Reverse engineering Credit Corp's consumer lending

Credit Corp Group (ASX:CCP) reported FY16 results and put in another predictable performance that's slightly above the last guidance.

FY16 FY15 % Change
Revenue $229.0m $189.1m +19%
NPAT $45.9m $38.4m +20%
EPS (basic) 98.4 cps 83.0 cps +19%
Dividend per share 50.0 cps 44.0 cps +14%

The last time I wrote about the company, two years ago, I mentioned the consumer lending division would be the major growth engine and it alone would allow for satisfactory earnings growth over the following few years.1

The best part is that it contributed -$2.5m NPAT to the FY14 results due to the upfront provisioning (20-25% of value) of the loans upon establishment. As a result of this provisioning model, we're unlikely to see the real contributions to the reported NPAT until 2 years after the loan book stops growing (average term is around 1-3 years).

Assuming that Credit Corp can make a 16.5% annual NPAT return on the net loan book. If we conservatively estimate the net loanbook will hit $100m (gross ~$125m) in FY16 and flatline from there; Provided everything else stays the same, by FY18 CCP would have added a further $16.5m to reach an annual NPAT of $51.3m. A 47.4% increase from FY14's NPAT or 10.2% annually over the next 4 years.

Even while navigating the exit out of SACC, the company has still managed to beat my guesstimates ending up with a net loan book of $104m (gross $135m) for the end of FY16.

Due to the continued growth in loan book, along with the high upfront provisioning, the reported profits for consumer lending remain substantially understated compared to pro-forma performance. I believe NPAT equalling 16.5% of the net loan book is probably still not a bad guesstimate. But I want to explore this a bit further in this post.

Taking a high level view on consumer lending profitability, the larger the loan book is for any given period, the more money (interest payments minus costs and provision adjustments) is made. We also know that the more loans that are written during the period, the more cost is incurred from upfront provisioning. It can be all summarised by the following homemade equation:

NPBT = gross_loan_book * x - net_lending * y
p = bx - ly

Using the past two year's worth of half yearly numbers...

Period NPBT (p) Gross Loan Book Avg GLB (b) Net Lending (l)
1H FY15 $2.9m $72m $67.5m $16.2m
2H FY15 -$1.4m $100m $85.8m $34.8m
1H FY16 $2.1m $121m $110.5m $31.9m
2H FY16 $6.1m $135m $128m $23.2m

Giving us four equations to work with two variables to solve...

[1]  2.9 = 67.5x - 16.2y
[2]  -1.4 = 85.8x - 34.8y
[3]  2.1 = 110.5x - 31.9y
[4]  6.1 = 128x - 23.2y

If we solve all the combinations and average the results...

[1]+[2]:    x = 0.1289, y = 0.3580
[2]+[3]:    x = 0.1062, y = 0.3021
[3]+[4]:    x = 0.0960, y = 0.2667
[1]+[3]:    x = 0.1611, y = 0.4921
[1]+[4]:    x = 0.0621, y = 0.0799
[2]+[4]:    x = 0.0993, y = 0.2852

Average:    x = 0.1089, y = 0.2973

Giving us a rough equation to calculate profitability (NPBT) of Credit Corp's consumer lending division...

p = 0.1089b - 0.2973l   [Half year equation]
p = 0.2178b - 0.2973l   [Full year equation; the income section doubled]

p = Net profit before tax (NPBT)
b = Average gross loan book
l = Net lending for the period

If we make some assumptions for FY17 based on the latest commentary from management...

let b = 150.1, l = 45

p = 0.2178 * 150.1 - 0.2973 * 45
p = 19.3

FY17 NPBT: $19.3m
FY17 NPAT: $13.5m (121% growth on FY16's $6.1m)

If this is broadly accurate, then 16% of Credit Corp's earnings growth is expected entirely from the consumer lending division in FY17. Maybe this is a reason why the earnings guidance from management for FY17 is atypically aggressive (13% - 18% growth) for this time of the year.

Consumer lending earnings will always lag pro-forma performance when it's growing due to the way the company aggressively handles upfront provisioning for loans written. The division is not going to grow by 121% next year, it's just the accounting. The shift in earnings growth projections is not something that's happened in the past year, but the seeds of which were sown years earlier. Investors, with attention for detail, could have potentially put the clues together and have seen the earnings bump coming a couple of years in advance.

I'll close out with some commentary from management on this very topic...

The loan book has now reached critical mass, which means that Credit Corp can look forward to very strong profits and returns from the lending business.2


NPAT from the lending segment is expected to grow significantly.2

I'm expecting the same clockwork of earnings upgrades throughout the year...

CCP last traded at $15.15. Up 13% today.

Disclosure: At the time of publishing I own shares in CCP.