Pioneer Credit (PNC)

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1 23 June 2014 Analyst Sam Byrnes Authorisation Chris Savage Pioneer Credit (PNC) Helping not chasing Recommendation Buy (Initiation) Price $1.55 Target (12 months) $1.80 Expected Return Capital growth 16.1% Dividend yield 3.0% Total expected return 19.1% Company Data & Ratios Enterprise value Market cap $80.7m $70.3m Issued capital 45.4m Free float 60% Avg. daily val. (52wk) $13, month price range $ $1.66 GICS sector Diversified Financials Disclosure: Bell Potter Securities acted as Co- Lead Manager in PNC's Initial Public Offering (IPO) and received fees for that service. Price Performance (1m) (3m) (12m) Price (A$) 1.60 Absolute (%) Rel market (%) Market disruptor model attracting flow PNC believes its distinct customer centric business model is a key differentiator in the Purchased Debt Ledger market and the reason behind its strong growth in debt ledger flows. PNC does not give deep discounts for early repayment of outstanding debts but instead assigns its customers a personal Account Manager to find a suitable payment arrangement. It operates with a view of creating a higher value customer in the future. PNC believes that this model is appealing to debt vendors because brand risk mitigation is more important than price in Forward Flow negotiation. Debt supply largely covered, down to execution Since its IPO on 1 May 2014, PNC has announced to the market that it has signed a Forward Flow Agreement with a major Australian bank that it did not previously have a Forward Flow program. It also announced that it has now substantially fulfilled its customer acquisition expectations underlying the FY2015 forecast disclosed in the prospectus at the time of the IPO. With debt supply now locked in, management needs to deliver its stated prospectus forecasts through collection efficiency and cost control. Investment view, BUY rating, PT $1.80 We believe existing Forward Flow Agreements from debt vendors combined with its differentiated customer centric model will underpin PNC s forecast ~36% compound EBIT growth for the three years to FY16. We are confident that PNC has the funding in place and the ability to execute on its stated strategy. We initiate coverage with a Buy rating and a 12 month Price Target of $1.80. We generate our valuation using a blend of Free Cash Flow Yield, PE ratio and EV/EBITDA. The Price Target is at a 16.1% premium to the current share price of $1.55 with a 19.1% total expected shareholder return. Absolute Price $1.7 $1.7 $1.6 $1.6 $1.5 Apr 14 May 14 May 14 Jun 14 PNC S&P 300 Rebased SOURCE: IRESS Earnings Forecast Jun Year end e 2015e 2016e Sales (A$m) EBITDA (A$m) EBIT (A$m) NPAT (normalised) (A$m) EPS normalised (cps) EPS normalised growth (%) n/a 48.1% 32.0% PER (on normalised EPS) (x) EV/EBITDA (x) Dividend ( ps) Yield (%) 2.0% 4.7% 6.2% Franking (%) 100% 100% 100% FCF yield (%) - normalised PDLs 0% 8% 12% ROE (%) 9.2% 13.0% 15.8% BELL POTTER SECURITIES LIMITED ACN AFSL DISCLAIMER AND DISCLOSURES THIS REPORT MUST BE READ WITH THE DISCLAIMER AND DISCLOSURES ON PAGE 20 THAT FORM PART OF IT. Page 1

2 Contents Investment case... 3 Key risks... 4 Business overview... 5 Industry overview... 8 Financials... 9 Valuation Board Major shareholders Page 2

3 Investment case Company description Pioneer Credit s (PNC) primary business is acquiring and servicing unsecured retail debt portfolios in the Purchased Debt Ledger (PDL) Market. It is headquartered in Perth and has representative offices in Sydney, Melbourne, Brisbane and the Philippines. PNC's debt purchases focus predominantly on credit card and personal loan accounts that are generally more than 180 days overdue. PNC does not invest in telecommunications or utility debt. Investment thesis We initiate with a Buy recommendation and PT of $1.80. Our positive view of the stock is based on the following: 1 Forecast strong earnings growth: We forecast compound EBIT growth over the next three years of 36% to FY16 driven by strong debt purchases driving future revenue growth. 2 Debt supply largely covered, down to execution: Since its IPO on 1 May 2014 PNC has announced to the market that it has signed a Forward Flow Agreement with a major Australian bank and that it has now substantially fulfilled its customer acquisition expectations underlying the FY2015 forecast disclosed in the prospectus at the time of the IPO. With debt supply now locked in, management need to deliver its stated prospectus forecasts through collection efficiency and cost control. 3 Market disruptor model attracting flow: PNC believes its particular customer centric business model is a key differentiator in the market and the reason behind its strong growth in debt ledger flows. PNC does not give deep discounts for early repayment but instead has Account Managers specifically assigned to customers to form an arrangement for regular payments to be made in the future with a view of creating a higher value customer in the future. PNC believes that this model is appealing to debt vendors because brand risk is more important to vendors than price in Forward Flow negotiation. PNC now has Forward Flow Agreements with three of the four major banks. 4 Previous debt purchases provide some visibility on future revenue: PNC s debt recovery model is based on recovering x the amount paid for debt ledgers over a 10-year period. Revenue is realised from debts purchased in previous periods, which gives us some degree of see-though to revenue. Also revenue is directly linked to customer payments resulting in high cash flow conversion providing earnings quality. 5 $1.80 Price Target: Based on a blend of Free Cash Flow Yield, PE ratio and EV/EBITDA we arrive at a valuation of $1.80. The Price target is at a 16.1% premium to the current share price with an 19.1% total shareholder return. Page 3

