ITJTY - Intrum: Financing Costs Are A Problem

2023-06-14 11:10:09 ET

Summary

• Intrum is at the fringes in terms of companies that depend on consumer credit. Cost to collect has risen on account of weaker disposable incomes.
• Moreover, higher net financing costs are becoming a major headwind for the bottom line.
• But the P/B is pretty low at around 0.36x and the dividend is likely going to be nearing the 10% mark, where it should be technically sustainable.
• However, we feel that, in a business where WC requirements are so high and ROICs are likely to fall, investors need to exercise caution.
• There is downside in being a European consumer credit company, where stickier European employment should play in Intrum's favour.

Intrum ( ITJTY ) is a Nordic company with exposure across Europe in the realm of consumer credit. As explained in our last article, the company has a business model whereby they guarantee or buy receivables from companies like telecom companies in order to reduce their bad-debt risk. They are on the hook for non-repayment of consumer debts, if that comes to pass. Weakening conditions for the consumer are an issue for ROICs, and the cost of collection is rising as credit qualities fall. The main Intrum engine is sputtering, and this isn't good for the dividend and explains the precipitous decline in the stock price. While valuations are small with Intrum, we think that both the operational engine as well as the interest-compressed bottom line are a danger to investors. It's best to stay away.

Note on Q1 2023

Intrum generates cash from the receivables it's invested in and becomes successfully collected. The ROIC is the metric to follow to understand how profitable these investments are.

In order to maintain cash flows, almost all of the proceeds are going to need to be reinvested into new assets given that ROICs have contracted. The reasons for this come down to the simple matter that disposable incomes have fallen. Employment is still fine, and we maintain that the sticky employment situation in Intrum's European markets should assure that, falling disposable incomes make the collection likelihood less as consumer credit worsens.

The lower ROIC correlates directly to the functional working capital intensity of the business, in this case, the working capital being investments into new receivables. Lower ROIC means less space for the dividend, which is nearing a 10% yield, although the dividend doesn't have a stable history, and we don't know what's coming next.

Around 20% of the debt is floating rate , and this pressure has been very visible on the bottom line results.

Interest expenses have driven all of the SEK300 million increase we see in that line item, and it has had a very material impact on earnings, about as much as the higher collections costs are having on the business. SG&A was also inflating by about SEK100 million, and all of these cost issues, together accounting for about SEK700 million, are going to be in the crosshairs as Intrum tries to counter with a cost reduction programme seeking about SEK600 million in cost reductions. They hope to achieve this run-rate reduction by the end of 2023, but we have no idea if they will succeed.

Bottom Line

Intrum's markets span Europe, primarily southern European countries and then quite a bit of Norwegian exposure as well as Eastern Europe. All of these countries are dealing with a more pronounced inflation issue stemming from Russian energy dislocation. At the same time, unions and labour protections mean employment is stickier, and therefore doomed consumer conditions are less likely than in the US. Nonetheless, worsened credit conditions do affect Intrum a fair bit. While it's difficult to say what is a sustainable dividend for Intrum, it seems that the dividend as it currently stands between SEK6-7 per share may be under pressure. If there's a 6% ROIC as of now, the vast majority of the ~50 operating cash flow per share needs to be invested just to keep cash flows flat and not shrinking. As of the FY, cash balances had to fall due to repayment, and they are struggling to grow in this latest Q1 due to dividend action needing financing to keep cash steady. Leverage is also getting high at 4.2x. Investing to keep it flat already uses the residual that could be budgeted for the dividend. ROICs need to rise, and the cost reduction programme will be important as economic conditions are unlikely to improve over the next 6-12 months given the likelihood of continued rate hikes. The <0.4x P/B is appealing from a valuation perspective, but the economics of the business are affected by the downturn quite a bit, and if the current price is still riding on a good dividend, there could be more disappointments ahead.

For further details see: