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Portfolio Recovery Associates Inc. (PRAA - Analyst Report) reported first-quarter 2014 earnings per share of 86 cents, in line with the Zacks Consensus Estimate. However, the results exceeded the prior-year earnings of 75 cents per share.

Earnings were primarily driven by a surge in revenues, which was attributable to the continuous improvement in cash collections.

Including costs associated with the Aktiv Kapital acquisition of 5 cents, net income of Portfolio Recovery was 81 cents in the reported quarter, up 8% from 75 cents earned in the prior-year period.

Operational Update

Portfolio Recovery’s total revenue in the reported quarter came in at $193.9 million, surging nearly 14% from the year-ago figure. However, revenues missed the Zacks Consensus Estimate of $198 million.

The upside in revenues was driven by a surge in cash collections. Cash collections from finance receivables rose 14% year over year to $313.4 million. Call center and other collections posted a 9.8% increase to $97.7 million, external legal collections grew 6.4% to $51 million, internal legal collections surged 50% to $43.9 million and bankruptcy court trustee collections rose 10.5% to $120.7 million.

Additionally, Portfolio Recovery’s revenues from its finance receivables income stood at $178 million, up 15% from $154.8 million in the year-ago quarter. Fee income increased 7.4% to $15.9.

Operating expenses rose 18% year over year to $122.3 million. This was mainly attributable to higher legal costs, and compensation and employee services expenses. Portfolio Recovery expects to incur expenses of $10 million in the second quarter in connection to the acquisition of Aktiv Kapital. Operating income increased 9% to $71.6 million. As a result, operating margin decreased to 36.9%, down from the year-ago quarter level of 38.9%.

Balance Sheet and Capital Structure

As of March 31, 2014, Portfolio Recovery’s cash and cash equivalents increased to $191.8 million from $162 million as of Dec 31, 2013. The company had $435.5 million outstanding under its line of credit as of March 31, 2014.

As of March 31, 2014, Portfolio Recovery’s total assets were worth $1.64 billion, rising slightly from $1.60 billion as of Dec 31, 2013. Shareholders equity stood at $910.2 million as of March 31, 2014, up from $869.5 million as of Dec 31, 2013.

Our Take

Portfolio Recovery’s earnings have shown steady improvement over the past few quarters. Strong cash collections lent support to revenues. However, an increase in operating expenses that outweighed the increase in revenues led to a margin contraction.

The company incurred expenses related to the pending acquisition of Aktiv Kapital which partially weighed on earnings this quarter. This combined with high legal costs, deferred Portfolio Recovery to achieve its return on equity goal of 20% for the first quarter.

On closure this Aktiv capital deal should bolster the consumer debt portfolio and earnings of Portfolio Recovery. Moreover, the deal will also enhance the European operations of Portfolio Recovery and help it achieve its return on equity (ROE) goal of 20% and EPS growth of 15%, thereby boosting investor confidence going ahead. The company expects the culmination of the deal to increase its ERC in a magnitude that will exceed what the company has been experiencing over the last six years.

Among other business strengthening initiatives of Portfolio Recovery, the buyout of the Individual Voluntary Arrangements Master Servicing Platform and other assets from Pamplona Capital Management, LLP that is expected before mid-2014 is also significant. We expect all the above endeavors to help the company come up with impressive numbers going forward.

Regarding the debt market scenario, Portfolio Recovery is set to gain in the long-term. However, in the near-term the prospects seem a bit marred by the competitive U.S. market that is limiting supply thereby leading to high pricing.

Zacks Rank

Portfolio Recovery carries a Zacks Rank #3 (Hold). Some better-ranked stocks in the financial services space include Euronet Worldwide Inc. (EEFT - Snapshot Report), Genral Finance Corporation (GFN - Snapshot Report) and Apollo Residential Mortgage, Inc. (AMTG - Snapshot Report). All three stocks carry a Zacks Rank #1 (Strong Buy).

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