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Collection House: Strengthening balance sheet is a must

It has become a common trend for corporations to outsource their receivables management tasks to collection agencies in order to save time and costs, however with growth stalling, the contest for market share is heating up and additional risks are finding their way into the industry.

Services provided by collection agencies, such as Collection House (ASX: CLH) or Credit Corp Group (ASX: CCP), are called upon by corporate customers, including the big four banks, insurance groups and the major telcos, as they specialise in chasing bad debts.

Outsourcing debts means that these companies can maintain a greater focus on improving other areas of the business, such as customer service, whilst relying on specialist groups to take care of outstanding debts.

Collection House, for instance, bought a total of $52.3 million worth of debt ledgers in the 2012-13 financial year and plans to buy a further $60-70 million worth this year. Meanwhile, Credit Corp’s debt ledger hit a record high $136.8 million in fiscal 2013.

Outlook

However, Credit Corp’s CEO Thomas Beregi believes that the volume of debt that will be sold by creditors will be static in coming years, whilst the amount outstanding on credit cards will also likely be flat. Should he prove to be correct, growth will be limited and could act as a drag on profit margins.

In light of such circumstances, collection agencies will ramp up their competitive measures to gain market share, but it is imperative that they maintain a high level of discipline in choosing which accounts to buy. Beregi said “The challenge for the industry is to ensure the price [paid for] debt and returns is appropriate”, meaning that companies should not let their standards slip when selecting which accounts to buy.

Although Collection House is a quality company and run by a strong management group, its level of debt is unsettling. To combat its $87 million in bank debt, the company raised a total of $20 million to strengthen its balance sheet, via a private placement ($13 million) and a share purchase plan ($7 million).

In comparison, Credit Corp is comfortable with its low level of gearing which should aid it in a competitive market.

Foolish takeaway

Although the industry may be facing short-term volatility, it should realise significant growth in the long term as more and more companies outsource their debt recovery responsibilities. Collection House is aiming to purchase more debt accounts of energy companies, whilst Credit Corp is focused on increasing its operations in the US, where the company believes it would thrive.

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Motley Fool contributor Ryan Newman owns shares in Collection House.

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