Axactor ASA (ACR) Earnings Call Transcript & Summary

Welcome to the Axactor ASA announcement of financial targets. My name is Nadia, and I'll be coordinating the call today. [Operator Instructions] I will now hand over to your host, Johnny Tsolis, CEO, to begin. Johnny, please go ahead.

Good morning, and thank you for taking the time to participate in this meeting. The agenda today is twofold. The main purpose is to announce financial targets for Axactor. This has been our intention for a while as Axactor is one of the few listed companies in this industry that hasn't done thus far, and we see this as a natural next step in our communication with the market. We do, of course, recognize that the timing is challenging with high degree of uncertainty on important parameters such as macro environment and interest rate levels. Nevertheless, we feel that it is important to share our view and targets. Secondly, we will take the opportunity to share a few preliminary Q4 financials. Obviously, this will be high level as we are only in the second week of January and the accounts are not finalized and audited for the year. We will also give a short recap of our strategy and give an updated market outlook. Regarding questions, this will work like during a normal quarterly presentation, where you may ask questions live after the presentation or through the available chat function. Please move to Slide 3 for a short Q4 business update. Even though the accounts for the year is not finalized, 2022 will be a very solid year for Axactor despite the challenging macro environment we have experienced throughout the year. Based on year-to-date Q3, it is clear that 2022 will be the best year in terms of financial results since the company was established in 2015. It is also satisfying to see that the operational performance is excellent. Customer satisfaction is record high, so is the employee satisfaction. These are the results of a complete turnaround of the company over the last 3 years which started with us redefining the strategy in 2020. There are 5 elements we would like to share. Firstly, Axactor is delivering on the promised strategy of growth. NPL investments was EUR 93 million for the quarter at close to EUR 290 million for the year, representing 2.7x replacement CapEx. On 3PC, we delivered 5% revenue growth in the quarter compared to same quarter last year. Secondly, we are delivering on the promised strategy of accretive portfolio investments. The gross IRR on the total book is lifted from 15.7% to 17.3% over the last 7 quarters. And the 2022 vintage was done at an attractive and accretive gross IRR level of 21.3%. The collection performance has been stable throughout the year and came in at 99%, both for the fourth quarter and for the full year. Cost control in Q4 was, as always, very good across all markets. We expect 2022 to come in at an all-time low on cost equivalents. The fifth and final thing I would like to share is that Axactor has improved the interest rate hedge for 2023. This has been done by changing our 3-year hedge of just about 20% of our total debt to a 1-year hedge with significantly -- which significantly improves our protection for 2023 and reduces our interest cost for the year. By doing this, Axactor now has a hedging profile that is more similar to some of the other players in the industry. That was the preliminary numbers we are able to share for Q4. Now let us move on to Slide 5 for a short recap of the main elements in our strategy. These 3 strategic levers are well known to those of you that are following Axactor on a regular basis, but I still think it's worth to remind the audience. In the following slides, I will go through them in more detail, but in brief: Axactor has a strong focus on doing accretive portfolio investments. And as you have seen over the last couple of years, we have done so successfully. Secondly, we always seek to improve our overall cost position. Axactor was incepted to disturb the industry on cost to collect, and we have obtained a superior cost position. Currently, we are investing extensively in data-driven valuation and data-driven operations to excel the cost position further. And thirdly, we are pursuing a niche strategy in terms of industry, segments and markets. Please move to the next slide for more details on accretive portfolio investments. Axactor's single most important profit improvement initiative is to buy portfolios at a satisfying gross IRR level. As you can see from the graph on the left-hand side, the average gross IRR on the total NPL book is steadily increasing quarter-by-quarter. We have managed to increase the gross IRR back book by 1.6 percentage points over the last 7 quarters. Please bear in mind that a 1 percentage point increase in the total NPL book gross IRR equals approximately 2 percentage points improvement in the return on equity. 