Home / Opinion / Is Credit Corp (ASX: CCP) an effective recession hedge?

With markets taking a battering, inflation soaring and central banks accelerating interest rate rises, it's no easy task finding places to invest (or hide) on the ASX. One such company thought to thrive in economic downturns is Credit Corp Group Limited.

With markets taking a battering, inflation soaring and central banks accelerating interest rate rises, it’s no easy task finding places to invest (or hide) on the ASX. One such company thought to thrive in economic downturns is Credit Corp Group Limited (ASX: CCP).

The company provides debt collection and consumer lending services. It buys purchased debt ledgers (PDLs) from banks and utilities, which contain defaulted bills and loans that the institution hasn’t been able to retrieve. Typically the best time to purchase PDLs is during a downturn when the expected recovery is low and thus cheaper for purchasers like Credit Corp. Credit Corp pays the client an upfront payment, usually ten cents on the dollar and collects upwards of twenty cents. It’s a tough industry littered with examples including its former biggest competitor Collection House (ASX: CLH) paying too much for PDLs and subsequently going under.

Fortunately, Credit Corp is steered by long-standing chief Thomas Beregi. He weathered the Global Financial Crisis as CFO in 2007 and was later appointed CEO in 2008 when the business needed rebuilding due to prior mismanagement. Ever since Beregi has built a foundation of pricing and risk management excellence, underpinned by compliance and sustainable practices. Credit Corp has never had a regulatory investigation and achieves notably lower external dispute resolutions than its competitors. Subsequently, the business is the clear number one in Australia and is making inroads into the US which is about ten times the size of its home market.

The past 18 months have been somewhat of a goldilocks period for Credit Corp. Unemployment in the US and Australia has hit record lows and household savings have increased dramatically.

Consumers have used government handouts and bank moratoriums to pay down debt and implement repayment plans. As a result, collections revenue has been strong leading to a record FY21 result. The flip side of a strong consumer is that PDL volumes have been below historical levels. Banks are recording lower arrears and defaults (also known as chargebacks), reducing the need for Credit Corp’s debt buying services.

Fast forward to today and credit balances have begun to normalise. In the US, personal lending is back at 2020 levels. Australia is better positioned. Outstanding credit balances are 37% below pre-pandemic levels. But the consumer is starting to feel the pinch, with the ANZ-Roy Morgan consumer confidence reaching the lows of April 2020. An increasing amount of economists expect a US recession. Meanwhile, the Reserve Bank of Australia’s commentary suggests it will do what is necessary to kill demand and tame inflation, even if it means sinking markets and the economy.

To get an idea of how Credit Corp behaves in a recession, investors should look to the Global Financial Crisis (GFC). Earnings initially suffered as it provisioned for higher unemployment and worsening economic conditions. But soon afterwards the business was able to grow collections and cash flow every year from 2007 onwards. Even as unemployment peaked at 10% and the US housing market collapsed, competitors Encore Capital (NASDAQ: ECPG) and PRA Group (NASDAQ: PRAA) noted payer rates and average payment size remained constant. Overindebted competitors collapsed, leaving Credit Corp to buy PDLs on the cheap and supercharge profit growth.

Today’s landscape has similarities to the GFC but is not identical. For example, unemployment is at record lows. Interest rates fell 5% during the GFC which supported households whereas today central banks are trying to do the opposite. Inflation is also eating away at incomes. Despite history suggesting collections should provide resilient, it’s difficult to see how a deteriorating economic backdrop doesn’t impact Credit Corp. At the very least, the business will struggle to record growth as it cycles the recent favourable collection environment. US peers, which are six months further ahead in the cycle, have seen collections drop off circa 20%

Fortunately, the business will be ready to capitalise on any downturn. It’s already booked a 13.5% loan impairment from when the pandemic hit. Credit Corp also has $396 million in undrawn debt facilities and zero debt.

Currently trading on 15x earnings, Credit Corp looks relatively cheap given its historical growth rate. But those earnings are elevated going into FY23, leaving a smaller margin of safety. If a  recession eventuates, the market will shoot first and think later as Credit Corp’s earnings take a temporary dip. This happened during the GFC when the share price collapsed over 90% and at the start of the pandemic when it dived 72%. Subsequently, Credit Corp is not an effective hedge against a recession, with the caveat that it is a long-term beneficiary once economic conditions recover. That’s the time to jump in, knowing that Beregi and his management team are executing on delivering the next decade of growth for shareholders.

The author owns shares in Credit Corp.