Good work here by Roger, but time to add a bit more information for those highlighted banks that trade in New Zealand
Bank |
Fitch Credit Rating (NZ Operations) |
Approx Probability of Default Over 5 years |
NAB, trading as BNZ |
AA- |
One in 300 |
Westpac New Zealand Limited |
AA- |
One in 300 |
ANZ Bank New Zealand Limited |
AA- |
One in 300 |
Heartland Bank |
BBB |
One in 30 |
I think this exposes the myth that what we are looking at here is Heartland up against a 'peer group'.
They are the peer group Snoopy whether you like to admit it or not other banks are into unsecured lending in a huge way too. The difference in credit ratings is something you make a valid point about but a 1:30 chance of failure over the next five years means that HBL as a far as I am concerned should carry a 3.33% risk premium amortized over 5 years = .67% risk premium per annum so in my efficient market hypothesis they should trade at approx. a 0.85 PE discount (12.15 / 13 gives the appropriate PE discount. Yes there's execution risk but I believe we are seeing good traction in their new initiatives so there's also execution risk that they'll outperform with their new lending initiatives. We could pontificate endlessly on possible outcomes post FY19, (too far in the future to reliably estimate), and as to reasons why their EPS growth has outperformed its peer group in the past but the fact remains in recent years and projected for this year and the next two their EPS growth is significantly superior to the other banks so one can very easily make the case that they are executing extremely well and deserve the benefit of the doubt regarding execution risk going forward. If one accepts this argument then they deserve a significant PE premium for their superior growth rate, far more of a premium than the discount their lower credit rating implies.
What you have calculated here Roger is what will happen if Heartland lives up to the consensus of what a broad group of analysts think will happen. However, these expectations say nothing about 'execution risk'. The probability of success of the respective business plans comes very muuch to the fore in what is
likely to happen. And most analysts with their glib forecasts do not consider this.
See above
Much of the historical outperformance comes from Heartland deftly disposing of what seemed to be an absolute basket case of land and property loans at the time. Given these are now largely disposed of, it doesn't seem right to assume that historical growth from this source will continue and so influence the future ghrowth rate going forwards. I don't think any industry forecaster , let alone Heartland have stated, that they will outperform their peers post FY2019. Note I am not saying this isn't possible, or it won't happen. But I would be cautious of using invented hyperbole to justify your value of Heartland shares post FY2019.
Nobody is forecasting further out than FY19 but its worth noting that HBL seems quite progressive on the digital front and that's the way the world is shifting.
The problem we have valuing Heartland is that most of the real peer group was destroyed in the great finance sector collapse in NZ. I suspect that if you are looking over the ditch, the best comparatives are other finance companies that, like Heartland, do not pass the duck test. The closest I have found to Heartland is the unlisted soon to be former subsidiary of the ANZ bank, UDC Finance, in New Zealand. In NTA terms in what we have to assume was a well thought out disposal process, it sold very recently to the Chinese at a much smaller premium to NTA than Heartland is trading at now.[COLOR="#0000CD"Its a pure finance company that loses the ANZ's A- credit rating and may well move to sub investment grade. This is sure to have impacted the price.[/COLOR]
I think at the very least in your valuation, you need to make an adjustment for business execution risk. In my own analysis I did this my requiring a gross return of 7.5% on the projected dividend flow, verses 6.5% for the big banks. I am not sure this is the best way to do it. But it is the best that I have come up with, so far.
SNOOPY