2022 is an attractive vintage with gross IRRs north of 21%. Also, the future commitment looks promising at 21.4%, meaning a 4.1 percentage points higher gross IRR than the average book by year-end 2022. In addition to increased return on equity, the associated risk is gradually reduced as scale reduces volatility and we get access to more data to be used in [ simulations ]. The second strategic lever is cost leadership. Please move to the next slide for more details. To be cost efficient and to take cost leadership means of course that your company has fostered a strong cost culture. If not, this would not be possible. But it certainly helps to practically start with clean sheets as Axactor did back in 2015. We have done a total of 8 company acquisitions, and we have taken the time and cost to integrate these companies in a satisfying way. We stated already in 2015 that cost position will be one of our competitive advantages, and we invested heavily in creating one common cloud-based IT platform, which gives huge IT cost advantages. This includes one IT infrastructure, one common financial reporting system, one HR system, common predictive dialer system, and the list goes on. We have also, over the last couple of years, done substantial investments in data-driven collections, which I'll come back to in a couple of slides. But first, let us move on to the next slide, where we can see that the efforts in building a strong cost culture and investment in systems are paying off in terms of low cost to collect and high EBITDA margins. I think it's fair to say that Axactor has a low cost to collect compared to most relevant peers. What you don't see in this slide is that our cost ratio is also trending downwards and has been dropping year-over-year as we have gained scale. The 2022 figures are not ready yet, but they definitely look promising, and we are expecting to be in the high 30s in terms of cost-to-collect percentage which is a strong improvement from the 44% we delivered in 2021. A natural result of this is also that our EBITDA margin is high compared to peers, especially when you consider that we have a meaningful share of 3PC business that has a lower EBITDA margin than the NPL business. So where do we go from here? Is there room for further improvement? Please move on to Slide 9 for some reflections on the topic. To answer my own question first, yes, we believe that over time, we should be able to improve our cost position further. Axactor is investing heavily in machine learning scorecards and robotics to increase collections and to reduce costs. In addition, we are aiming for continued growth and will gain further scale effects. We also believe that our focus on sharing best practices across our 6 markets will continue to give benefits and improve our cost position. Let me give you just one example on how machine learning can help us improve. Debt collection is all about understanding which cases to work on and how to work on them. Therefore, we have developed scorecards to help us identify which cases to work amicably, which ones to go legal on and which one not to focus on currently. Previously, these decisions were mainly done manually. However, it turns out that by using our massive amount of data, the scorecards helps us to increase collections as we are working on the correct cases and reduces cost as we are not working on the cases with no current potential. The last of the 3 levers is our niche strategy, which we have named tagged best of what we do. On Slide 10, I'll go briefly through what we mean by this. In Axactor, we strongly believe in focusing our work and efforts instead of trying to capture all segments and markets. Therefore, we are prioritizing the bank and finance segment, which accounts for the vast majority of our 3PC and NPL business. Main reasons are the claim size and claim type perfectly suits our collection competence and we see attractive opportunities, both in the 3PC and the NPL market. The same goes for debt type. We are experts on handling unsecured debt. And in 5 out of 6 markets, we are only handling unsecured claims. In Spain, however, we have decided to build up a solid and sizable secured operations, and we have done so successfully. But if you look at the total balance sheet, 95% of our NPL book values are unsecured debt. Regarding markets, we have chosen the 6 markets in Europe where we believe to see the most attractive returns over time. All of our markets are mature in terms of NPL transactions, has a stable legal and political environment and has proven to provide attractive returns year-over-year. Our main goal is to build scale and market position in current markets and not actively seeking for new market entries. A good example of this is last year's Axactor acquisition of CR service in Italy, where we strengthened our position in the Italian 3PC market for bank and finance collection services. Before I jump into financial targets, I will just spend a couple of minutes giving an updated market outlook, starting at Slide 12. Let me start by saying that we see no major shift in macro factors impacting the collection industry the last couple of quarters. The interest rates in Europe are increasing and will impact Axactor's cost of funding. However, given the change in our interest hedge, the increase for Q1 2023 will be fully offset compared to Q4 2022. I will give more details on the next slide. Regarding other macro factors, we continue to see mixed outlook on back book collections. On the negative side, rising inflation and interest rates will reduce disposable income for consumers. All