We bought Asset Acceptance Capital (AACC) on Feb. 10 and Aug. 9 for an average price of $16.96. So far, we’re down 5%.
Last Thursday, The Motley Fool considered Portfolio Recovery Associates (PRAA) as its best small-cap pick for 2007. The firm is a debt recovery company that competes directly with our own Asset Acceptance Capital.
The Fool pointed out that the opportunity in this field is immense. Americans have a negligible savings rate and are facing high gas prices, rising interest rates, negatively amortizing mortgages, and tapped-out home equity.
From Jim Gillies at the Fool:
Then consider Americans’ collective use of debt to finance their lifestyles — to the tune of $2.37 trillion as of November 2006, according to the U.S. Federal Reserve. But to be raw material for PRA, or competitors such as Asset Acceptance or Encore Capital (ECPG), that debt needs to default, and be charged off and sold into the market. And it is, in hefty amounts — $128 billion in 2005 according to The Nilson Report. How’s that for opportunity?
We, of course, know all this. That’s why we bought Asset Acceptance twice already.
Let’s compare the Fool’s choice in the industry to ours and see who owns a stock with more potential.
First, the Fool’s PRAA ($47.46):
Market cap = $756 mil
Forward P/E = 15.3
PEG ratio = 1.0
PSR ratio = 4.2
Profit margin = 24%
Return on equity = 20.3%
Quarterly revenue growth = 27.5%
Quarterly earnings growth = 20.4%
Total cash = $27 million
Total debt = $1 million
200-day moving price average = $44.03
Insider ownership = 7%
Next, our AACC ($16.14):
Market cap = $570 mil
Forward P/E = 11.5
PEG ratio = 0.9
PSR ratio = 2.4
Profit margin = 17%
Return on equity = 16.4%
Quarterly revenue growth = -7.5%
Quarterly earnings growth = -22%
Total cash = $33 million
Total debt = 0
200-day moving price average = $17.07
Insider ownership = 80%
What we see is a difference of philosophy. The Fool has flagged the leader, which is growing well and selling at a higher price, to tap the potential of the industry. We have flagged the laggard, which has stumbled and is selling at a lower price. The Fool is betting on continued leadership; we are betting on a turnaround.
Each is a legitimate approach. I’m encouraged by AACC’s 80% insider ownership, one of the highest figures on the market. You can be sure that the people in charge of the firm want to see it get back to strong growth figures and a higher stock valuation.
Because of AACC’s problems, which it’s in the process of fixing, the stock is available at a price-to-sales ratio half that of PRAA’s. In other words, we get twice what a PRAA investor gets in terms of sales per dollar invested.
The reason we get that is that the company’s problems have made investors less willing to pay up for the shares. This is the essence of value investing. We are betting that down the line, AACC will right itself, improve its numbers, and investors will pay up for the stock and send it rising at a faster pace than the stock of PRAA.
Currently, AACC loses in comparisons on profit margin, return on equity, growth, and stock performance. Will that change as the company continues its turnaround? If you think so, as I do, then buying the stock makes sense.
Let’s examine some different recovery scenarios.
AACC should get better at acquiring recoverable debt as cheaply as possible, thereby improving its profit margin. It should also grab a greater percentage of the market’s debt, thereby improving its growth.
If its P/E stays the same, but earnings grow 15% next year instead of the 11% estimated, the stock will rise to $16.93. If the P/E expands to 15, matching PRAA’s, then the stock will rise to $22.08. In the former scenario, we would break even. In the latter, we would gain 30%.
This is looking at just the math. The market never sticks with just the math. As a company turns itself around, excitement levels rise and the P/E expands. For instance, the Dow’s P/E is currently 17. If AACC came to match that, its stock would rise to $25.02, giving us a gain of 47%.
Now, how do the earnings projections stack up? In AACC’s favor. This year, it’s seeing earnings drop 21%. Next year, they’re slated to grow 11%. PRAA, on the other hand, is on track to grow earnings 20% this year, but slow to 13% next year.
The market focuses on expectations and momentum. If these two industry heavyweights converge in the 11-13% growth range next year, but AACC accelerates to it while PRAA slows to it, then AACC’s stock should be the better performing of the two.
One thing we can count on is that the insiders at AACC who own 80% of the stock will do all they can to make that happen.
