Portfolio Recovery Associates (Nasdaq: PRAA) is my second-longest held position, and the company has never really given me a good business-related reason to think about selling. The accounting here is admittedly a bit "advanced" and the stock probably is not right for everyone, but it is a business (debt collection) I really happen to like.
Revenue rose 31% this quarter to $93M - about 10% ahead of the hurdle laid out by the analysts. Net income, though, climbed 67% (to $19.5M), and the company's EPS of $1.14 handily beat the estimate of $0.93. Cash collections jumped 42% to $128M, while the company spent $87M on new paper (with a face value of $1.67B).
For the quarter, call center collections (the largest segment; about 42% of all collections) were up 9%, while the company's internal legal collections (an area of growth that the company is focusing on) were up 167% to $11M. For the quarter, 40.1% of cash collections were applied to amortization - down slightly from 40.3% last year, and still pretty high relative to the levels of a few years ago.
Looking out a bit, I do not see any reason to think that PRAA is going to be hurting for product. Major card issuers like US Bancorp (NYSE: USB), Wells Fargo (NYSE: WFC), Capital One (NYSE: COF), and JP Morgan (NYSE: JPM) have a lot of bad credit card paper on their books and they are eventually going to get rid of it - and it stands to reason that if the market leaders have this issue, so too does almost everyone else. So even though we keep reading about declining bad debt charge-offs, that needs to be seen in the context that the absolute levels are still quite high.
On top of that, management says that the purchasing environment is still relatively attractive. This, frankly, is my biggest fear - if the company cannot buy enough charged-off collections at a good price, the future growth of the company gets dicey.
Elsewhere, though, the company's dynamic scoring process still seems to be paying off in terms of enhanced productivity, and the expansion into more bankruptcy business should help. Bankruptcy business is not as lucrative in terms of the ratio of collections to purchase price, but it takes less work to get the money and it offers an annuity-like stream of cashflow.
There is a little external risk here as well. It seems like some states are looking to crack down harder on debt collection. I do not see this being a huge risk to PRAA, though. States generally acknowledge that businesses must be allowed to collect on bad debts, and it is really only the abusive collectors that are at risk. PRAA wisely chooses to avoid that route, so I think more regulation could actually force some companies out of business and reduce PRAA's competition for purchasing charged-off receivables.
PRAA has been on a pretty good tear lately and my old target of $74 does not offer much upside at all. I have not yet run the numbers on a new price target, but I cannot imagine that I will raise it enough that it would be a good idea to recommend others get in at these prices.
That, in turn, is going to lead to some deep thinking for myself - do I go ahead and cash in these shares (and pay the capital gains) and move into a more undervalued-idea, or do I sit tight and accept a lower expected return than I normally take? I always hate selling the stock of companies that are doing well (and have pretty much always done well), so it is not going to be a simple decision.
Disclosure - I own shares of JP Morgan and PRAA.
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