Published:
August 24, 2007
Shares
in debt collection specialist Portfolio Recovery Associates (Nasdaq:
PRAA, $51.68)
have fallen more than
-20% over the past month. The stock reacted negatively
after the company released earnings that met analysts'
expectations but reported a softer-than-expected collection
rate.
PRAA's business model is simple. The company buys defaulted
credit card, auto loan and other debts from lenders. Because
this debt is in default, PRAA pays just a few pennies for each
dollar of debt it purchases. The company then turns around and
tries to collect on that debt, calling consumers in default and
trying to negotiate a settlement. As long as PRAA can collect a
few pennies more than it pays for the debt, the company makes a
solid profit. And PRAA has been doing just that for years.
The company posted a +17% rise in earnings for the second
quarter -- impressive growth by any measure. The problem was
cash collections, a measure of how much cash PRAA actually
collects from the debt it buys. PRAA didn't quite meet analysts'
forecasts on that metric.
But, we don't see this as a major problem. The company recently
opened up a new call center to handle collection calls that
isn't showing the productivity of its other locations. But
management is taking steps to improve that operation. And the
firm apparently sees no fundamental deterioration in is business
prospects -- PRAA bought more than $2.5 billion in defaulted
debts in the second quarter, the second-highest quarterly
purchase in PRAA's history. As collections from these new debts
start to flow, cash collection rates are likely to rise again.
And my staff and I believe that the current credit environment
is actually a major benefit for PRAA. Specifically, one of the
impediments to PRAA's growth in recent years has been the rising
cost of buying up bad debts. With consumer credit quality high
for most of the past four years, the supply of bad debt
available for purchase fell. As supply dwindled, competition
between credit recovery firms picked up and the cost of buying
this debt rose. That had an impact on profitability.
But lately, the trend has reversed. Credit quality has declined
somewhat and banks have been writing off more bad debts -- this
represents a greater potential market for PRAA. It's not
surprising that the company made larger debt purchases in the
second quarter. And trading at just 14 times next year's
earnings estimates and growing at more than +14% annualized,
PRAA is a bargain at current levels.
Paul Tracy
Editor
StreetAuthority
Market Advisor
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Paul Tracy co-founded StreetAuthority.com and became the firm's
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for equity research and managing a team of seasoned professional financial
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full-service brokerage operations as well as economic research work on a Money
and Banking project funded by the National Bureau of Economic Research. He has
also spent time doing outside consulting and research for the University of
Virginia, has appeared as a guest expert on several prominent financial radio
shows, and has been a featured speaker at various investment conferences across
the U.S.
Paul graduated with a B.S. in Finance and Management from the McIntire School
of Commerce at the University of Virginia.
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