PRAA - PRA Group: Appears Undervalued And Loan Supply May Increase

Summary

• The main business of PRA Group is the management, catalog, and acquisition of loans with no or negative yield.
• The company expects a significant amount of estimated remaining collections in 2023 and 2024, more than $1.4 billion in cash collections in 2023.
• Cash receipts don’t really seem to stop during the economic crisis. At least they didn’t fall from 2008 to 2011, and they did behave well during COVID-19.

Loan buyer PRA Group, Inc. ( PRAA ) expects significant cash collection from underperforming loans in 2023 and 2024. Even if the numbers in 2022 were not that beneficial, I believe that PRAA is a must follow stock. Let’s keep in mind that the company’s business model behaves well during recessions or health care emergencies. I ran a cash flow statement model, which implied a stock valuation that appears significantly more expensive than the current stock price.

PRA Group

With facilities in Australia, Europe, and the Americas, PRA Group is a business and financial services company with international reach. The main business of this company is the management, catalog, and acquisition of loans with no or negative yield. The company’s business model appears significantly diversified with loans from the United States, U.K., Europe, and Australia.

The central operations segment is dedicated to the purchase of loans or credits from companies such as Visa ( V ) or Mastercard ( MA ) as well as private lenders, other credit cards, lines of credit, and legal situations among others. Vendors include banks, credit unions, finance companies, and retail establishments. The prices depend on the age of the loan, the geography of the operation, and other related conditions at the discretion of the seller and the company's experience in managing this type of asset. Purchases by PRA Group are made primarily through auctions and negotiations.

PRA Group conducts operations in call centers as well as legal actions. Call center operations, primarily within the United States, are for large markets. Legal actions usually have long resolution periods, and have the highest income when they are strategically located. The insolvent operations section locates situations of this type in Germany, the United States, and Canada. Also, PRA Group has digital platforms for the location and acquisition of debts.

There are a few reasons that make the PRA Group quite an attractive company right now. First, the company’s business model appears to behave well under recessions. Cash receipts don’t really seem to stop during the economic crisis. At least they didn’t fall from 2028 to 2011, and they did behave well during COVID-19. According to management, during recessions , there seems to exist more supply of loans to purchase.

It is also worth noting that the company expects a significant amount of estimated remaining collections in 2023 and 2024. We are talking about more than $1.4 billion in total collections in 2023, and more than $1 billion in 2024.

Finally, I believe that readers would appreciate the company’s cash efficiency ratio, which was equal to 65% in 2022, 68% in 2021, and 61% in 2020. I believe that we are talking about a profitable business model.

The Figures For 2022 Were Not As Good As In 2021, But The Company Continues To Acquire Assets

The revenue for 2022 included $520 million from the United States, $181 million from the United Kingdom, and $966 million from other countries. The numbers in 2021 in the U.S. and other countries were better than that in 2022.

With that, the company continued to find suitable loans in very different industries. For Q4, the company acquired loans from major credit card vendors worth $10 million, and loans from private label credit cards worth $60 million. In Q4 2021, the company acquired more loans than that in Q4 2022.

Balance Sheet

As of December 31, 2022, the company reported cash worth $83 million, investments of $79 million, finance receivables worth $3.29 billion, and income taxes receivable of $31 million. Deferred tax assets stood at $56 million with rights of use assets of $54 million.

Non-current assets include property and equipment worth $51 million, goodwill of $435 million, other assets worth $86 million, and total assets of $4.17 billion.

The asset/liability ratio is more than 1x, and PRA Group reports a good amount of cash. I believe that the company's balance sheet appears in good shape.

With respect to the list of liabilities, PRA Group reported accounts payable worth $7.329 million, accrued expenses of $111 million, and income tax payable close to $25.693 million. Besides, debt includes interest bearing deposits worth $112 million and borrowings close to $2.5 billion. Finally, total liabilities stood at $2.89 billion.

It is worth noting that the total amount of debt decreased in 2022. With that, many investors will likely not be interested in PRA Group because of its total amount of debt. Under my cash flow model, I believe that CFO growth and future net income could justify the total amount of debt, however I understand that certain investors are a bit skeptical.

Market Expectations Include Sales Growth In 2024 And 2024 Operating Margin Of 30%

Expectations for 2023 and 2024 include 2023 net sales of $901 million with 2024 net sales of $959 million. The operating margin would stand at close to 28.5%-30% with net income close to $80 million in 2023 and $109 million in 2024. Interestingly, PRA Group reported positive FCF/Sales in 2020 and 2021, but analysts don’t expect positive free cash flow in 2023.

Valuation

My valuation model includes 2033 net income of $48.854 million together with a share based compensation expense of $1.506 million, a depreciation and amortization of close to $0.520 million, and an amortization of debt discount of -$38,823 million. Note that I expect a small decline in net income for the next ten years with growing stock compensations. 2033 changes in expected recoveries would stand at -$150 million with 2033 deferred income tax of $258.632 million and changes in net unrealized foreign currency transactions of around $136.171 million.

I also assumed 2033 changes in operating activities close to $3 million, other assets close to $73.6 million, changes in accounts payable of $27.768 million, changes in income tax payable of $59.439 million, changes in accrued expenses of -$90.397 million, and other liabilities of -$29.500 million.

Besides, with net cash provided by operating activities of $303 million and 2033 capex of $1.075 million, I obtained 2033 free cash flow of $304 million. Note that the previous assumptions lead to positive FCF around 2025 and FCF growth from 2025 to 2033. I believe that my numbers are conservative.

Like other investment advisors, I assumed a WACC close to 6.07% , which implied a NPV of future free cash flow of $772.845 million. Also, with a residual value of $4.26 billion obtained from an EV/FCF multiple of 14x, I obtained an enterprise value of $5 billion together with an equity value of $2.51 billion. Considering that the company traded at more than 100x FCF in the past, I believe that my EV/FCF multiple of 14x is conservative.

Note that I am assuming borrowings close to $2.5 billion and cash close to $83.5 million. Finally, with a share count of 38.980 million, the target price would be $65 per share.

Risks

In relation to the risks that PRA Group experiences, we must focus primarily on the risks due to changes or legal disputes and regulations for the operation of its business both in the United States and globally.

Besides, changes in inflation could affect the company's operations both positively and negatively. Similarly, the company depends on its successful acquisition and a high return on revenue to be able to finance and maintain the current state of its operations. If the loans acquired don’t perform as expected, I believe that the FCF and the net income would decline, which would lead to lower stock valuations.

I also believe that changes in the lending industry or changing credit origination strategies could be very detrimental for PRA Group. If credit origination becomes more sophisticated, nonperforming loans would most likely not become available, which may lower the company’s purchase opportunities. The company offered certain commentaries in this regard in the last annual report.

We cannot predict how our ability to identify and purchase nonperforming loans and the quality of those nonperforming loans would be affected if there were a shift in lending practices, whether caused by changes in the regulations or accounting practices applicable to credit originators or purchasers, a sustained economic downturn or otherwise. Source: 10-K

Conclusion

PRA Group buys loans from large banks, credit card providers, and consumer finance players, and tries to generate cash collections. I believe that it is a great moment to review the group because management noted significant cash collections expectations for 2023 and 2024. It is also worth noting that PRA Group’s business model appears to behave well during economic crises. In my view, even taking into consideration risks from regulars or lack of loan supply, the current stock price does not correctly reflect the true value of PRA Group.

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