elements that reduces the debtor's disposable income will potentially have a negative impact on our structures back book. This, in turn, puts pressure on debtor's ability to repay, and hence postpone collections. However, on the positive note, low unemployment rates, increasing salaries and government aid packages are improving the disposable income and can be expected to partly offset the challenges. The full net effects are probably still yet to be experienced, but so far, we have seen limited impact as a result of macroeconomic factors on collections in 2022. Let's move to the next slide for more details on how interest hedging will impact interest costs for Q1 2023. As I mentioned earlier in the presentation, we have changed our hedging from a 3-year hedge to a 12-month hedge, sharply increasing the short-term interest protection. As a result of this, we estimate flat interest expenses on borrowings from Q4 2022 to Q1 2023. The main reason for this is that in addition to increased hedging ratio as a result of the change, we did not have full hedge effect from the 3-year hedge in the previous quarter. With the new hedge, an interest increase of 1 percentage points is estimated to increase quarterly interest expenses by EUR 800,000 and reduce annualized return on equity by 0.6 percentage points. You can find more details in the footnote on this slide. I will only underline that the estimate assumes same debt level for the 2 comparing quarters which will not necessarily be the case as it depends on the RCF draw in Q1 this year. But macro factors are one thing, and they have been challenging for a long time already. The main questions investors in this industry should ask themselves in 2023 is what will happen with the portfolio market, both in terms of prices and volume and how will the access to funding develop. On the next slide, I will present our projections on the IRR development and how Axactor will react in the market. First, let me say that, of course, there is a significant uncertainty regarding the price level on portfolios going forward. It will depend both on available volume, competitors' appetite for gaining market shares, et cetera, but above all, the industry's access to funding. And it is the funding situation, and in particular the bond market sentiment that is the main explanation for why we are comparing the current situation with previous experience from the financial crisis back in 2008 and 2009. Back then, just as we are experiencing now, access to funding was significantly reduced. It is still possible to use the bond market, but we have seen amazing margins being paid in Q4 last year. Another comparison could potentially be the volumes. During the pandemic, we have experienced small volumes for the 2020 and 2021 vintages for obvious reasons. 2022 looks to be a more normal year in terms of volume, but still on the modern side. However, for 2023 and 2024, we believe that default rates again will increase, potentially even sharply increase. This will result in a large NPL volume for sale. The combination of high volume and low access to attractive funding, fueled by regulations that incentivize banks to offload balance sheets, should set the ground for sharp increase in portfolio IRRs going forward. Obviously, some of the volume will be shifted from portfolio sales in GPC, but we have a clear indication that most banks that are selling portfolios today have a preference to continue that strategy. Again, there's a great deal of uncertainty on this, especially regarding timing. What I can say, however, is that Axactor will have patience and focus on deleveraging until we see a new price level that fully reflects the new cost of funding, and in addition, an additional premium for increased risk, both on collection and hedging costs going forward. If you turn to the next page, I will try to elaborate a bit more on the details. If we start with a short-term view for 2023, we believe that transaction volumes will be low based on the fact that buyers and sellers will not be able to agree on price. The main reason for this is, again, the uncertainty regarding funding cost and the fact that several peers have also stated that they will focus on deleveraging going forward, and most likely focused on the debt to maturity structure. The transactions that will take place should be done at high IRRs due to the large imbalance in supply and demand. However, we have seen transactions lately where prices are not reflecting the new and increased cost of funding. In 2024, we expect the market slowly to come back to normal with increased transaction volumes, but this projection assumes 2 things: one, that the bond market normalize at margin levels that are sustainable for our industry; and two, that the IRRs fully reflects the new funding costs for the industry plus a reasonable risk premium as the NPL companies must be able to deliver a satisfying return to shareholders. For 2025 and onwards, we expect that a new normal is established. With prices adjusted on portfolio, the industry will again be able to use different sources of funding and volumes will probably normalize. And just to repeat Axactor's response to this, we will, in the short term, deleverage until we see