4 Key risks Risks facing PNC include but are not limited to: Debt Pricing: PNC price debt to buy from Banks and other institutions based on the amount it estimates it can collect from customers that are currently in arrears. The collection period extends over a number of years and revenue is booked along the way based on the book value of the debt. A lower rate of collection could result in PNC not meeting its targeted rate of return on its Purchased Debt Ledgers. Key Forward flow agreement: PNC has purchased debt from three of the big four banks in the past however, 85% of the debt purchased by PNC was from one financial group. Should PNC lose this Forward Flow Agreement, there would be severe reductions to the supply of debt to PNC. Since IPO, PNC has signed new clients that will diversify its supply of debt ledgers. Low visibility on pricing model: Investors have limited visibility on whether the company is compromising future returns by overpaying for assets to increase market share. We have no real see through on this and rely on the expertise and reliability of management. Execution of new product and service offering: PNC has indicated that it intends to broaden its service offering to become a larger more diversified financial services firm. The amount of investment (capital and operational) required, depending on the offering, could hamper its performance. PNC has indicated that it aims to offer first trial products to customers in late FY15, however there is no detail in the execution of this strategy just yet. We believe this risk is mitigated by PNC s existing customer base as the foundation for the new product. Customer acquisition is costly in any new business but should be less so for PNC selling to existing customers. Availability of debt for purchase: The Banks make up the majority of the debt that PNC and other competitors purchase. Banks ultimately control how much debt recovery they will do in-house and how much they will sell, meaning PNC s growth to some extent is reliant on the Banks propensity to sell its aged debtors and its inclination to sell to PNC. PNC has in place forward flow agreements to mitigate this risk and ensure a base level of debt is purchased. Economic conditions: Deteriorating economic conditions could reduce the customers ability to pay back debts on time according to payment arrangements. This would affect the rate of return PNC earns on its PDL assets. Similarly, positive changes to the economy can increase customers ability to pay and result in increased returns on its PDL assets. Poor economic conditions can also increase the amount of debt available for purchase and result in higher collections in future years. Efficiency of staff collection: The profitability of PNC relies on the efficiency of its people to collect its outstanding debt. There is a relatively high turnover of staff in collection roles which affects collection efficiency. Increased competition: New competition entering the PDL market could drive up prices for portfolios and put pressure on margins. PNC s existing Forward Flow Agreements are sufficient to supply PNC s growth requirements and there is little evidence of pricing pressure on PNC to date. Regulatory risk: PNC operate within a heavily regulated industry. Changes to the regulatory environment could have a material impact on PNC s future financial performance and its ability to operate in its current manner. Changes in regulations often bring added costs associated with achieving compliance of new laws. Page 4

5 Business overview Pioneer Credit (PNC) employs over 200 staff. PNC s strategy is based on customer service and rehabilitating its customers with the view of evolving them into new consumers. Company history PNC purchased its first debt portfolio in 2009 after being re-acquired by Managing Director Keith John. Since then it has signed numerous forward flow agreements, strengthened its relationships with its debt sellers and grown both its purchases and collections strongly. Figure 1 - Company history 2009 Keith John reacquires Pioneer Credit Dec-09 First monthly purchase of >$1m in a debt portfolio May-10 SOURCE: COMPANY DATA Banskia invests $2.8m in Pioneer. Banksia has since invested $8.1m in total. Banksia remains a 16.8% shareholder and has a board seat Oct-10 entered into its first Forward Flow Agreement with a major bank Jun-12 Customer payments exceed $14m Aug-12 Call centre relocated to Perth CBD tower Jun-13 Reaches purchases of ~$27m, FY13 EBIT $5.8m Aug-13 Opens Manilla call centre The above history illustrates that the company s history as a PDL purchaser is relatively short, beginning in PNC have however managed to grow its business relatively quickly to annual revenue of $16.6m as illustrated below. Figure 2 - FY13 EBIT by Reporting segments Figure 3 PNC performance history 100% Purchased Debt % 35% 30% 25% 20% 15% 10% 5% 0% Revenue EBIT ($m) EBIT margin % SOURCE: COMPANY DATA SOURCE: COMPANY DATA AND BELL POTTER SECURITIES ESTIMATES Differentiated customer centric model drives supply PNC's debt purchases focus predominantly on credit card and personal loan accounts that are generally more than 180 days overdue. PNC has not invested in telecommunications or utility debt as other major industry participants do. We do not expect PNC to enter this space given its strategy of building its customer base for future products we believe that financial product customers would be more attractive. PNC states that its business model is based on a customer service model meaning; It does not treat its customers as debtors, but customers with accounts; Its Account Managers are trained to work to understand its customer s situation and arrive at a realistic payment arrangement; and Account Managers are trained to build relationships with their customers and maintain contact, having regular thankyou hours where Account Managers call to thank performing customers for their payments. Page 5

