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My Second-Cheapest Stock Is Up 20% — Here’s Why

A few weeks ago, I wrote that the second-cheapest stock I could find was Portfolio Recovery Associates (NASDAQ:PRAA). This neat company operates in a classic Peter Lynch business — one that’s distasteful, albeit for no good reason.

PRAA is a debt collector. It buys up defaulted debt at roughly 8.5 cents on the dollar, then sends its team of people to collect on those debts.

I’ve never understood why Americans hate debt collectors. It seems to me that if you borrow money, it’s your responsibility to pay it back. If you don’t — and worse, if you run away from that obligation — what’s wrong with the lender trying to get his money back?

It’s also an interesting business — one that’s part science and part art. Debt collectors need to try every legal tactic they can to get people to honor their obligations. It might be a lump sum payment, or a recurring payment plan. Sometimes the company has to resort to legal remedies, which might be internal or external. They can even squeeze revenue out of bankruptcies.

Regardless, I love creativity in business, and this is the ultimate business for exactly that!

The reason PRAA has popped up 20% since my recommendation is that the company reported some great earnings. The report sheds light on why this is such a great business, and what to do going forward.

Portfolio Recovery’s numbers were great. Cash collections were up 27% year-over-year, revenues were up 31%, net income up 35% and diluted EPS up 35%. For the full year, revenues soared from $459 million to $593 million, net income was up 26% to $126 million and diluted EPS went from $5.85 to $7.39.

The company has $32 million of cash on hand, long-term debt of $200 million and $127 million drawn on a revolver. PRAA is able to borrow that money at a rate that is much less than what it collects, so it’s a form of arbitrage that is working very nicely.

This business is about properly assessing portfolios of debt that the company has the opportunity to buy, getting it at the right price, hiring the right people as collectors, and generating a solid return on equity (which it does, at about 21%).

Why am I so optimistic about the company going forward?

For starters, Portfolio Recovery is what I consider a perpetual cash machine. Americans continue to deleverage, but there are trillions of dollars in outstanding debt held by the American consumer. With wages stagnant and unemployment still high, some debt will simply go unpaid, and that amount is going to be in the hundreds of billions.

While I wouldn’t say there is a high barrier to entry in this business, there are significant barriers. It requires proper debt portfolio assessment, the capital to purchase the portfolio, and the talent to collect on it. That’s all specialized stuff, because a bank won’t just throw money at any old debt collector with which to purchase defaulted debt.

PRAA pumps out cash flow — about $130 million in the TTM. As long as its debt service remains in the 3%-4% range, that cash flow might eventually be able to provide a dividend to investors.

In any event, the company is expected to grow EPS at a 20% rate this year, 12% next year and 15% over the long-term. A 15x multiple on earnings of $8.90 give a rough fair-value target of $133, which suggests another 12% upside exists before we even hit that target.

If you want to take a multi-pronged approach, investors can buy into Visa (NYSE:V) and MasterCard (NYSE:MA) to take advantage of the global propensity to charge purchases … then buy into Portfolio Recovery to buy into the inevitable charge-offs that comes from spendthrifts.

Lawrence Meyers owns shares of Portfolio Recovery Associates. He is president of PDL Capital, 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 and follow his tweets @ichabodscranium.

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