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Portfolio Recovery Stays Neutral

Zacks Equity Research

We reiterate our Neutral recommendation on Portfolio Recovery Associates Inc. (PRAA) as its operating efficiency, increased cash collections and benefits of diversification are offset by rising operating and interest expenses. Stiff competition and relatively low barriers to entry are the other headwinds.

Portfolio Recovery reported fourth-quarter 2011 operating net income of $1.54 per share, which surpassed the Zacks Consensus Estimate of $1.52 and the prior-year earnings of $1.20 per share. Operating net income amounted to $26.6 million compared with $20.6 million in the fourth quarter of 2010.

Portfolio Recovery remains a small but significant player in a large market, with a focus on quality and profitability rather than pure volume growth. Since its inception in 1996, the company has recorded an average cash collection rate of 2.42 times the purchase price for acquired debt.

Both cash collections and collector productivity (cash collections per hour paid) continue to remain at record high levels with improved leverage at Portfolio Recovery’s operating call centers. Moreover, the company’s strong operating cash flows allow it to take advantage of inorganic growth opportunities.

Portfolio Recovery has also expanded beyond its primary debt collection business into government collections, audit services and claims settlement through various acquisitions. These acquisitions have further boosted the company’s revenues, expanded its geographic presence and increased its competitive strength against its peers such as Asta Funding Inc. (ASFI) and Encore Capital Group Inc. (ECPG).

However, Portfolio Recovery faces ample challenges in acquiring defaulted consumer receivables and obtaining placement of fee-for-service receivables due to the highly fragmented and competitive nature of the accounts receivable management industry. Additionally, operating expense has been escalating since 2007, leading to a decline in operating margin.

Moreover, rising borrowing costs and increasing leverage have resulted in higher interest expenses over the past several quarters. Since a newly acquired debt takes modest time to begin generating cash but increases interest expenses immediately, the higher interest expense hits faster and creates a huge impact on the net income.

The Zacks Consensus Estimate for Portfolio Recovery’s first-quarter 2012 earnings stands at $1.31 per share, down an estimated 2.4% from the year-ago quarter. For 2012, earnings are expected to be $6.59 per share, a forecasted growth of 13.4% over 2011.

Currently, Portfolio Recovery carries a Zacks #3 Rank, implying a short-term Hold rating.

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