6 Because of this customer centric model, PNC has never had a complaint at the Ombudsman close in the customer s favour. PNC believe that its record on customer service combined with paying a fair price for debt portfolios is the main reason for its purchases growth to date, and into the future. Figure 5 shows PNC s supply of debt purchased to date, by client. 85% of all debt purchased since inception has come from one financial group. This is the product of a relatively new business heavily relying on one relationship for business growth. As PNC grows, we expect the supply base of PNC s debt to broaden and reduce its risk to any one party. PNC have already announced the expansion of its supplier relationships with ne Forward Flow Agreements reached. Figure 4 - Historical aggregate debt purchases by type of debt Figure 5 - Historical aggregate debt purchases by client 8% 6% 4% 5% 44% 48% Credit Cards Personal Loans Other 11% 74% Client 1 Client 2 Client 3 Client 4 Clients 5-10 NB - Client 2 is a subsidiary of Client 1 SOURCE: COMPANY DATA SOURCE: COMPANY DATA How PNC purchases its debt PNC acquires debt portfolios either through one-off agreements or through Forward Flow Agreements. A Forward Flow Agreement is an arrangement where the acquirer agrees to purchase ledgers at an agreed price at regular intervals spanning the term of the agreement (usually 12 months). This allows both parties certainty on the minimum amount of debt to be sold. Currently, almost all of PNC s debt is acquired through Forward Flow Agreements as illustrated in figure 6 below. At IPO, PNC had seven purchase programs under Forward Flow Agreements with an average term of 16 months. Of these, five were with major banks and five of PNC s agreements are an extension or renewal of older agreements. Since IPO, PNC have announced new vendor partnerships and that it has now substantially fulfilled its customer acquisition expectations underlying its FY15 prospectus forecasts. The price PNC pays for debt varies according to the type, time in arrears, demographic of the customer and PNC s past experience with the issuer. PNC usually pays between cents in the dollar for its debt as shown in figure 7 below. Figure 6 - Forward flow contributions to debt purchases ($m) Figure 7 - what PNC pay for debt as a % of face value % FY12 FY13 1H14 Other Forward flows 80% 60% 40% 20% 0% 29% 39% 26% 2% 4% Weighted by face value c c c c <10c SOURCE: COMPANY DATA SOURCE: COMPANY DATA Page 6

7 How PNC recovers its debt PNC employs around 150 customer service staff between two call centres located in Perth CBD and Manila, whose job it is to work with its customers to come to a positive outcome on the outstanding debts. PNC allocates one Account Manager per customer in an effort to provide personalised service to each customer and to facilitate better outcomes. PNC seeks to enter into a Payment Arrangement with its customers. Payment Arrangements are designed to aid the customer in paying back as much of the debt as possible. PNC is much more likely to achieve a positive outcome on the debt if the customer has agreed to a structured Payment Arrangement. Figure 8 - Payment Arrangement key features Fixed Schedule Payment Arrangement No. of a/cs ~6,800 Average balance $9,304 Weighted average age of Arrangement 1.4 yrs Weighted average interest rate 14.9% Non Scheduled Payment Arrangement No. of a/cs ~2,100 Average balance $9,320 Weighted average interest rate 15.2% As at Dec13 SOURCE: COMPANY DATA Figure 9 - Payment Arrangement book balance ($m) SOURCE: COMPANY DATA H2 FY12 H1 FY13 H2 FY13 H1 FY14 Non Schedule Fixed Schedule Who are PNC s customers? Typically, the customers that PNC acquire from debt vendors have been in default of their payment obligations for at least 180 days. PNC believe that, at the time their account is acquired, the majority of customers cannot pay, despite their willingness to do so. Generally, an adverse event has affected their ability to pay and PNC believes that many customers recover from these events in time. The new consumer The business as it stands today is growing through debt portfolio acquisitions. Phase 2 of PNC s strategy is to become a seller of financial products to its customers once they have been restored to financial health, the new consumer. PNC is targeting offering first trial products to customers in late FY15. Currently we only consider PNC s existing operations when assessing the investment case of PNC. Once PNC has delivered on its near term customer acquisition strategy, we expect it to outline in more detail its plan for new products. Page 7

8 Industry overview PDL market Often vendors of debt portfolios invite a number of debt purchasers to bid for portfolios up for sale. Vendors evaluate the bids based upon price, reputation as well as other factors in determining whom to sell. Vendors are affectively selling customers accounts, and are aware of the potential for brand damage should debt collectors mishandle accounts. Two main players dominate the debt purchasing industry, Credit Corp (CCP) and Collection House (CLH). We estimate that these two companies represent ~75% of the market. Other smaller players include Pioneer Credit, Baycorp and NCML (owned by Thorn Group). We estimate that the market size in FY14 for Debt Ledger Purchases is ~$300m, which equates to a face value of $ b in debts written off and sold to the PDL market. Figure 10 - FY14 PDL market environment Expected FY14 PDL investment % on FY13 Pioneer Credit $30.2m 13.9% Credit Corp $135 - $140m (including US purchase) -1.5% to +2.1% Collection House $75 - $90m +44% to +73% Estimate for total market $300m SOURCE: COMPANY DATA AND BELL POTTER SECURITIES ESTIMATES Industry outlook The amount of credit extended to consumers as well as the financial health of consumers directly affects the amount of credit in arrears and therefore the availability of PDLs for purchase. Data released by the Reserve Bank of Australia suggests that consumer credit has grown at a CAGR of ~6.7% over the past 15 years. However, more recently, consumer credit growth has slowed to a 5 year CAGR of -1.7%. Household savings is another factor that affects the level of loans in arrears. In times of low household savings, borrowers may struggle to meet loan obligations due to changes in circumstances. Since the GFC, Australia has experienced a rapid increase in the household savings rate as a defensive response to the shock impact that the crises had. We believe that as the global economy recovers the savings ratio will start to revert toward the pre-gfc average of 4%. While we expect market growth to strengthen, we believe PNC is in a position to grow market share through its unique brand positioning and not rely on industry growth. Figure 11 - Consumer Credit MAT growth rate 20.0% 15.0% 10.0% 5.0% 0.0% -5.0% -10.0% Figure 12 - Household savings ratio 14% 12% 10% 8% 6% 4% 2% 0% SOURCE: RESERVE BANK OF AUSTRALIA Consumer credit MAT growth rate SOURCE: ABS Household savings ratio Page 8

