My two favorite small caps reported earnings over the past week, and as growth stocks, they are not disappointing. In fact, their numbers are phenomenal, and regulatory changes are working very much to their favor. I’m speaking of debt collectors Portfolio Recovery Associates (PRAA) and Encore Capital Group (ECPG).
A quick look at each before going into what makes these small caps such great buys:
Portfolio Recovery’s net income exploded to $47.3 million, or 93 cents per share. That not only beat estimates by 5 cents, but also represented a 60% increase over last year, and margin improvement from 37.9% to 40.2%.
This came on a 31% increase in revenues, the result of robust double-digit gains in every single category — 27% in cash collections, 24% in call center collections, 21% in external legal collections, 30% on internal legal efforts, and 32% on PRAA’s newest area: bankruptcy court trustee collections.
These numbers are, simply put, astronomically great.
Portfolio Recovery is buying debt on the cheap, by issuing cheap capital (such as 3% convertible notes), then executing on all forms of collection. PRAA has $109 million in cash with which to purchase more debt, and $217 million left on its credit line.
Encore Capital, which is about half the market cap of Portfolio, saw equally strong results. ECPG earnings came in at $1.02, beating estimates by 9 cents, and up 24% YOY. The revenue generated from the company’s collections portfolio increased an astonishing 60% to $235 million over last year, coming on a 54% increase in gross collections obtained.
Encore Capital has moved into a rather specialized, but competitive, space of buying up tax liens and collecting on them. This transaction involves Encore buying defaulted tax liens from municipalities and collecting on the unpaid taxes. Because the tax lien has priority positioning, even over most bank mortgages, it’s a transaction collateralized by the underlying real estate.
ECPG also has plenty of cash to buy debt, with $271 million on their credit facility and $110 million in cash. The company also recently expanded into the U.K. with an acquisition, and also expanded operations here with the purchase of formerly publicly held Asset Acceptance Corporation.
Why Debt Is Best
Both companies are benefiting from the regulatory environment. Financial institutions that hold the original debt have been frightened by the Consumer Financial Protection Bureau, fearful that if they just sell off debt to any ol’ agency, that the feds will come after them for any unfair debt collection practices.
Consequently, the holders of bad debt are insisting on strict compliance requirements that any debt-buyer must meet if they wish to purchase debt.
If you know anything about financial services compliance, then you know it is not only burdensome but extremely expensive. The result is that many smaller players — even ones that have been around a long time — are seeing their supply of debt dry up because they are unable to meet compliance requirements.
In turn, both PRAA and ECPG, which have the experience and deep pockets to handle these burdens, are getting a bigger bite of the apple.
With consumer debt running into the trillions, there is ample supply for years to come. The explosive growth both companies are seeing in the availability of debt, and their collection of it, sets these companies up for strong long-term growth.
Analysts peg long term annualized growth for both companies at around 15%. I think it’ll be closer to 20%, meaning the 80% to 90% returns we’ve seen so far in these stocks over the past 12 months is likely to occur again.
And frankly, if we see better than 20%, both stocks could easily double again in the next year.
As of this writing, Lawrence Meyers was long PRAA and ECPG. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at firstname.lastname@example.org and follow his tweets @ichabodscranium.