A look at Credit Corp's maintenance capex

Last week's post was a fun exercise in applying linear regression in predicting reported profits for the Consumer Lending segment of Credit Corp Group (ASX:CCP). The opportunity with predicting and capitalising on large profit/guidance upside surprises - as was the case with the release of the FY16 results - is over because in recent years management have set clear expectations in advance.

What if we look at the company as a whole? In this post we're going to take a stab at the maintenance capital expenditure required to sustain the current level of customer receipts ongoing, to determine the NPAT "run-rate". How would this compare with the reported NPAT?

Before we continue, let's recap on the different segments within Credit Corp:

• Aus/NZ PDL Purchasing. The company's core business. Buying bad debts (purchased debt ledgers or PDLs) from banks, financial institutions, telcos, utilities, etc and then attempting to collect the outstanding amount. Together with commission collections, this segment makes up 75% of the company's EBIT.
• Consumer Lending. Established around 2012, this segment provides credit for those unable to obtain it from mainstream lenders. It currently contributes 22% of EBIT.
• USA PDL Purchasing. Kicked off in 2012 to pursue what the company does best in a much bigger market. Hit with years of unfavourable pricing - due to regulatory uncertainly resulting from the fallout of the GFC - this segment has been in a temporary holding pattern. In the past two years however, prices have become favourable and the company has started expanding its operations and ramping up purchasing. Currently just 3% of EBIT.

We'll be exploring the NPAT run rate of the company, excluding the USA PDL Purchasing segment. Although this is a segment that is likely to have a the biggest difference between reported profits and run-rate, there's not enough data to make an educated guess. It's easier with the other two segments since:

• Aus/NZ PDL Purchasing have flattened with the PDLs purchased at a level that is lower than previous years. Management have also provided some commentary on the likely impacts of this to reported NPAT.
• Consumer Lending provides numbers around net lending and the increase in loan book. With these numbers, it's possible to make a guess on the amount of net lending required to maintain the current loan book.

The table below contains the reported FY18 operating and investment cashflow numbers. We then subtract the USA segment from the Group giving an Aus/NZ only view. Finally, we impose our estimates for PDL purchases and Consumer net lending that will maintain the current level of receipts. The final result is an estimate of the NPAT in Aus/NZ, under a zero-growth scenario.

Assumptions

A. USA PDL Collections

This number wasn't explicitly disclosed, but can be back solved with figures provided in the FY18 results presentation³. Math:

costs / collections = 0.444 (1)
collections / assets = 0.7 (2)

costs = revenue - ebit
      = 23,972 - 2,712
      = 21,260

costs / collections = 0.444 (from 1)
21,260 / collections = 0.444
collections = 21,260 / 0.444
            = 47,883

B. Maintenance Capex: Net funding of Consumer Loans

FY18 Net Lending minus the increase in Gross Loan book.

C. Maintenance Capex: Aus/NZ Acquisition of purchased debt ledgers

Quoting CEO Thomas Beregi on 31/07/2018⁴:

The top end of our guidance range for Australia is around $120m of outlay and purchasing that sort of level, possibility even a little bit less, we will maintain earnings in the Australian business in 2019. Leading into 2020, purchasing at that sort of level, which is below historic market share, will probably see a slight decline in earnings from the core Australia/NZ purchasing business. However, as we ramp up in the US, we are looking at a substantial uplift in profits particularly 2020 year, and that will more than offset the limited decline in the core business.

Judging from the commentary, $125m might be enough as maintenance capex. But let's be a bit more conservative and pick $135m.

What does this all mean?

If my assumptions and numbers are to be believed, the NPAT run-rate is 23.3% higher than the one reported for Aus/NZ. Or 22.6% higher at the group level.

The most variable assumption is the maintenance capex for Aus/NZ PDL purchasing. Taking it as a range of $125m-$140m, it translates to an NPAT run rate that is 17.7% to 34.5% higher than the reported FY18 figures.

Another way to look at it, a forward P/E of 13.5 (midpoint of FY19 guidance) becomes 10.0 to 11.5.

Oh, did I mention this is a company that has posted double-digit EPS growth every year for the last 10 years at a CAGR of 27%?

Conclusion

The aim was to demonstrate that there's a considerable buffer between the run rate and the report NPAT numbers. This was achieved by stripping out the growth capex, and removing elements that are difficult to make assumptions for.

Of course none of this matters if the future prospects of the company are unfavourable. My primary concern over the last few years has been the competitive bidding and limited PDL supply in Aus/NZ, constraining Credit Corp's ability to grow. While this is still the case, the company has now plenty of opportunities in consumer lending and especially in the sizeable USA PDL market where conditions have turned favourably.

With plenty of dry powder on hand, I expect management to act decisively to new opportunities that will present themselves in the coming years.

CCP last traded at $19.17.

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