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Portfolio Recovery Steady at Neutral

PRAA EXLS

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We have reiterated our Neutral recommendation on Portfolio Recovery Inc. (PRAA - Analyst Report) based on top-line growth and improving financial position, which are partly offset by increasing operating expenses and high competition.

Portfolio Recovery generated second-quarter income from continuing operations of $26.11 million or $1.51 per share, surpassing the Zacks Consensus Estimate of $1.42 and the prior-year earnings of $19.5 million or $1.14 per share.

Portfolio Recovery remains a small but significant player in a large market, with a focus on quality and profitability rather than on pure volume growth. Strong deal flow and portfolio acquisition are expected to stimulate future collection activity, thereby strengthening the supply and pricing chain and the fee income businesses.

Moreover, Portfolio Recovery has expanded beyond its primary debt collection business into government collections. This diversification has helped the company in mitigating some of the stress on collections caused by the recent economic softness while continuing to add to earnings.

Additionally, Portfolio Recovery is expected to benefit from Claims Compensation Bureau, which has expanded beyond securities class action settlements and payment processing into anti-trust class action settlements. This is expected to be accretive to the earnings of the company in the medium to long term.

Moreover, both cash collections and collector productivity (cash collections per hour paid) continue to be at record highs doe to improved productivity at the Portfolio Recovery’s operating call centers and the company continues to hire new collectors. The company’s strong operating cash flow position tends to provide scope for growth opportunities.

However, the accounts receivable management industry (owned portfolio and contingent fee) is highly fragmented and competitive. This intense competition continues to apply downward pressure on Portfolio Recovery’s adjusted estimated collections to purchase price ratio, which is a significant productivity metric.Going ahead, relatively low barriers to entry and high returns will likely create more entrants over time, thereby adding pressure on pricing.

Additionally, Portfolio Recovery has experienced negative operating leverage for the past few quarters due to the effects of the global economic crisis in the last couple of years that negatively impacted the top-line growth. Moreover, escalating operating expenses have resulted in declining operating margins.

Further, borrowing costs and increasing leverage have resulted in higher interest expense in recent quarters. Since a newly acquired debt takes some time to to begin generating cash, this higher interest expense hits faster and creates a huge impact on net income.

Considering all the pros and cons, the Zacks Consensus Estimate for Portfolio Recovery’s third-quarter 2011 earnings currently stands at $1.48 per share, up 37% year over year. For full year 2011, the Zacks Consensus Estimate stands at $5.78 per share, up 33% from 2010.

Portfolio Recovery is expected to announce its earnings after the market closes on October 27, 2011. The company competes with Asta Funding Inc. ( and Exlservice Holdings Inc. (EXLS - Snapshot Report).

Currently, Portfolio Recovery carries a Zacks #4 Rank, which translates into a short term Sell rating, indicating downward pressure on the shares over the near term.

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