On Oct 16, 2014, we issued an updated research report on Portfolio Recovery Associates Inc. (PRAA). We believe that the company’s focus on quality, profitability, diversified portfolios and strong cash flow position it to generate long-term growth. However, the competitive accounts receivable management industry, drop in total estimated collections to purchase price ratio and higher interest expenses are concerns.
Portfolio Recovery remains a small but significant player in a large market, with focus on quality and profitability rather than pure volume growth. The company also deployed $153 million to acquire debt in the first quarter and $966.9 million in the second quarter of 2014.
Portfolio Recovery’s bottom-line results have shown great improvement over the past few years. Although net income slightly fell in the first half of 2014, once synergies from the acquisitions during the quarter are realized, they are expected to aid bottom-line recovery. Moreover, performance of the fee-for-service business has started showing improvement since the second quarter of 2012.
The takeover of Norway-based Aktiv Kapital in Jul 2014 has granted Portfolio Recovery access to sellers of consumer debt in 13 new markets, thereby enabling geographic expansion. Further, the acquisition of the IVA Master Servicing Platform from Pamplona Capital Management during the second quarter is widening Portfolio Recovery’s product offering, particularly in the U.K. This bodes well for long-term growth.
Both cash collections and collector productivity (cash collections per hour paid) continue to be at record highs as efficiency improves at Portfolio Recovery’s operating call centers and the company keeps hiring new collectors.
On the flip side, the highly fragmented and competitive nature of the accounts receivable management industry makes the acquisition of defaulted consumer receivables and obtaining placement of fee-for-service receivables challenging for Portfolio Recovery. Further, operating expenses have been mounting since 2007, thereby leading to a decline in operating margins.
In several of the past quarters, rising borrowing costs and increasing leverage have been resulting in higher interest expenses. Portfolio Recovery’s interest expenses increased 76.9% year over year in the first half of 2014 due to increase in borrowings.
Moreover, post Aktiv Kapital purchase, borrowings increased to as much as $1.5 billion from $448.8 million as of Jun 30, 2014. This has led to an increase in the financial leverage, which might make the company more vulnerable to adverse economic conditions or industry hazards. Such increased debt levels may also warrant the use of a significant portion of operating cash flow to service debt payments, which could limit the company’s financial flexibility.
Earlier, this Zacks Rank #2 (Buy) stock reported second-quarter 2014 results that missed the Zacks Consensus Estimate but increased from the prior-year quarter. Higher revenues that were driven by cash collections mainly led to the year-over-year improvement in earnings.
Other stocks in the financial services space that look attractive at current levels include Blackhawk Network Holdings, Inc. (HAWK), Moody’s Corp. (MCO) and Discover Financial Services (DFS). While Balckhawk sports a Zacks Rank #1 (Strong Buy), Moody’s and Discover Financial have the same Zacks Rank as Portfolio Recovery.
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