 7.6% CLH appears to be a better value play.  The P/E for CCP is 12.21 with a dividend yield of 3.5%, also fully franked. 

However there are other measures we can look at, but first you need to be reminded the debt collection industry is heavily regulated.  Both these companies claim to operate with high ethical standards, taking great care to stay within full compliance of the law.  Ethics aside, both have turned in some impressive performances in the last three years.  Here is a brief comparison of the two companies on some key performance measures for 2009, 2010, and 2011.

 

2009

2010

2011

CLH Net Profit After Taxes (NPAT)

$7.9M

$8.9M

$10.1M

CCP NPAT Net Profit After Taxes (NPAT)

$11.4M

$12.5M

$21.0M

 

CLH Return on Equity (ROE)

8.2%

9.7%

10.5%

CCP Return on Equity (ROE)

15.3%

15.3%

20.2%

 

CLH Long Term Debt

$69.7M

$66.9M

$73.9M

CCP Long Term Debt

$82.6M

$38.8M

$0.0M

 

While the P/E for CCP stands around 12.2, note their superior Return on Equity performance over the last 3 years; consistently above the 15% mark used as a measure by value investors.  Also note the increase in NPAT in 2011 of around 60%.  However, the number that should jump out at you is Long Term Debt. 

As of the end of fiscal year 2011, CCP has no long term debt.  Now the significance is that both companies have pledged to increase purchases of consumer debt ledgers in 2012, with CCP concentrating on expansion into the US market while CLH boldly proclaims it plans to increase its consumer debt ledger purchasing by $60M to $70M, more, they claim, than any other debt buyer in Australia.  The question is, with $73.9M in debt already on the books, where will they get the money?  Issuing shares to raise capital in the near future is a real possibility with this company.

On balance CCP appears to be the safer play here but analysts like both companies.  Although their coverage universe is small, two analysts have STONG BUY ratings on CLH and CCP has 3 STONG BUY recommendations and 1 BUY recommendation. 

In the event things do not take a dramatic turn for the worse, both these companies have demonstrated solid fundamental performance over the last three years and should continue to do so.  And if things deteriorate to the point more and more consumers and small businesses end up in collections, what is not to like about these two companies?

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