"Under the Radar" uncovers little-known companies worthy of investors' consideration. Check in at 5 every morning to find out about stocks that tend to beat their bigger brethren. BOSTON ( TheStreet) -- The U.S. credit-card charge-off rate -- debt considered a loss -- at the likes of Visa ( C), MasterCard ( MA) and American Express ( AXP) rose to 11.5% in August. Delinquencies are also on the rise, a sign debtors are still being pummeled by the economy. Is it possible to profit from this unfortunate situation? Norfolk, Virginia-based Portfolio Recovery Associates ( PRAA) is a specialty finance company that purchases and collects defaulted consumer receivables. Banks, credit-card companies and auto financers sell their "uncollectibles" to Portfolio Recovery for pennies on the dollar. The company has a proprietary system to identify defaulters who are likely to pay up. They seize or force the sale of assets to collect a portion of the amount owed. A catastrophic recession throws a wrench in the gears, since the extent of debt defaults is extreme. That can affect business in one of two ways: either economic pressures crimp the collection process or they allow Portfolio to scoop up profitable defaulters. The cost of receivables is falling, so the company can pick its price. But profit from such purchases may not materialize for years. Anyway, the company's second-quarter net income rose 3% to $12 million, and earnings per share inched up 1% to 76 cents. Revenue grew 12% to $71 million. Volume squeezed margins. Its gross margin dropped from 36% to 33% and its operating margin fell from 33% to 30%. Nevertheless, the stock looks attractive, especially considering recent pessimism. The shares were downgraded by Davenport on Aug. 6 due to strong price performance, insider selling and a weak near-term earnings outlook. Since the downgrade, the shares have fallen 2%.
A lot of investors are bailing on Portfolio Recovery, perhaps fearing the recession and the payoff from cheap purchases will be extended. Its stock lost 10% of its market value in last week's sell-off. A beta of 1.4 demonstrates volatility. But on the basis of valuation, Portfolio remains attractive. The shares trade at a price-to-earnings ratio of 15, and a forward price-to-earnings ratio of 13, a discount to the market and specialty finance peers. This is a niche company with complex risks, but it's deserving of further attention. One intriguing, counterintuitive thesis is that companies are charging off more than necessary in order to purge weak debtors. It doesn't make sense, from a business perspective, to charge-off customers who are profitable. On the other hand, the Congressional backlash against credit-card companies and ongoing threats of fee reductions are providing incentives to companies to seek reliable customers and reduce exposure to previously lucrative deadbeats. Front-loading losses will make future performance look better. There's also a possibility that sly consumers are riding the waves of bankruptcy and default. An influx of paperwork might be creating cracks in the system and many so-called uncollectibles could turn out to be collectible, but crafty. -- Reported by Jake Lynch in Boston.