9 Financials Historicals Revenue drivers PNC s revenue is driven by collections of PDL s purchased in previous years. Below is a brief summary of the PDL book and the revenue. Note that we have included other revenue (legal services etc.) in customer payments. Figure 13 - Historical Revenue drivers Year end 30 June FY11 FY12 FY13 Purchased Debt Ledgers Opening book value Purchases Customer payments (book value) Closing Book value Customer payments and other revenue Change in fair value of PDLs PDL Revenue Revenue margin (revenue/customer payments) 82% 67% 71% Growth Purchases 125% 60% Customer payments 159% 63% Revenue 111% 74% Portfolio book value 158% 149% SOURCE: COMPANY DATA The Key take-outs are: New business gaining momentum: PNC purchased its first debt portfolios in 2009 and has been gaining traction with debt sellers as evidenced by its level of purchases growing to $26m in FY13; Revenue growing: Revenue is following the growth in purchases as PNC continues to recover debts purchased from previous years; and Customer payments growing faster than purchase rates: PNC believes that it will continue to recover debts from portfolios liquidating over ten years. This means that customer payments will continue to grow faster than portfolio purchases in the near term as the book is still immature. Page 9

10 Historicals Profit and Loss Figure 14 below summarises the historical P&L for PNC. The P&L is complicated by the change in fair value of the PDL assets. This is effectively an amortisation of the book by the amount attributed to the assets liquidated in the period. We view the non-cash change in fair value of the book as part of normal operations and so exclude it from EBITDA when comparing to peers. For a cash flow proxy we use EBITDA (pre change in Fair Value). Figure 14 - Profit and Loss Year end 30 June FY11 FY12 FY13 Customer payments Change in value of PDL's Total Revenue Growth 111% 74% Total operating expenses as a % of customer payments -71% -45% -44% EBITDA (pre change in FV) Growth 390% 62% Change in Fair Value of PDLs EBITDA (post change in FV) Growth 419% 91% EBITDA margin 14% 34% 37% Depreciation and Amortisation EBIT SOURCE: COMPANY DATA The key take-outs are: Strong revenue growth: PNC has grown revenue significantly in the past couple of years. Revenues have more than tripled from $4.5m in FY11 to $16.6m in FY13. PNC s revenue growth has seen EBITDA margin expansion from 14% to 37% over the same period; Operating cost leverage evident: Operating costs as a percentage of customer payments has fallen from 71% to 44%. As PNC has grown, investment in floor space and Account Managers has been lumpy and affects margins in the period the investment made; Skew to the second half: In recent years, PNC has invested in training of Account Managers and floor space in the first half meaning the margin is significantly better in the second half. We believe this skew will be repeated in FY15; and Low depreciation and amortisation: PNC is a low capital intensity, high operating cost business, with growth driven by investment in operating costs such as labour, occupancy and telecommunication. As a result, the depreciation charge is not significant. There is almost no intangible assets on PNC s balance sheet resulting in no amortisation charge Page 10

11 Forecasts Revenue drivers Below are the main drivers of PNC s revenue forecasted out to FY16. The main contributors are PNC s amount of PDL investment and the rate of PDL collections. It is important to note that our FY14 and FY15 forecasts are in-line with prospectus forecasts Figure 15 - Revenue Forecasts Year end 30 June FY13 FY14e FY15e FY16e Purchased Debt Ledgers Opening book value Purchases Collections (book value) Closing Book value Customer payments and other revenue Change in fair value of PDLs PDL Revenue Revenue margin (revenue/customer payments) 71% 68% 68% 66% Growth Purchases 60% 14% 25% 19% Collections (book value) 111% 52% 55% 34% Closing Book value 149% 39% 29% 21% The key take-outs are: Strong purchases in FY14, but capital constrained: In its prospectus forecasts PNC has guided that it will spend $30.2m on debt portfolios in FY14 up 14% on FY13, and that this amount is 100% covered by existing Forward Flow Agreements. While this is solid growth we believe that PNC was capital constrained for most of the year pre-ipo having an impact on its growth; Purchases in FY15 now substantially covered: Since IPO PNC has announced that it has entered into a one year Forward Flow Agreement with a Major Bank that it has not previously had a Forward Flow Program with. PNC stated that it has now substantially fulfilled its customer acquisition expectations underlying the FY15 prospectus forecast; Forecasting strong revenue growth: We are forecasting revenue growth of ~46% CAGR over the next 3 years driven by strong PDL purchases (~20% GAGR to FY16) almost fully covered by existing vendor agreements; Collection rates: We forecast cash collection rates using a liquidation schedule based on previous periods purchases. Our collection rates are in line with prospectus forecasts in FY14 and FY15. We assume PNC collect $2.90 over a 10 year period, for every dollar spent on debt purchases; and Revenue margin forecast to decline slightly: We are forecasting revenue margins in line with prospectus forecasts to FY15 of 68%. This implies that PNC expects to collect times (1/(1-.68) its purchase price. Given we have elected to remain conservative collecting 2.9x the purchase price, we forecast the revenue margin falling to ~66% in FY16. This multiple will vary according to the type of debt being purchased and its duration outstanding. Page 11

