Morningstar | Corporate Action: Credit Corp FVE Increases on Improved Guidance; Recommend Participating in SPP
No-moat Credit Corp’s positive market update and capital raising that materially strengthens its balance sheet provide a platform for future strong earnings growth and prompts an increase in our fair value estimate to AUD 21.50 per share from AUD 20.70. The company's U.S. purchase debt ledger, or PDL, business is likely to be the primary driver of growth, supported by its growing consumer loan business and emerging opportunities in a rebalancing Australian PDL market. We expect gearing (net borrowing/consumer loans and PDLs) to reduce to about 17% in fiscal 2019 following the capital raising, below the target range of 25%-30%. The capital raising overcomes previous elevated gearing of about 41%, which we had called out as being a constraint on significant growth opportunities. The company has a fiscal 2019 price/earnings of 15.8 times and fully franked dividend yield of 3.3% at our fair value estimate.We forecast underlying net profit after tax of AUD 70 million for fiscal 2019, at the higher end of the company’s reaffirmed guidance of AUD 69 million-70 million. We expect earnings will be at the high end of guidance due to the upgraded guidance on PDL acquisitions to AUD 210 million-215 million from AUD 200 million-210 million and net lending to AUD 55 million-60 million from AUD 50 million-55 million. We forecast more subdued earnings per share growth in fiscal 2019 due to the higher share count from the capital raising but expect EPS to grow at a compound annual growth rate of 9% in the next five years.
So long as it’s not cheaper to buy shares on the ASX, we recommend existing shareholders take up their allotment of shares under the share purchase plan, or SPP. The capital raising is split between a completed oversubscribed institutional offer, which raised about AUD 125 million at AUD 20.45 per share, and the SPP, which is estimated to raise about AUD 10 million. The SPP price is expected to be AUD 20.45 per share, roughly 5% below our fair value estimate.
Credit Corp’s strengthened balance sheet puts it in a far better position to exploit the major opportunity we see in the U.S. PDL market. During the first half of fiscal 2019, Credit Corp established new purchasing agreements with two new U.S. lenders, including with the largest U.S. PDL seller. Management also indicates it is in negotiations with another large U.S. PDL seller that is looking to return to selling PDLs after being out of the market. The company is increasingly optimistic regarding the U.S. PDL market, indicating PDL supply conditions remain favourable, with charge-off rates still growing and no signs of pricing pressure. We agree with management’s expectation that these favourable conditions are likely to last for an "extended period." This view appears to us to be supported by its two major established competitors in the U.S. PDL market, PRA Group and Encore Capital Group. Both recently pointed to favourable market conditions of strong supply of PDLs at reasonable prices. They also both purchased record-high U.S. PDLs in 2018, with PRA up 23% to USD 657.1 million and Encore up 19% to USD 638 million.
We forecast the company’s overall PDL revenue to grow at a CAGR of about 10% over the next five years, similar to the strong revenue growth experienced over the past five years and higher than our previous forecast CAGR of about 8%. We expect this future growth will be primarily driven by the favourable conditions in the U.S. PDL market, which is 10 times the size of the Australian market. Its strengthened balance sheet and strong cash collection record should also support our growth forecasts.
Furthermore, the company is well positioned to take advantage of opportunities emerging in Australia’s PDL market. Widely reported strengthening in lending criteria and reduced appetite by lenders to provide funding for PDL purchasers in Australia is likely to constrain competitors from acquiring PDLs. There are also early signs of consolidation in the market with listed competitor Collections House recently acquiring privately owned ACM Group. Additionally, its other Australia-listed competitor, Pioneer Credit, is facing significant disruption from receiving a qualified audit report with respect to its first-half fiscal 2019 result as well as a query from the ASX Listings Compliance department. This is due to Pioneer’s use of the fair value method to value PDLs, compared with Credit Corp and other market participants, which use the amortised cost method. In combination, these developments are likely to reduce the level of demand for Australian PDLs from competitors and potentially a more favourable Australian PDL market for Credit Corp to regain market share.
Credit Corp Group is engaged in debt purchase and collection as well as consumer lending. Co.'s segments are comprised of: debt ledger purchasing, which is comprised of purchases of consumer debts at a discount to their face value from credit providers with the objective of recovering amounts in excess of the purchase price over the collection life cycle of the receivables; and Consumer lending, which provides various financial products to credit-impaired consumers.
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