Portfolio Recovery: Appreciated at Last?

Portfolio Recovery Associates (Nasdaq: PRAA  ) , a two-time Motley Fool Hidden Gems recommendation, hit the trifecta in its first quarter.

  1. Results smashed analyst expectations (including my own).
  2. Shareholders are getting a one-time special dividend of $1 per share.
  3. And the company is repurchasing 1 million shares (about 6.2% of total outstanding).

These latter two moves came in response to a trial balloon Portfolio's management floated last quarter about taking on some leverage (read: debt) to enhance shareholder returns. Making an even greater splash, earnings were surprisingly released a day early, after an exchange filing was inadvertently made public. Given the breadth of good news the company reported, I doubt many were complaining about the early release.

The business and results
Another quick primer for newcomers: Portfolio Recovery buys defaulted consumer debt from credit card providers like MasterCard (NYSE: MA  ) , Visa, or Discover Card (a division of Morgan Stanley (NYSE: MS  ) ). It also picks up bankruptcy paper, telecom debt from providers like Verizon (NYSE: VZ  ) , auto loans, student loans, mortgage deficiency paper, etc. -- all for pennies on the face value dollar. The company then works this debt through its own collector workforce, collecting two to three times the purchase price over the next seven years.

It's simple in theory, but in practice, the business requires experience to appropriately value debt, discipline to purchase debt only at reasonable prices, and well-trained collectors to work the paper. Overpaying for debt is akin to burning money, and excellent pricing models aren't much use if collectors can't cajole debtors to pony up.

Now that we've established how the firm does business, let's see how well it does that business:

($millions)

Q1-07

Q1-06

Growth

Cash Collections

$67.3

$58.5

15.1%

Portfolio Amortization Rate

32.5%

32.7%

N/A

Cash Collections Recognized as Revenues

$45.5

$39.4

15.5%

Other Cash Receipts

$8.5

$6.0

43.1%

Total Revenues

$54.0

$45.3

19.1%

Net Income

$12.9

$10.7

20%

EPS (Diluted)

$0.80

$0.67

19.5%

New Purchased Receivables

$39.6

$16.2

144%

Operating Margin

38.7%

39%

N/A

The "Other Cash Receipts" line stems from Portfolio's three wholly owned fee-for-service businesses. Anchor Receivables collects on debt owned by others. IGS Nevada specializes in "asset location," also known as skip-tracing. And RDS collects debts owed to local, state, and federal governments.

What's good for shareholders...
Fools almost universally seem to admire Portfolio Recovery. Witness CAPS, where bull ratings for the stock outnumber bears 1,843 to 43. Management does an excellent job focusing on building its business, paying little attention to short-term Wall Street concerns. Yet the stock price has admittedly stagnated over the past year

Portfolio Recovery's dividend and share repurchase announcement was matched by its chief competitor Asset Acceptance (Nasdaq: AACC  ) . Both companies are extremely conservative with their equity. No options have been granted at Portfolio since 2003, and page 25 of the proxy statement from Asset Acceptance actually spells out that the company considers shares already owned by executives sufficient motivation to increase the company's value. Thus, these repurchases will actually benefit outside investors, not simply divert shareholder capital into management's pockets.

Overall, Portfolio's dividend and share repurchase will cost about $70 million. Investors might worry that management isn't finding enough new debt to purchase with the cash it's collecting, but fear not, Fools. Portfolio Recovery's level of new charged-off debt purchasing was the second-highest quarterly amount ever, eclipsed only by the massive purchasing the company did in Q4 2005, in the wake of new bankruptcy legislation. I'm eagerly awaiting the 10-Q to see how collection performance for past portfolios has evolved -- particularly for those 2005 purchases. Meanwhile, operating margin, which had been depressed over the past few quarters, rebounded nicely.

Valuation station
I suppose I'm going to take a bit of a victory lap right now. I maintain a fairly detailed valuation model on Portfolio Recovery, which I updated for Hidden Gems subscribers on our message board earlier this month. With Portfolio bouncing around in the low $40s through much of March and April, I recrunched the numbers, bringing in as many pessimistic assumptions as I could (with a single exception, perhaps, which I'll get to in a moment).

The result? As of the end of 2006, I couldn't get my estimate of a reasonable intrinsic value below $51. The one optimistic assumption I allowed myself was that Portfolio would continue to grow new purchases of debt by 20% annually for the next seven years. While it's certainly too early to infer a long-term trend, the company's Q1 2007 purchasing suggests it's off to a rousing start.