that prices on portfolios fully reflects actual funding costs, plus a reasonable risk premium, including cost of hedging going forward. With that said, I think it's time to move on and present Axactor's financial target on Slide 17. I shall be the first to admit that this has not been a very easy exercise. However, we have tried to set realistic short-term targets and to give a clear direction for targets in the longer run. But I hope the audience can appreciate a great deal of uncertainty, especially regarding funding cost and market prices on portfolios going forward. Nevertheless, if we look at the 2023 targets, we fully believe these figures are achievable also given the uncertainty mentioned above. If we start with portfolio investment level, we expect it to be between EUR 100 million and EUR 150 million for 2023. The reason for the reduction compared to, for example, 2022 is the fact that we will wait and see that portfolio prices adjust according to the augmentation presented on the previous slide. Please note that Axactor has still approximately EUR 70 million committed in forward flow contracts for this year. So, the deployment CapEx will be a combination of these and new portfolio acquisitions. From 2024 and onwards, we expect a normalized investment level of EUR 200 million to EUR 300 million. We expect to achieve a return on equity of minimum 9% for 2023. Interest hedging is providing partly protection against increased funding costs for the year. However, in the longer run, the visibility is more unclear due to uncertainty in the interest rate development. Regarding dividends, we are aiming for an annual payout of 20% to 50% for both 2023 with the first payment in 2024 and onwards. Regarding leverage, Axactor will target our leverage ratio of a maximum 3.5x pro forma adjusted cash EBITDA, both for year-end 2023 and beyond. If we move to the next slide, we have compared the financial targets in relation with past performance, and this comparison confirms that all of our 4 financial targets should be realistic and achievable. NPL investment level, both short term and long term is basically the level we have been delivering for the last few years. The replacement CapEx is approximately EUR 114 million for 2023 and the long-term investment target in the case growth. Return on equity is in line with the year-to-date and Q3 lower levels. Increased interest costs not covered by the hedge will be compensated by strict cost control, scale effects and improved operational performance in 2023. Normal dividends has been paid by Axactor previously, and the leverage ratio is in line with historical levels. Before we round off and open for questions, I would like to give a few more comments to future potential on return on equity and a short recap of our debt maturity structure starting on the next slide. It is easy to agree that the dual target for 2023 at 9% is moderate compared to Axactor's full potential. Going forward, there are several main elements that can pull the return on equity upwards. Starting by a very easy-to-understand argument, the runoff of discontinued business will improve the return on equity by approximately 1%. We expect the discontinued business to be more or less fully out of our books by year-end 2023. The next argument is to continue to do accretive portfolio acquisitions. We have done so successfully for the last 2, 3 years, and we expect this to continue. The final effect will, of course, depend on the acquired volumes and the IRR achieved. But as you have seen, this could be a major contributor to future growth for Axactor. In addition, further scale effects as we continue to grow, both our 3PC and NPL business are to be expected. Unfortunately, there is one element that could potentially reduce the return on equity potential and that is, of course, even higher interest costs going forward. Over time, this effect will be mitigated as new accretive vintages that is reflecting the new cost of funding is added to the NPL book. Last item before we go to Q&A is a quick reminder of our maturity profile on the next page. Axactor has a EUR 545 million RCF facility that matures in December this year. The refi process has started, and we expect the refinancing to be finalized before the summer. In addition, we have 2 bonds outstanding, ACR02 and ACR03. ACR02 is maturing 1 year from now, and out of the original EUR 200 million outstanding loan, Axactor has repurchased EUR 31 million. As previously mentioned, we will follow the deleveraging strategy for now and we'll take close attention to the bond market for the next 2, 3 quarters to see if it's possible to refinance at sensible margins. Until we see new NPL pricing that reflects new cost of funding, et cetera, the focus will be on repaying debt going forward. Regarding ACR03, given the long remaining duration of almost 4 years, we are not doing any proactive actions of any kind currently. That was what we had on the agenda today. But before we open up for questions, let me remind all of you to have also a quick look at Page 21. I guess it goes without saying, but I will say it anyway, the forward-looking statements and assumptions made in this presentation is management's view. Let's go to the Q&A session.