12 Forecasts Profit and Loss The summary forecast Profit & Loss is shown in Figure 16 below. Figure 16 Forecast P&L Year end 30 June FY13 FY14e FY15e FY16e Customer payments Change in value of PDL's Total Revenue Growth 74% 52% 55% 30% Total operating expenses as a % of customer payments -44% -48% -49% -47% EBITDA (pre change in FV) Growth 62% 48% 53% 42% Change in Fair Value of PDLs EBITDA (post change in FV) Growth 91% 20% 47% 38% EBITDA margin 37% 29% 28% 30% Depreciation and Amortisation EBIT Net interest expense/income Pre-tax profit Tax expense NPAT Weighted average no. of fully diluted shares Diluted EPS Growth 0% 36% 49% 31% Total dividend (cps) Yield 1.9% 4.6% 6.1% The key take-outs are: Top-line growing strongly: We are forecasting revenue growth of ~46% CAGR over the next 3 years driven by strong PDL purchases (~20% GAGR to FY16) almost fully covered by existing vendor agreements; Forecast step up in Opex: Margins are forecast to reduce from 37% in FY13 to 29% and 28% in FY14 and FY15 respectively. This is driven by a step change in operating expenses including increased employment costs, floor capacity expansion and training costs associated with expanding the Customer Service Team. New Account Managers do not generate customer payments as efficiently resulting in a cost drag from significant growth. We expect margins to improve in the years following as a large percentage of the workforce gain experience; Strong EPS growth: We forecast EPS growth of ~49% in FY15 and 35% in FY16 driven primarily by strong revenue growth outlined above; and Dividend policy: We are forecasting a FY14 dividend of 3.1 cents reflecting a payout ratio of 50% of pro forma NPAT for the period from 1 January 2014 to 30 June Going forward, PNC has stated its intention to target a payout ratio of 50% of Statutory NPAT. We estimate that translates to 7.3 cents in FY15 or (4.7% yield). We expect the dividend to be fully franked and weighted to the second half. Page 12

13 Forecasts Balance Sheet Key Balance Sheet and Cash Flow items are forecasted below. FY13 Balance Sheet is adjusted for the impact of the capital raising at IPO. The full pro forma Balance Sheet as outlined in the prospectus is displayed on the back page of this report. Figure 17 Forecast selected Balance Sheet items Year end 30 June FY13 pro forma FY14e FY15e FY16e Cash and cash equivalents ($m) Total Debt ($m) Net debt/(cash) Net Debt / Portfolio carrying value -4.8% 18.1% 33.8% 42.2% ND/ND+E -5% 18% 33% 41% Net Debt/EBITDA (pre-amort) (x) Interest Cover (EBIT/Interest expense) Intangible assets ($m) PPE ($m) NTA per share ($) The key take-outs are: Well capitalised for growth strategy: After the IPO, PNC had a small net cash position based on FY13 pro forma numbers. We forecast that at its FY14 result PNC will have ~$10m in net debt after its investment in debt ledgers. We forecast PNC s debt position to grow quite quickly as it heavily invests in its stated strategy; Gearing level: We forecast PNC s gearing to rise to 41% by FY16. This level of gearing is consistent with other industry debt purchasers. We are also comfortable with forecast net debt/ebitda remaining under 1x; Current debt facility is sufficient: PNC has the funding in place to support its growth with a $47m Senior Debt facility in place; Forecast to remain within debt covenants: PNC s debt facility includes debt covenants of: 1. Interest cover > 3x: As illustrated above PNC is forecast to remain well above interest cover of 3x; 2. Gearing ratio not exceeding 45%: As measured as total debt/aggregate balance of the loan book. We forecast PNC to reach 42% in FY16. We do not have PNC exceeding this gearing level in any forecast year; and 3. Variance to Budget ratio of at least 0.85:1: This is to compare actual revenue to budgeted revenue for a period. No Intangibles and low PP&E: PNC is a service business with low Property, Plant and Equipment as well as no meaningful intangibles. We view this as an attractive feature of PNC. The Depreciation and Amortisation charge is very low as a result. Page 13

14 Forecasts Cash Flow Free cash flow is dictated by the amount of PDL investment made during the year and is the main reason that DCF is not an ideal method of valuation. Below are some of the key cash flow items forecasted to FY16. Figure 18 Forecast cash flow items Year end 30 June FY13 FY14e FY15e FY16e Net operating cash flows ($m) Capex ($m) PDL investment Free cash flow after PDL investments Operating Cash Flow per share (cps) (pre PDL investment) GCF as a % of EBITDA 106% 87% 98% 99% The key assumptions are: Strong reinvestment in PDL s continues: In the short term, PNC s reinvestment in debt purchases will significantly exceed operating cash flow. PNC is confident that the Forward Flow Agreements it has in place will supply the debt needed to make prospectus forecast purchases of $30m and $38m in FY14 and FY15; Low capex requirements: PNC does not require a large amount of maintenance capex to stay in business. It also expenses the vast majority of costs involved in growth projects as they relate mostly to people and floor space expansion; and Strong cash flow conversion: PNC has strong cash flow conversion given its revenue recognition is tied to cash collections. We do not foresee this changing in this business. The weaker cash flow conversion number in FY14 is in most part a result of PNC switching to PAYG tax payments in May 2013 after recouping losses in FY12. Page 14

