Portfolio Recovery's Acquisitions Show Potential; Rising Expenses a Concern - Analyst Blog

On Jul 7, 2014 we issued an updated research report on Portfolio Recovery Associates Inc. PRAA. We believe that the company's purchase of finance receivables, its diversified portfolio, strong balance sheet and inorganic growth strategies position it well to generate long-term growth. The acquisition of Aktiv Kapital should also increase estimated remaining collections ERC, investment in new portfolios, cash collections and improve earnings going forward. However, the competitive accounts receivable management industry, drop in the total estimated collections to purchase price ratio and higher interest expenses are concerns.

Portfolio Recovery remains a small but significant player in a large debt market, with focus on quality and profitability rather than pure volume growth. The company deploys significant sums to acquire debt. The strong balance sheet of the company further enables it to invest in a growing portfolio of acquired accounts in North America and Europe. Moreover, Portfolio Recovery's bottom-line results have shown great improvement over the past few years. In particular, with improvement in the fee-for-service business, the company has been able to surpass its return on equity target.

Apart from its primary debt collection business, Portfolio Recovery has expanded into government collections, audit services and claims settlement with the acquisitions of IGS Nevada, Alatax, Broussard Partners, MuniServices, Claims Compensation Bureau and Mackenzie Hall. Moreover, with the closure of the pending acquisition of Aktiv Kapital, the company's ERC is expected to outperform the historical highs and be accretive to new cash collections, revenues and earnings growth. Additionally, the pending acquisition of the IVA Master Servicing Platform from Pamplona Capital Management bodes well for long-term growth.

On the flip side, Portfolio Recovery faces considerable challenges in acquiring defaulted consumer receivables and obtaining placement of fee-for-service receivables, given the highly fragmented and competitive nature of the accounts receivable management industry. Moreover, Portfolio Recovery has been facing mounting operating expenses since 2007. We expect a further rise in expenses in the coming years, unless an effective cost management policy is adopted.

In several of the past quarters, rising borrowing costs and increasing leverage have been resulting in higher interest expenses for Portfolio Recovery. Notably, a newly acquired debt takes some time to begin generating cash and increases interest expenses immediately. As a result, the higher interest expense creates a greater adverse impact on the net income.

Earlier Portfolio Recovery reported first quarter 2014 earnings that were in line with the Zacks Consensus Estimate. Notably this Zacks Rank #3 (Hold) stock delivered positive earnings surprises in three of the last four quarters with an average beat of 12.01%.

Other Stocks to Consider

Better-ranked stocks in the financial services space include American Express Company AXP, Apollo Residential Mortgage, Inc. AMTG and SS&C Technologies Holdings, Inc. SSNC. All three stocks have a Zacks Rank #2 (Buy).