[Operator Instructions] And our first question today gives you Ulrik Zurcher of Nordea.

I have to say, I was a little bit surprised about the deleveraging in 2023 because you have, as you show, you have been able to invest at a much higher gross IRR on the market volumes in 2022. So how certain are you that you will deleverage if, for example, you see, as you've seen this year, supposedly good opportunities in '23 as well.

Thank you, Ulrik. I think what is clear is that at least the first couple of quarters, we will definitely not invest substantially above the forward flow commitments we already have. And the reason for it is that we would like to see the actual shift that we expect is necessary for the industry actually materialize because we have seen examples -- as you know, the funding has gone dramatically up over the last few quarters, and so far, parts of it has been priced in, in Q4 in some of the deals. Some of this has fully priced in, and some deals especially here in the Nordics hasn't priced in anything of it. So we would like to see that prices actually capture both the increase in EURIBOR but also the increased bond spreads that the industry is experiencing. And that's in combination with the maturity that we have in January next year. We think it makes sense to be a little bit patient and see that this materialize before we start investing substantially again.

So you can't really rule out a situation where pricing improves a lot, let's say, in the second half of next year, maybe that costs are a bit down, and then you will go back to growth mode again.

No, it cannot be ruled out. Absolutely not. It's a chance that gross IRRs will actually improve more than what you could expect just looking at the interest cost. And that is because -- it could be a buildup of imbalance in the MoM and supply because if you listen to what the most players in the industry are saying these days, and I've been saying for the last quarters and months is that deleveraging is on the agenda. You know that the maturity profile for the industry is quite okay for 2023 when it comes to bond maturities. But '24 and '25, there you have some major maturities. And I think we as an industry need to handle these as well. But if we see that gross IRRs are sharply going upwards, of course, it will make sense to invest. But I think also we need to -- the one assumption that then needs to be in place is that we will see that we are able to refinance at a sensible level because the spreads that we have seen in the bond markets lately, then you -- if that will be the case, then gross IRRs needs to sharply increase just to basically cover up for the increased interest costs.

I think I understand a bit more where you're coming from. Because I just -- for example, you're saying you might pay a dividend next year but it's not necessarily that we expect another dividend in 2024, for example, if the market is attractive again. Because I mean you'll have an ROE, let's say it's 10% in '23 or even '24, then you should still grow not say dividend.

Yes -- well, of course, I will leave it to the Board to decide the level of dividends and if -- and not to pay it out. But also, we have said that we will pay between 20% and 50%. And even if you paid 20% dividend, there's still a lot of room for investing. And then in that case, that's an area that we are describing here, Ulrik, I think it's fair to say there's a lot of ways you could look into funding. I mean you can use different sources of funding. And we will look at the whole range if gross IRRs are going up substantially.

And last question. I'm impressed by the gross IRRs or the improvement, but could you also to get a comment on the net IRR? I'm just saying if the cost to collect more or less unchanged between the old vintages in 2022?

Yes, you can say that the costs are -- we are improving the cost side, so you can expect at least the same increase in IRR probably slightly higher because of us being more cost-efficient year-over-year.

All right. I'm just checking that you haven't like changed that portfolio that you buy. But yes, thank you very much. Very helpful update, sir.

[Operator Instructions] And our next question goes to Hakon Astrup of DNB Markets.

Very helpful update. Two questions from me, the first one on dividends. You're now targeting dividends from next year. Can you just remind us if you have any say restrictions in your debt covenants that is impacting the potential to pay dividends?

It is a restriction, but it is up 60%, if I recall correctly. So 20% to 50% is within the policy, it's within the restrictions in the term sheets and covenants.

And also, you mentioned that you could potentially refinance the bond maturing early next year if we have acceptable margins. But what is acceptable margins for you?