Credit Corp beats guidance for the 7th year running

Credit Corp (CCP) was one of the first companies to report this year. The company exceeded guidance and received a positive reception from the market - up ~21% in following week. Misunderstanding around the nature of CCP’s lending business drove the price below $8 last year, but since withdrawing from Small Account Credit Contract lending in October and increasing guidance, the share price began to recover. EPS grew at 15.6% p.a. over the past five years. Management has guided 13-17.5% profit growth for FY17. CEO Thomas Beregi said it was "one of the strongest earnings guidances we've ever been able to provide at this early stage of the year." Management has a history of outperforming guidance, having exceeded the top-end of the initial guidance range for 7 years. Trading at 14.2x FY17 earnings according to FactSet estimates. In the video below, Mr Beregi explains the business, the results, and the outlook for the year ahead. Transcript included.
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An introduction to Credit Corp

Credit Corp is a business that was listed in 2000. Our core business is debt purchasing in Australia. It involves buying past due debts which are debts that have not made payments for six months or more to the original creditor, be it a bank, or telco or finance company. We buy those past due debts once the banks have exhausted all their collection efforts, we pay a discount to the face value outstanding and our job is to collect more than we paid for those debts, enough to cover our costs and make a return. That’s how we operate our business.

We have also diversified into consumer lending. We lend to consumers that have had trouble with credit in the past and therefore have a credit default and can't access finance from mainstream banks and their only alternative is a whole lot of predatory and very unsustainable products. We provide them with a very sustainable, affordable and flexible alternative that meets their needs and complies with responsible lending. In addition to that, we have expanded into the US where we are now also purchasing debts.

The industry in Australia has probably had a shaky past. About ten years ago, a number of companies went through a period of difficulty just prior to the GFC when companies including Credit Corp sometimes paid too much for the debts they bought and were unable to get a sufficient return. This affected earnings for a period. Since then Credit Corp worked hard on improving its operations, its efficiency and its effectiveness. It has invested heavily in its analysis of the portfolios it buys and makes sure that it pays a price that ensures it delivers an appropriate return. Moreover, Credit Corp is very much a reformed organization. We now have 1200 staff compared to a few hundred we had years back.

What are your sustainable competitive advantages?

We have three essential sustainable competitive advantages. I think we have already mentioned the core one which is analytics and discipline. This is key to everything we do. We have a large group anchored by a leading team that is staffed by a number of qualified Actuaries. And their job is to price risks in both our lending business and also our debt purchasing business. They provide us with forecasts mining through all our past data of what all our assets will deliver, so that when we are pricing a new asset, they will provide us with analysis to determine what sort of returns we will be able to get, how much we will be able to collect from those assets, what it would cost for us to do so and the time over which we will get those returns. We then go back into our return criteria to determine the price. We religiously stick to the numbers over the years; we have refined our models to an extent where they are now very accurate, and so it can provide nice high prices. They are competitive, and they meet the requirements of our clients; the major banks, finance companies, and Telcos in Australia, without the risk of overpaying and losing money.

It is also important that we have very strong operations. It’s a very labour-intensive business when managing 1100 people working hard every day in our call centers across Australia, the Philippines, and the USA. And so, that’s very important.

The other thing we need to do is to be very compliant and sustainable. Our clients, shareholders and even our people demanded of us do so, and it’s the right thing to do. We have a number of stakeholders, so we follow all the laws and guidelines in Australia, in fact, our standards go well beyond them in our businesses. We are not involved in any activities that could be designated as predatory or unsustainable or anything that investors and other stakeholders would not wish to be associated with. We provide our clients with strong brand protection.  An association with Credit Corp is never going to be something that one of our clients or other stakeholders is going to be embarrassed about.

Can you explain your lending business?

Our lending business is the most sustainable alternative in the Australian market for people who have limited credit options. In fact, there was an article that appeared in the press today from one of the consumer action law centres, a very vocal group, actually congratulating Credit Corp for its products, in fact, our exit from a particular type of loan product called small amount credit contract.

In Australia, a lot of people with poor credit records has payday loan as their only alternative. Payday loans are regulated under a type of product that is specified in the legislation as a small or microcredit which is a loan of less than $2000 for a duration of less than 12 months. Typically, payday loans are in fact much less than adding duration, generally only a month or so. The critical issue with a payday loan is that there is a concessional interest rate cap which works out to many hundreds of percent, up to 400% per annum. So, it is a very high-cost product to many interest rate bases. It is a small amount that is advanced, but it is paid back over a very short term. They are often marketed as a short-term solution. It’s very quick and easy when you take out one of these loans, you repay it back at a very short period so that you don't have debt hanging around with you for a long time, and then you move on and get on with your life after having repaid the debt.  The real problem with those products is that in such a short duration that the repayment, repayments are very high and there often unaffordable for the consumer. So, what happens is that consumer has to defer other living expenses to make the repayments, and so they need to borrow again. So, what is originally a short-term product ends up being a long-term indebtedness at very high cost. We have seen examples of consumers who took 10, 12, 15, 20 in succession until they eventually collapsed under the burden of the interest costs. That’s essentially what might be the option for most people in Australia who are excluded from Mainstream credit.