15 Valuation We apply three valuation methodologies to arrive at our Price Target for PNC: Free Cash Flow yield; PE ratio; and EV/EBITDA multiple. We have elected not to use a DCF valuation as it can be easily manipulated by the level of projected PDL purchases, especially in the outer years used to calculate terminal value. Free Cash Flow yield FCF yield is a measure used to compare the value of a company to the level of cash flow produced. We feel that this is an appropriate method given the importance for PNC to convert its assets into cash in a timely manner. PNC s free cash flow can be volatile depending on the amount of PDL s acquired in any given period. Therefore, for valuation purposes, we adjust the level of purchases to level of collections (i.e. the value of the PDL book remains constant) and assert a FCF yield appropriate for a mature book. The table below sets out our calculations of free cash flow. Figure 19 - Adjusted FCF calculation Adjusted free cash flow Operating cash flow Capex Purchase of PDL Adjustment of PDL purchase back to level of collection PDLs needed to maintain Book Free cash flow Free cash flow per share Current FCF yield (adjusted) 0.1% 8.5% 12.0% 13.8% We assign a free cash flow yield of 7.0% that we believe is appropriate for PNC assuming that its book is fully mature and that it will only purchase the amount of PDLs needed to maintain the size of the book in that particular year. We arrive at a valuation using this method of $1.88. Figure 20 - FCF yield valuation methodology Target FCF yield Adjusted FCF in FY15 Implied valuation Implied valuation per share FCF yield 7.0% 6m 85m $1.88 PE ratio & EV/EBITDA ratio Both P/E ratio and EV/EBITDA multiples are relative valuation techniques. We examine a compilation of PNC s closest listed peers to come to a fair trading multiple for PNC. CCP and CLH are the only listed debt purchasers and as such are the main focus. However, we have included in the peer group other similar consumer finance stocks. Below is a list of peers listed on the ASX. Page 15

16 Figure 21 - ASX listed peer group PE ratio (x) EV/EBIT (x) Dividend Yield (%) 2-yr forecast Ticker Share price Market Cap Year end FY14e FY15e FY14e FY15e FY14e FY15e EPS CAGR Credit Corp CCP $ m Jun % 4.9% 7.7% Collection House (BPe) CLH $ m Jun % 5.0% 11.9% Cash Converters CCV $ m Jun % 4.5% 17.7% Thorn Group TGA $ m Mar % 5.2% 7.9% Average % 4.9% 11.3% Pioneer Credit (BPe) PNC $ m Jun % 4.7% 39.8% SOURCE: BLOOMBERG AND BELL POTTER SECURITIES Given that PNC has recently listed and does not have an EPS number for FY13, we have shown above the two year EPS compound growth forecasts from FY14 to FY16. The growth profile of PNC is significantly above that of the average of the above peer group as illustrated by the 2-year Compound Annual Growth Rates. We therefore believe that a 10% premium to the peer group average multiple of 7.9x FY15 EV/EBIT is appropriate to apply to PNC. This is comparable to the CCP multiple of 7.4x. Using this method, we arrive at a valuation of $1.74. Figure 22 - EV/EBIT multiple FY 15 EBIT estimate +10% to peer group multiple Enterprise value Current net debt Equity value Equity value per share EV/EBIT 10.3m 8.7x 89m 10m 79m $1.74 We use the same methodology when valuing PNC on a P/E multiple of 12.3x FY15 earnings. This compares to the CCP PE ratio of 10.6x. Using this method, we arrive at a valuation of $1.80. We outline our P/E valuation in Figure 23. Figure 23 - PE ratio valuation approach FY 15 EPS estimate +10% to peer group multiple Valuation using PE ratio PE Ratio 14.6c 12.3x $ month Price Target We use a blend of the valuations generated by the three approaches shown to arrive at a 12-month Price Target. We apply a higher weighting to the FCF yield method as we believe this is the most appropriate way of evaluating PNC given its profitability relies on its ability to convert assets to cash flow. Figure 24 - Calculation of Price Target Valuation Weighting Price Target FCF Yield $ % $0.75 PE Ratio $ % $0.54 EV/EBIT $ % $0.52 Total $1.81 Price Target $1.80 This method calculates a 12-month Price Target of $1.80. The Price Target is at a 16.1% premium to the share price combine with our expected dividend yield is forecast to deliver a 19.1% total shareholder return. Page 16

