More families will sadly be in financial distress in 2014 as unemployment rises. And many with low-paid jobs, limited income growth and high debt will struggle with rising living costs. The result: more unpaid bills and bad debts – and opportunities for companies that specialise in this area.
Reserve Bank data on household finances is one of the scarier charts going around. It shows the incredible rise in household debt as a percentage of household disposable income since 1993. Although interest costs have fallen, household debt relative to income remains elevated.
A 5.8 per cent unemployment rate in December was helped by a continuing fall in the labour-force participation rate as baby boomers retire, and the loss of 31,600 full-time jobs was worse than the market expected. Jobs fears are weighing on sentiment; Westpac’s Consumer Sentiment index in January was at its lowest since July 2013.
Higher-than-expected inflation data this week confirmed rising living costs, in part because of higher vegetable and fruit prices. And an easing Australian dollar in 2014 will lift import costs and start to pressure inflation, in turn creating a bias for the Reserve Bank to lift interest rates later this year.
These are difficult conditions for struggling families who live from pay cheque to pay cheque. It only takes a sudden job loss to tip them into financial distress, and create more work for companies that rearrange debt, provide short-term finance, or recoup unpaid debts.
That said, it is too simplistic to suggest a sluggish economy is automatically good for the earnings of a handful of so-called “hardship stocks”, or that they are screaming buys.
For one thing, debt-related stocks often do best when conditions are not too hot or cold. That is, they can buy ledgers of distressed debt without paying inflated prices, while reasonable employment levels mean a decent proportion of that debt is recovered.
Also, several hardship stocks have had stellar share-price gains in the past 12 months. The impressive FSA Group has delivered a one-year total shareholder return (including dividend reinvestment) of 175 per cent. Its average annualised gain over three years is almost 65 per cent, according to Morningstar.
FSA is Australia’s largest provider of consumer-debt solutions and lends to individuals and small businesses. After a “backdoor listing” on ASX and $600,000 capital raising, the company is now capitalised at $161 million and starting to attract more support from broking analysts.
It is best known for the Fox Symes Debt Solutions business, which offers debt solutions such as budgeting advice, informal creditor arrangements, personal insolvency agreements and bankruptcy advice. Consumers who urgently need help to restructure their debts are its target market.
FSA says it has approximately 48 per cent share of the market for people who enter into arrangements to pay creditors through debt and personal insolvency agreements, and bankruptcies.
The company upgraded its profit guidance in December: “Due to stronger trading conditions, FSA Group expects its PAT (profit after tax attributable to members) to be up 30 per cent to 38 per cent for the half-year ended 31 December 2013, when compared with the half-year ended 31 December 2012.”
Its stock raced higher on the news, but it is the strength of FSA’s business model and growth in its lending business that bodes well for longer-term gains. The company has a high proportion of recurring earnings and can scale the business without significant additional capital.
The Fox Symes business provides fee-for-service and the average client life is 4.5-5 years. The home loan and small business divisions provide faster growth, provide arrears and bad debts are managed well. The two divisions have a neat fit, with Fox Symes having more than 17,500 clients.
FSA can continue to rise in 2014, but I would wait for a pullback in its share price before buying. It is due for a pause after almost tripling from the 52-week low of 48 cents, and would be more interesting if its $1.28 share price retreated towards $1. There’s a lot to like about FSA – at the right price.
Other hardship stocks are also nearing value territory after recent falls from their highs. Credit Corp Group, the leader in debt purchase and collection, has fallen from a 52-week high of $10.89 to $9.29. Its return on equity (ROE) is consistently above 20 per cent and debt is low.
Successful expansion in the US this year could be the next big growth engine for Credit Corp and re-rate its stock, although stronger competitive bidding for distressed debt ledgers could be a challenge. Consensus analyst forecasts have Credit Corp’s Price Earnings (PE) at 12.9 in 2013-14, which is not excessive for a company of its quality.
Among smaller stocks, Collection House continues to impress, but is trading near its 52-week high. The well-run Thorn Group, owner of Radio Rentals, is worth watching and would appeal below $2.
Listed pawn shop and micro-lender Cash Converters International looks fully valued, even after recent share-price losses. A class action against Cash Converters, launched by law firm Maurice Blackburn Lawyers, is a potential headwind, although Cash Converters has denied the claims.
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations or offer financial advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis are at January 23, 2014.