Looks Like Another Good Quarter For Portfolio Recovery

I have to confess that I've been thinking a lot lately about selling Portfolio Recovery Associates (Nasdaq: PRAA), booking my gains, and moving on to a new idea. But here again I'm conflicted – I do not like selling the stocks of very well-run companies just because they get a little expensive. So, I hold on … and today's earnings report makes me feel a little better about it.

Solid Earnings

PRA reported that revenue jumped 38% in the fourth quarter, reaching just under $101 million. EPS jumped 50% to 1.20. That compares very favorably to the average estimates of $97 million and $1.12 and the high-end estimates of $99 million and $1.16.

Looking at the details, Portfolio Recovery reported a 52% increase in cash collections (to $144 million) and maintained the same amortization rate as in the year-ago quarter. Call center collections, the company's core business, was the laggard if 19% growth is “lagging”. External legal collections rose 38%, while the company's efforts to grow its internal legal collections paid off in 70% growth (though a still-small absolute level of collections at $13 million). Purchased bankruptcy collections were up 110% to $56 million; most interesting to me because this is the first time something has been a larger contributor than internal call center collections.

Productivity was also better – collector productivity per hour paid rose 2% from the third quarter to $204 per hour paid. All in all, operating expenses rose 26% with a big jump in spending on internal legal – a business that has quite a bit of promise, but is still something of a drag on margins.

Paying Less But Getting More?

The company was also once again quite active buying paper. In this quarter, Portfolio Recovery bought written-off paper with a face value of $1.87 billion, paying a bit under $86 million for it. Although paper prices have been moving up as credit quality and household finances improve, PRAA paid $0.045 on the dollar – down from $0.067 in the third quarter (when the company paid $92.5 million for $1.38 billion in face value). Of course some worry that PRA bought lower-quality paper, but Portfolio Recovery has a long history of realizing value from its paper – even if the company's projections for its 2010 purchases are a 210% return (versus the long-term average of 243%).

Better Times On The Way

All in all, it looks like things are getting better in this market. JPMorgan (NYSE: JPM), Citigroup (NYSE: C), Bank of America (NYSE: BAC) and American Express (NYSE: AXP) all seem to be reporting better charge-off data on credit cards. Moreover, it doesn't look like the job situation is getting any worse in the country – an important consideration as Portfolio Recovery really cannot collect if people don't have jobs. That said, this is always something of a mixed blessing – it ups the odds that PRA will enjoy good collections, but it has always brought more competition back into the market and bid up the price of paper.

The Bottom Line

As the economy improves, I think Portfolio Recovery will see a lot of earnings leverage. After all, contrary to a lot of the stereotypes, a lot of the people who default on debt actually do want to make good … and once they get the economic wherewithal to do so, they do. Moreover, even though the market for paper is largely an auction market where the high bid wins, PRA's long standing in this market does serve it well when dealing with sellers. Moreover, there is something to be said for know-how and employee relations in this business and PRA knows how to find, train, and retain good collectors.

So, what's the stock worth? This is a trickier type of stock relative to a healthcare company or industrial. Nevertheless, even very modest projections of mid-single-digit free cash flow growth for the next decade and a relatively high discount rate of 12% are sufficient to power a price target in the $90's. I'm happy to hold PRA shares for the time being.

I would HOLD shares of Portfolio Recovery Associates.
   Note - I mistakenly wrote that I would "Buy" PRAA at these levels in my initial post. With an expected return of about 20% from these levels, that doesn't meet my "Buy" standard. 

Disclosure: I own shares of Portfolio Recovery Associates and JPMorgan