17 Board The board consists of four members including the CEO. Below we have provided a brief summary of the key members of the Board: Non-Executive Chairman: Michael Smith (since February 2014) Michael Smith is the Managing Director of strategic marketing consultancy firm Black House, the Chairman of iinet and Synergy and the National President of the Australian Institute of Company Directors. Michael is also the Deputy Chairman of Automotive Holdings Group, Non-Executive Director of 7-Eleven Stores Pty Ltd and a Board member of Giving West and Creative Partnership Australia. Managing Director: Keith John (founder) Keith John is the founder of Pioneer and has been in the receivables management industry since Keith is a Board member of the Australian Collectors and Debt Buyers Association. Previously Keith served as a director of ACA International Inc (US based representative body of the worldwide receivables management industry) and TCM Group International Inc (one of the largest independent network of affiliated receivables management agents in the world). Non-Executive Director: Mark Dutton (since May 2010) Mark Dutton is the founder and a Director of Banksia Capital, a private equity manager focused on Western Australia. Mark is a Non-Executive Director of Mineral Resources. Previously Mark was a Partner at Navis Capital and a Director at Foundation Capital and at BancBoston Capital. Prior to his career in private equity, Mark worked in Audit and Corporate Finance at PwC in the UK and Russia. Non-Executive Director: Rob Bransby (since February 2014) Rob Bransby is the CEO and Managing Director of Western Australia s largest private health insurer HBF. Prior to his role a HBF, Rob worked as a Banker at National Australia Bank for 25 years. Rob is a Non-Executive Director of Goldfields Money, President of Private Healthcare Australia and is the Australian representative on the International Federation of Health Plans Council of Management. Page 17

18 Major shareholders Detailed below is a list of the top shareholders as at IPO on 1 May Figure 25 - Top 20 shareholders Top 20 No Shares % Alana Natasha John <The John Family Business Assets A/C> 7,168, % Banksia Management Pty Ltd <The Banksia Capital Fund> 5,612, % National Nominees Limited 4,079, % Citicorp Nominees Pty Limited 2,646, % BC Fund II Pty Ltd <Banksia Capital Fund Ii> 2,033, % J P Morgan Nominees Australia 1,554, % HSBC Custody Nominees (Australia) Limited - A/C 2 1,468, % CS Fourth Nominees Pty Ltd 1,093, % BNP Paribas Noms Pty Ltd <Drp> 987, % Bernard Jocelyn Patrick Prefumo <The Prefumo Family A/C> 903, % QIC Limited 819, % Niribi Pty Ltd <The Robinson Family A/C> 593, % Pershing Australia Nominees Pty Ltd <Accum A/C> 521, % Sharlin Nominees Pty Ltd <The Sharlin Investment A/C> 519, % Avy Nominees Pty Ltd <The Gray A/C> 450, % James Arthur Singh Kristy Nicole Milward <The Jk Investment A/C> 436, % BNP Paribas Nominees Pty Ltd <Agency Lending Drp A/C> 354, % Midbridge Investments Pty Ltd 337, % HSBC Custody Nominees (Australia) Limited 331, % Bainpro Nominees Pty Limited 312, % Total 32,226, % SOURCE: COMPANY DATA, Below is a list of Shareholders that have over a 5% interest in the company disclosed to date. Figure 26 - Substantial shareholders (>5%) Substantial holders No Shares % Keith John 8,056, % Banksia Management Pty Ltd 7,646, % Discovery Asset Management Pty Ltd 2,812, % Solaris Investment Management LTd 2,812, % Commonwealth Bank of Australia 2,433, % Total 23,761, % SOURCE: COMPANY DATA, Page 18

19 Pioneer Credit as at 23 June 2014 Recommendation Buy Price $1.55 Target (12 months) $1.80 Pioneer Credit (PNC) 23 June 2014 Table 1 - Financial summary Jun Year end e 2015e 2016e Price $1.55 Profit & Loss (A$m) Recommendation Buy Sales revenue Diluted issued capital (m) Change 74.0% 52.0% 54.5% 30.5% Market cap ($m) 70.3 EBITDA (pre PDL amortisation) Target Price (A$ps) $ Change 61.7% 47.6% 52.7% 41.6% EBITDA (post PDL amortisation) Jun Year end e 2015e 2016e... Change 91.4% 20.1% 47.0% 38.3% Valuation Ratios Deprec. & amort. (0.1) (0.4) (0.4) (0.6) (0.8) Underlying EPS ( ps) EBIT % change 48.1% 32.0% Net Interest (0.6) (0.8) (1.7) PE (on underlying EPS) (x) Pre-tax profit EV/EBITDA (x) Tax expense (2.0) (2.9) (3.8) EV/EBIT (x) tax rate 30% 30% 30% Associates NTA ($ps) Minorities P/NTA (x) Underlying Net Profit Book Value ($ps) Change 48.1% 32.0% Price/Book (x) Abs. & extras Reported Profit DPS ( ps) % pay-out 31.4% 49.9% 49.7% Jun Year end e 2015e 2016e Yield (%) 2.0% 4.7% 6.2% Cashflow (A$m) Franking (%) 100% 100% 100% EBITDA (pre PDL amortisation) Performance Ratios Change in working capital (2.5) (0.7) (0.3) Revenue growth (%) 111.1% 74.0% 52.0% 54.5% 30.5% Gross operating cash flow EBITDA growth (%) 418.8% 91.4% 20.1% 47.0% 38.3% Net interest (0.6) (0.8) (1.7) EBITDA/sales margin (%) 33.7% 37.1% 29.3% 27.9% 29.5% Tax (3.2) (2.8) (3.8) EBIT/sales margin (%) 32.4% 34.9% 27.8% 26.4% 28.0% Operating Cash Flow Gross cash conversion (%) 96.8% 106.4% 86.7% 97.8% 99.3% Capex (1.1) (0.7) (0.8) Free cash-flow yield (%) -26.2% -19.4% -14.6% Purchase of PDLs (30.2) (37.9) (45.0) FCF yield (%) - normalised PDLs 0.1% 8.5% 12.0% Free Cash Flow (18.4) (13.6) (10.3) ROE (%) 9.2% 13.0% 15.8% Acquisitions ROIC (%) 9.1% 10.4% 11.2% Disposals Dividends paid - (2.1) (4.8) Leverage Ratios Equity Net interest cover (x) Net change in cash (18.4) (15.7) (15.0) Net Debt/EBITDA (pre-amort) (x) Net debt/equity (%) 21.3% 48.9% 71.6% Balance Sheet (A$m) Net debt/net debt + equity (%) 17.5% 32.8% 41.7% Cash Net borrowings/ PDL carrying value 18.1% 33.9% 43.0% Receivables PDLs Half yearly (A$m) 1H14e 2H14e 1H15e 2H15e Other current assets Sales revenue Current Assets EBITDA Fixed Assets Deprec. & amort. (0.2) (0.2) (0.4) (0.2) Intangibles EBIT PDLs Interest expense (0.3) (0.3) (0.2) (0.5) Non Current Assets Pre-tax profit Total Assets Tax expense (0.7) (1.3) (0.6) (2.3) Short term debt tax rate -30% -30% -30% -31% Creditors Underlying Net Profit Provisions Other curr liabilities Revenue drivers e 2015e 2016e Current Liabilities Purchases Long term debt Cash Collections Other Non-curr liabilities Customer payments (book value) (4.8) (6.8) (11.7) (18.3) (26.3) Non Current Liabilities Collections % of book 20% 15% 15% 18% 20% Total Liabilities Net Assets Share Capital Reserves Retained Earnings Shareholders Equity Net debt/(cash) $m Page 19

