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Morningstar | Credit Corp’s FVE Increases on U.S. PDL Opportunities and Strong Cash Collections

A combination of stronger-than-expected cash collections, continued strong performance in its Australian consumer lending business, and inaugural full-year profit from its new United States purchased debt ledger, or PDL, business, along with the time value of money, leads to no-moat Credit Corp’s fair value estimate increasing to AUD 19.80 per share from AUD 18.00. At our new fair value estimate, the shares trade at a 14 times fiscal 2019 P/E multiple and a dividend yield of 3.6%. The company reported strong earnings growth in fiscal 2018, with net profit after tax, or NPAT, growing 16.6% to AUD 64.3 million, moderately above our estimate of AUD 62 million.

We forecast NPAT of 68.1 million in fiscal 2019, growing to AUD 79.7 million in fiscal 2020, with the forecast acceleration in earnings driven by its U.S. PDL business and its growing Australian consumer finance business. The U.S. PDL business is already delivering strong collections and cost efficiency metrics almost on par with more established larger U.S. PDL acquirers, with further operational improvements expected. We expect it to benefit from continued favourable conditions in the expansive U.S. PDL market. Charge-off rates, or defaults divided by total loan balances, in the U.S. market increased to 3.8% in second-half 2018, from 3.5% in first-half 2018, and are still below long-term historical averages of 4.5%-5%.

We are also more comfortable that Credit Corp’s strong cash collections capability and balance sheet capacity should continue to allow it to fund its strong growth opportunities in the U.S. PDL market and the Australian and New Zealand impaired consumer finance market. In fiscal 2018, the company’s cash receipts increased by 10.1% and cash flow from operations excluding the purchase of PDLs and loans was more than sufficient to fund its PDL acquisitions and loan originations for the year.

This allowed it to reduce its gearing (net borrowing divided by the carrying value of PDL’s and loans) to 41.3% from 43.4%. This remains below its bank covenant of 60% and warehouse facility covenant of 50%, and the company has indicated that it is willing to increase financial leverage if opportunities arise. Nevertheless, we believe these relatively high leverage ratios will be a handbrake on growth, and the firm will need to continue its strong cash generation record to fund the strong growth opportunities in front of it in both the U.S. PDL market and the Australian and New Zealand consumer finance markets.

The company is also experiencing strong growth opportunities in the Australian impaired consumer finance market. Prime lenders such as the major banks are increasingly focused on compliance and stronger lending standards and reducing their exposure to riskier loans. We think the 2018 Royal Commission is likely to heighten this focus and lead to more opportunities for nonbank lenders such as Credit Corp. The firm has also confirmed that it maintains access to prime lenders to fund both its PDL acquisition and loan originations, with its primary lender Westpac reaffirming its commitment to the company. The availability of lower-cost funding from prime lenders allows it to price its finance products, such as Wallet Wizard, at much lower rates than its competitors, which we believe will assist it in driving continued growth in this market.

A more recent development from the focus by prime lenders on compliance and reputational risk is that the company was able to use its strong compliance record to acquire some PDLs in Australia uncontested, although this did not result in materially lower pricing. However, pricing is much more favourable in the large U.S. market, with its far greater supply of impaired debts. The company’s investments in the U.S., including the new facility, which opened in Salt Lake City in June, are poised to assist it in generating accelerated earnings from fiscal 2020.