Given Q1's outstanding results, my estimate of fair value will only rise. (I can't get more specific until I've seen the company's 10-Q.) But even after Wednesday's 14% rise -- part of a 34% run since its early March nadir -- the stock isn't priced outlandishly. Portfolio Recovery's been steadily trending lower on a relative valuation basis for most of the last year. Today, I'd call it reasonable, though not cheap.

P/E Ratio

Enterprise Value/Cash Collections (trailing)

Enterprise Value/Expected Remaining Cash Collections

Current

19.3

3.20

1.52

Median*

20.7

3.35

1.55

Minimum*

15.8

2.62

1.21

Maximum*

29.5

5.22

2.23

*Since December 2002 IPO. All calculations use month-ending prices, and are calculated on a rolling twelve-month basis.

What to watch for
To temper enthusiasms (particularly my own), remember that the first quarter is always the seasonal best for Portfolio's business. Also, while new receivables purchases were strong, the end of the first quarter concluded a "forward flow" agreement the company entered a year ago, which was responsible for a large percentage of its purchasing over the past 12 months. That "flow" has been renewed for a single quarter, but there's no guarantee beyond Q2; afterward, Portfolio will have to rebid for it. True, the company signed another forward flow agreement with a second party for a similar amount in the first quarter, but if it loses that original agreement, the company will be sprinting just to stand still. On the positive side, management seemed quietly pleased that tight prices in the charged-off debt market might be loosening a little.

The Foolish bottom line
In the three years since its first Hidden Gems recommendation, Portfolio Recovery is up 115%. Yet that return has largely come in stutter-steps -- brief, rapid gains amid long stretches of stagnation. This latest flat interlude has lasted a year, with management focusing on the business at hand while the market bid the company ever lower. Given its continued excellence, it seems that the share repurchase and special dividend represent the company saying "Enough!" Wall Street, show a little respect, please. This company has done nothing but execute.

Portfolio Recovery is a Motley Fool Hidden Gems recommendation. If you're interested in small-cap companies with great potential, take a free 30-day trial to Hidden Gems.

Fool contributor Jim Gillies owns shares of Portfolio Recovery. He is also short Sep07 $45 PRAA puts. Send him feedback. MasterCard is an Inside Value pick. The Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (81)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 08, 2008, at 12:29 PM, INOMACS wrote:

    PORTFOLIO RECOVERY IS NOTHING BUT A BUNCH OF BOILER ROOM CROOKS THEY HAVE THE MOST RUDEST PEOPLE WORKING FOR THEM, ALSO THEY CREATE FALSE ACCOUNTS AND USE TREATING SCRAE TACTICS FOR PAYMENT, ONE OF THESE DAYS WE SHOULD ALL GO DONE TO THEIR OFFICES IN NORFOLK VA, AND SPEAK TO THEM IN PERSON, OR AT LEAST HAVE THEM SHOW PROOF OF A DEBT WHICH THEY LIE ABOUT, THAT'S HOW THEY STAY IN BUSINESS TREAHTENING PEOPLE WITH FALSE ACCOUNTS.

  • Report this Comment On June 17, 2012, at 4:32 AM, clbjblk wrote:

    Motley you should have a talk with who ever promotes a stock that most of there workers have a bad credit rating, I do not run your business but one more senseless editor who thinks it is nice to pick on people a person half the time because there ins co. ripped them off and they do not have the time to take off work to justify there being mistreated and these Portfolio that you speak so highly of try to pay your bill and get it off you credit report is a nightmare, you should sit down and tell this editor of THE MOTLEY FOOL to get a heart or get a new job. I thought you had more sense than to kick somebody when they are down. The man with the article was nice before me but if you live off of greed keep that editor and have him call me, he needs to do his homework or does The Motley FOOL like promoting this. It sounds like the fool has hit a low point send the bookies over they can parley that editor. I better see a retraction or proof like that Editors drug test results and maybe he will have room to talk, this is advise use it or loose part of you profits by promoting buying people feeding off of greed. I will be waiting to see if this get printed or is this a form of discrimination I have helped get those people off of good people who they made a mistake on but did not care or even listen I hope you get to the bottom of this or I will help you. Happy Fathers DAY. Please use my name or handle your problem or I will get FRESH BREWED TO HELP YOU and have a talk with a warning slip in your hand to who ever printed this play it smart. This person just really upset people who are good people that do not have lawyers on retainer and the greed of Portfolio Recovery you can start making some put plays with your options man or do the human thing by morals not greed.

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