20 Recommendation structure Buy: Expect >15% total return on a 12 month view. For stocks regarded as Speculative a return of >30% is expected. Research Team Staff Member TS Lim Industrials Sam Haddad John O Shea Title/Sector Head of Research Industrials Industrials Phone tslim shaddad joshea Hold: Expect total return between -5% Chris Savage Industrials csavage and 15% on a 12 month view Jonathan Snape Industrials jsnape Sell: Expect <-5% total return on a 12 month view Sam Byrnes Bryson Calwell John Hester Industrials Industrials Associate Healthcare sbyrnes bcalwell jhester Speculative Investments are either start-up enterprises with nil or only prospective operations or recently commenced operations with only forecast cash flows, or companies that have commenced operations or have been in operation for some time but have only forecast cash flows and/or a stressed balance sheet. Such investments may carry an exceptionally high level of capital risk and volatility of returns. Tanushree Jain Financials TS Lim Lafitani Sotiriou Resources Di Brookman Stuart Howe Fred Truong Bernard Lai Quantitative Tim Piper Fixed Income Healthcare/Biotech Banks/Regionals Diversified Oil & Gas Resources Resources Gold Research Assistant tnjain tslim lsotiriou dbrookman showe ftruong blai tpiper Damien Williamson Fixed Income dwilliamson Barry Ziegler Fixed Income bziegler Bell Potter Securities Limited ACN Level 38, Aurora Place 88 Phillip Street, Sydney 2000 Telephone The following may affect your legal rights. Important Disclaimer: This document is a private communication to clients and is not intended for public circulation or for the use of any third party, without the prior approval of Bell Potter Securities Limited. In the USA and the UK this research is only for institutional investors. It is not for release, publication or distribution in whole or in part to any persons in the two specified countries. In Hong Kong this research is being distributed by Bell Potter Securities (HK) Limited which is licensed and regulated by the Securities and Futures Commission, Hong Kong. This is general investment advice only and does not constitute personal advice to any person. Because this document has been prepared without consideration of any specific client s financial situation, particular needs and investment objectives ( relevant personal circumstances ), a Bell Potter Securities Limited investment adviser (or the financial services licensee, or the representative of such licensee, who has provided you with this report by arraignment with Bell Potter Securities Limited) should be made aware of your relevant personal circumstances and consulted before any investment decision is made on the basis of this document. While this document is based on information from sources which are considered reliable, Bell Potter Securities Limited has not verified independently the information contained in the document and Bell Potter Securities Limited and its directors, employees and consultants do not represent, warrant or guarantee, expressly or impliedly, that the information contained in this document is complete or accurate. Nor does Bell Potter Securities Limited accept any responsibility for updating any advice, views opinions, or recommendations contained in this document or for correcting any error or omission which may become apparent after the document has been issued. Except insofar as liability under any statute cannot be excluded. Bell Potter Limited and its directors, employees and consultants do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this document or for any resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this document or any other person. Disclosure of interest: Bell Potter Securities Limited, its employees, consultants and its associates within the meaning of Chapter 7 of the Corporations Law may receive commissions, underwriting and management fees from transactions involving securities referred to in this document (which its representatives may directly share) and may from time to time hold interests in the securities referred to in this document. Disclosure: Bell Potter Securities acted as Co-Lead Manager in PNC's Initial Public Offering (IPO) and received fees for that service. ANALYST CERTIFICATION Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers and were repared in an independent manner and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report. Page 20