Black Friday Bargain Stock: Portfolio Recovery Associates

You like bargains? You like quality on the cheap? Meet Portfolio Recovery Associates (Nasdaq: PRAA  ) , the leading player in a burgeoning industry. For one low price, you get a huge market opportunity, steady business performance, shareholder-aligned management, and nearly the cheapest relative valuation in the company's history. What more do you want?

What's the opportunity?
Portfolio Recovery (PRA) buys defaulted consumer debt (mainly charged-off credit card accounts) for pennies on the (face value) dollar, and then collects 2.5 to 3.0 times its initial purchase price over the next seven years.

Look at the American consumer: a negligible savings rate, oil near $100 a barrel driving gas prices higher, tapped-out home equity, mortgage defaults, and the fears of an ever-wider economic downturn. Then consider Americans' continued use of debt to finance their lifestyles --  to the tune of $2.48 trillion as of September 2007.

Some portion of debtors end up unable or unwilling to repay their debt. After cajoling, pleading, and threatening the debtor (and perhaps using a collection agency or two) credit card lenders like Capital One (NYSE: COF  ) , Bank of America (NYSE: BAC  ) , and Citigroup (NYSE: C  ) often find it simpler to cut their losses and write off bad accounts -- an activity that's been pursued at substantially greater rates in 2007, than in 2006.

Charged-off debt is PRA's raw material. Engaging in a little "Economics 101," what we're seeing is an increased supply of raw material, while the demand side of the equation is also improving.  We're coming out of a multiyear period where a lot of capital was chasing charged-off paper; some capital was supplied by hedge funds salivating over the wide profit margins of the disciplined debt collectors. Now, capital is exiting the space (perhaps the hedge funds have other uses for their money ... mortgage-backed securities, anyone?). Both PRA and chief competitor Asset Acceptance (Nasdaq: AACC  ) have spoken on recent conference calls of moderating charged-off debt prices. If you prefer actions over words, consider that PRA's new debt purchases in the first nine months of 2007 are up 114% over last year.

To summarize: greater supply, matched with lower demand, equals lower debt prices, which is a very good thing for PRA. It's ramping up debt-buying accordingly, but can it collect?

Why is it quality?
By definition, PRA is buying someone else's problems, requiring a shrewd understanding of which debts may truly be worthless, and which may yet yield cash. It must also manage a large workforce of collectors who are not exactly dealing with clients on the happiest of subjects.

PRA management is widely lauded as the best in its class. What earns it these accolades?

  • Refusal to overpay: Debt purchases target specific rates of return that provide long-term business value. A prospective purchase that fails to meet this hurdle is discarded.
  • Continuous improvement: Collector productivity (cash collections per hour paid) has risen 48% since the company's 2002 IPO.
  • Alignment with shareholders: Management's is under mandate to own a certain amount of stock. The company's vice president of acquisitions (the guy who knows how that debt will collect) just plunked down $200,000 of his own money to buy more shares.

Why is it cheap?
Simply put, fear. Fear that a slowing economy and imploding mortgage market will make collecting on debt more difficult. I consider this fear misplaced; most of PRA's purchased debt was charged-off two, three, or more years ago. In other words, these aren't the debts of recent subprime mortgage borrowers. These debts were incurred by folks who had their own personal subprime crises years ago. 

Similarly, a recent slowing of cash collections has translated to lower current earnings, and the market is extrapolating these events into the future. But the seeds of salvation are already apparent. Remember, new debt purchases are up 114% year to date. Big spending today translates into ever-greater cash collections tomorrow.

Meanwhile, relative to its own history, PRA is C-H-E-A-P:

P/E Ratio

Enterprise Value/Cash Collections (trailing)

Enterprise Value/Expected Remaining Cash Collections

Current

13.2

2.43

0.91

Median*

20.6

3.31

1.52

Minimum*

14.7

2.62

1.00

Maximum*

29.5

5.22

2.23

* Since December 2002. All calculations use month-ending prices, and are calculated on a rolling-12-month basis.

Put simply, PRA trades for less than its estimated future collections -- assuming it never buys another portfolio. That's too low, Fools.

The Foolish bottom line
I think Portfolio Recovery is the best Black Friday Bargain Stock, but tell us what you think in Motley Fool CAPS. Based on your responses, we'll declare the best bargain stock early next week.

Ready for more Fool-light specials? Dash to the rest of the series here.


Read/Post Comments (2) | Recommend This Article (67)

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 November 26, 2007, at 6:32 PM, mmpitcher wrote:

    Im new to stock trading but your articles make perfect sense. This was a very useful in the thought process behind selecting stocks.

    Thank you for all you do.

    Missy

  • Report this Comment On December 03, 2007, at 12:41 PM, rindy wrote:

    Also take a look at JVI, newly listed on the AMEX

    They collect their receivables via a successful, outsourced litigation model

    -Rindy

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