Buying distressed debt portfolios from mainstream lenders and wringing value out of them is fuelling robust growth at debt management specialist Arrow Global (ARW). Moreover, with plenty of loan books still up for sale, that impressive pace looks thoroughly sustainable. All of which leaves Arrow’s shares too cheaply rated compared with those of financial service sector peers with less exciting prospects.
- Growing fast
- Specialist collection skills
- No shortage of debt books to buy
- Shares undemandingly rated for sector
- Paying more for portfolios
- Regulatory burden is growing
Based on data from management consultant OC&C, the UK debt purchase market is expected to grow at an annual compound rate of 11.5 per cent between 2012 and 2017. That significantly reflects regulatory pressure on banks to boost capital and writing back provisions by shedding non-performing loans is a great way to do that. Essentially, Arrow shouldn't struggle to find books to buy. Moreover, Arrow’s prospects aren’t limited to the UK. It already boasts a portfolio in Portugal with a face value of over €1.2bn (£1bn) and is eyeing further opportunities in the European market. During the first quarter alone, Arrow purchased debt portfolios with a face value of £246m, bringing its total portfolio’s face value to £9.7bn. Analysts at broker Numis Securities expect Arrow’s share of the debt purchase market to reach around 9 per cent by 2015 from just 2 per cent in 2010.
Funding further acquisitions shouldn't be problematic, either. Not only did Arrow’s IPO last October raise £42m, but it issued £220m-worth of senior secured notes in January 2013 and also boasts a £55m revolving credit facility. True, buying portfolios is bolstering the group’s net debt burden, which rose by over £23m in the first three months of the year to £201m. But, representing just over twice adjusted cash profits, that’s not perceived by analysts as overly burdensome.
ARROW GLOBAL (ARW) | ||||
|---|---|---|---|---|
| ORD PRICE: | 229.5p | MARKET VALUE: | £400m | |
| TOUCH: | 229.5-230p | 12-MONTH HIGH: | 278p | LOW: 207p |
| FWD DIVIDEND YIELD: | 2.7% | FWD PE RATIO: | 11 | |
| NET ASSET VALUE: | 62p | NET DEBT: | £201m | |
| Year to 31 Dec | Turnover (£m) | Pre-tax profit (£m)* | Earnings per share (p)* | Dividend per share (p) |
|---|---|---|---|---|
| 2011 | 50 | 6.2 | na | na |
| 2012 | 66 | 14.0 | na | na |
| 2013 | 95 | 33.5 | 16.1 | nil |
| 2014* | 102 | 37.5 | 16.8 | 4.7 |
| 2015* | 123 | 48.8 | 21.8 | 6.1 |
| % change | - | +30 | +30 | +30 |
*Panmure Gordon forecasts, adjusted PTP and EPS figures Normal market size:10,000 Matched bargain trading Beta: 1.25 | ||||
Arrow's success, however, is about more than merely buying loans - generating a better return than the vendors could manage is key. With a return on equity of 26.5 per cent, Arrow is certainly managing that. This comes down Arrow’s robust data collection and analysis skills, allowing it to better determine which borrowers can best pay off their debts and by how much. This focus, estimates Numis, allows Arrow to typically enhance the number of paying customers in a portfolio by 50 per cent - and that’s after the vendors and various debt collection agencies have already worked hard to bolster collections. "We believe the data and analytical skills of Arrow are very hard to replicate and consequently make the group’s superior returns sustainable," reckons Numis.
Still, it is getting costlier to buy debt books. The first quarter's total portfolio acquisitions cost the group £33.2m, which implies a purchase price of 13.5p per pound of face value. That’s materially higher than the 4.2p level paid by Arrow out in 2013's first quarter. This, however, reflects "underlying asset quality more than competitive dynamics," say analysts at Goldman Sachs. The investment bank reckons that better recoveries and lower associated collection costs should support returns.
Regulatory change is another issue. There has been an increased focus on collection practices in recent years, leading to more stringent compliance requirements for debt purchasers. In April oversight for the sector passed from the Office of Fair Trading to the Financial Conduct Authority, too, bringing with it more regulation - potentially involving extras cost.
