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We retain our Neutral recommendation on Portfolio Recovery Associates Inc. (PRAA - Analyst Report). Its strong top-line growth, increased cash collections and strategic acquisitions are partly dwarfed by rising operating and interest expenses and stiff competition.

Portfolio Recovery reported first-quarter 2012 net income of $1.47 per share from continuing operations, which surpassed the Zacks Consensus Estimate of $1.31 per share as well as prior-year earnings of $1.34 per share.

Portfolio Recovery remains a significant player in the market, with a focus on quality and profitability rather than on pure volume growth. Since 1996, the company has collected at an average rate of 2.43 times its initial purchase price for an acquired debt.

The company purchased debt totaling $9.8 billion for $408.4 million last year, while $111.4 million was spent on portfolio acquisitions to purchase $1.46 billion of debt in the first quarter of 2012. Moreover, both cash collections and collector productivity continue to be at record highs as productivity improved at the company’s operating call centers and it continued to recruit new collectors.

Portfolio Recovery has also expanded beyond its primary debt collection business into government collections, audit services and claims settlement through various acquisitions. The acquisition of Mackenzie Hall Holdings Ltd., in January 2012, is expected to boost the company’s revenues, expand its geographic presence and increase its competitive strength against its peers such as Asta Funding Inc. and Encore Capital Group Inc. (ECPG - Snapshot Report).

However, Portfolio Recovery has experienced negative operating leverage in the last few years due to the effects of the global economic crisis that affected top-line growth. Further, operating expenses have been rising, thereby leading to a drop in operating margins.

Moreover, rising borrowing costs and increasing leverage in the past several quarters have been pushing up interest expenses. Since a newly-acquired debt takes time to start generating cash but increases interest expenses immediately, this creates a huge impact on the net income.

Currently, Portfolio Recovery carries a Zacks #3 Rank, implying a short-term Hold rating.

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