Our product is not a small amount credit contract. It doesn't fall under that section of the legislation. There's no concessional interest rate cap, so we are regulated just the same as all the banks and finance companies are. We charge an interest rate that is around one-tenth of that which is applicable to a payday loan, where under the cap it would be applicable to the type of lending that we are doing where people are repaying their loans over a much longer duration from six months to three years. Therefore the payments are quite low and affordable. We are doing thorough underwriting to ensure that the payments are affordable. So, when someone borrows from Credit Corp, they don't need to defer living expenses, they don't need another loan to make the repayments. It’s an affordable and sustainable product, and so it is a very viable option that keeps us away from all sorts of adverse scrutiny, from regulators, from politicians in other areas. And it's actually providing a solution rather than being part of the problem. If someone is financially excluded and can't obtain financing, it limits their ability to live like the rest of us who can access finance. When they take out a payday loan in many instances, I would say the situation actually gets worse over time. Whereas, when they take out one of Credit Corp’s products, it delivers them with financial exclusion in the way that is safe, affordable and sustainable, therefore, it is part of the solution that’s actually enabling them to reach all their ambitions in their lives.

How big is the US opportunity?

We have worked at our US businesses over a number of fronts. So, we have had to do two things effectively for us to be in a pathway to success in the US. Over the last few years, we've been losing money in the US, small money out of few million dollars each year. In the latter stage of this year, just through operational improvement, we will get the business to break even. The other thing that has been the case in the US business is that debt buyers have been paying prices which are unsustainably too high, and none of them have been able to make money. The good news is that we are now seeing signs in the commentaries from major debt buyers and also in some of the pricing we are seeing in the tendering processes that we are participating in now, that prices are falling. We need prices to fall by around 15% from where they are today, and then we have a business that can make the same target return that we task all our businesses to achieve which is the same return we make when we purchase a debt here in Australia. So that basically means we can accelerate our purchasing in the US. If pricing meets our return criteria, we will buy significantly more than we did last year. We will staff up our facility. We have a facility in Salt Lake City, Utah that we have developed over the last three years. It has 140 staff with capacity for more 90 staff. We outlaid 35million blowing debts last year. In order to achieve breakeven over the latter stages of this year, we will also outlay 35million. But there is the prospect that we will increase purchasing if we see the prices fall to our targeted level. This will enable us to grow up to the capacity of our search and potentially beyond. The idea would be, we could with feeling managed growth in a market environment that is rational, we can achieve a business that is outlaying about $100 million a year and delivering an impact that is about half the size of our current core business. So, that’s around $20m a year which is a very solid business for something that we developed from scratch organically just four years ago.

How do you see your earning mix evolving?

As a finance business, what’s probably more relevant is our bottom-line profits from each, and we do manage them separately, and that’s really what we are targeting to achieve. So, I’ll probably talk in those terms if it is okay. But in terms of after-tax earnings, we would probably be looking at just under half our earnings still coming from our core debt purchasing business in Australia, possibly around 40-45% from our core business. We would probably be looking at around 30% from the lending business and another 30% from the US.

How big can your Australian loan book become?

Presently, we are offering a fast originated cash loan product that amounts of up to about $5000 over terms of up to 3 years. This product is tailored to people with poor credit records, who have trouble getting finance from mainstream lenders. With that market justification lending, we think we can grow the book to a bit over $200 million per annum over the next few years.

How did you get to your guidance numbers?

Over the last seven years, our earnings growth and EPS growth has been around 22% per annum at the average. In the current year, 2016 our earnings grew by 20%. We are guiding at 13 to 18%. Given the prospects of our business and the fact that we start the year with a very sizeable loan book that has now reached critical mass where it is generating increased level of profitability and driving towards our pro forma returns, we think those levels are achievable. Obviously, as management, our job is always to achieve and exceed the expectations we set ourselves. We are firmly focused on the upper end of that guidance range, and if we outperform, we will obviously be delighted. That's one of the strongest terms earnings guidance we have been able to provide at this early stage of the year. So, the business is in a very good shape, and the strength of the guidance demonstrates that.

Dividend payout ratio

50% is the number for us given our growth profile and the fact that we want to maintain relatively low gearing. We feel like all our businesses are entering a period of opportunity, and rather than have to continually go equity markets to raise an additional capital, if we keep our gearing low and leave ourselves with substantial headroom to raise that gearing in order to find the capital to drive the growth and opportunity that we see across all our businesses, we think that will reward shareholders in the long run better than a heightened payout ratio.

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