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  1. #1
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    Default Turners (TNR) bonds

    Hi All. Long time sharemarket investor but very shy bond market investor here. In fact TNRHA, the soon to mature (30th September 2016) bonds have been my only bond investment for some years. I was skeptical two years ago when Dorchester issued these bonds, but the 9% coupon rate was enough to overcome by skepticisim! Now in effect the bonds are being reincarnated as TNRHB, but with a much lower 6.5% interest rate. Are they still the compelling investment that I believed the TNRHA bonds were two years ago? Let's see.

    SNOOPY
    Last edited by Snoopy; 19-09-2016 at 08:41 AM.
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    Default Gross Income: TNRHA vs TNRHB vs TNR Shares

    Quote Originally Posted by Snoopy View Post
    Are they still the compelling investment that I believed the TNRHA bonds were two years ago? Let's see.
    From an income perspective, I always like to compare the gross dividend an investor would receive if they held the shares with the equivalent bond yield.

    TNRHA TNRHB
    Bond Coupon Rate at Issue 9.0% 6.5%
    TNR equivalent share price (one month before bond issue) $2.50 $3.02
    TNR equivalent dividend (adjusted for 10:1 share consolidation) 4c + 6c = 10c (actual gross) 3c + 3c +3.5c +3.5c = 13c (forecast net) or 18c (forecast gross)
    Gross Share Yield 4.0% 6.0%

    Helped by imputation credits from the shares beinhg available from late FY2016 on, the gap between income form the bonds and income from the shares has closed considerably. Because not all of the profits are paid out as dividends (policy is a 50-55% payout ratio), we can expect the retained earnings to grow profits over time. As the profits trend up, then so should the share price. OTOH the bond price will not change if held until maturity two years away. IMO the balance has now tipped towards buying the shares, not the bonds, from an overall investment perspective.

    SNOOPY
    Last edited by Snoopy; 19-09-2016 at 08:46 AM.
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  3. #3
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    Default Banking Covenants on TNR

    Quote Originally Posted by Snoopy View Post
    Are they still the compelling investment that I believed the TNRHA bonds were two years ago? Let's see.
    Below is a comparison of the different financial covenants that Turners agreed to with their banks at the time of issue of both respective bonds. These numbers are taken from each respective bond prospectus.

    TNRHA (issue) TNRHA (forecast at maturity) TNRHB (issue)
    Interest Cover (EBITDA to Total Interest) 3.0 times 3.5 times 3.0 times
    Interest Cover (Dorchester Finance Limited, Oxford Finance Limited) N/A N/A 1.25 times
    Maximum Leverage Ratio (Gross Debt to EBITDA) 3.75 2.0 2.5
    Minimum Debt Cover Service Ratio (cashflow for debt servicing)/(total debt service costs) 1.1 1.1 N/A
    Equity Ratio (Dorchester Finance Limited, Oxford Finance Limited) N/A N/A 20%
    Maximum CAPEX as a percentage of base case 110% 110% 110%

    I should note that these covenants can be subject to amendment after the bonds are issued, and are not 'set in stone' for the life of the bonds. But I make the following observations.

    1/ The allowed leverage ratio at the time TNRHA bonds were introduced was set temporarily high, because the business at that time was in a consolidation phase.
    2/ It looks to me that with TNRHB, the 'tool for keeping parent bank capital risk in check' has changed. Changed from looking at 'debt servicing costs' to having a 'minimum equity ratio' on the loan book.
    3/ The issue of the TNRHB bonds looks to affirm a rather more risky capital regime in terms of 'interest cover' and 'maximum leverage ratio'.
    4/ Notwithstanding (3), the 20% equity ratio required on the finance company loan books is reassuringly conservative

    SNOOPY
    Last edited by Snoopy; 19-09-2016 at 08:49 AM.
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    Default TRAHB Bond Covenants: Introduction

    Quote Originally Posted by Snoopy View Post

    TNRHB (issue)
    Interest Cover (EBITDA to Total Interest) 3.0 times
    Interest Cover (Dorchester Finance Limited, Oxford Finance Limited) 1.25 times
    Maximum Leverage Ratio (Gross Debt to EBITDA) 2.5
    Equity Ratio (Dorchester Finance Limited, Oxford Finance Limited) 20%
    Maximum CAPEX as a percentage of base case 110%

    I should note that these covenants can be subject to amendment after the bonds are issued, and are not 'set in stone' for the life of the bonds. But I make the following observations.
    What were TNRHB bonds have now been renamed TRAHB bonds. It is just a name change to reflect the change in name of the parent company. A couple of years back, I made a 'not too persuasive' analysis on how the then 'Turners Limited' (now 'Turners Automotive Group') was doing in sticking to their bond covenants. Now I intend to make a better attempt.

    I have a problem running these covenant checks. The covenants are clear. But the 'segment reporting' in the annual report may not correspond exactly to the two 'bond prospectus' groupings of:

    1/ Non-finance Covenant Group &
    2/ Bank Borrower Finance Companies

    as listed on page 16 of the bond prospectus (the prospectus that I have previously referenced in post 12). I have assumed that all of the 'bank borrower finance companies' are listed under the 'finance' segment, while 'Automotive Retail', 'Collection Services NZ', 'Collection Services Aus' and 'Insurance' are all lumped into the 'Non-finance Covenant Group'. But I can't be sure of that. Subsidiary 'Southern Finance' was not specifically mentioned as being part of the 'finance' segment as an example.

    Next, for covenant calculation purposes, I have to decide how to allocate the corporate head office costs across divisions. There is every reason to suggest the more revenue a division generates, then the more attention that division will require from management. So this is my preferred method of allocating head office costs across the other divisions. This, however, is a 'rule of thumb' that I cannot be assured accurately reflects the real allocation of head office time and resources.

    The next problem is working out what the EBITDA figure is for each of the two categories. The company annual interest bill is shared amongst all the divisions of the company. But how is it split up? I have split the interest between segments in proportion to the disclosed liabilities of that segment. The proportion of segment liabilities in relation to the total liabilities determines how the liabilities and hence how the 'interest due for payment' is spread out. To me this seems logical. However, there is no obligation on the company to spread their total interest expense obligations across divisions in this way.

    I am discussing this because I would like readers to see there are quite a few assumptions behind an analysis such as this. And therefore quite a few ways that the answers I am deriving can go wrong. Yet this is the fairest way I can think of to make use of the 'segment information' as presented in the annual report for the 'Turners Automotive Group'. So let's get going.

    SNOOPY
    Last edited by Snoopy; 08-09-2017 at 09:34 AM.
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    Default TRAHB Bond Covenant 1: Interest Cover

    Quote Originally Posted by Snoopy View Post
    So let's get going.
    The standard we are looking for here ( p13 bond prospectus ) is:

    1/ EBITDA/I > 1.25 ( Bank Borrower Finance Companies: Dorchester Finance Limited and Oxford Finance)
    2/ EBITDA/I > 3.00 ( Non-finance Covenant Group )

    FY2016 EBIT DA EBITDA I EBITDA/I Pass Test?
    Finance Segment $14.619m $0.173m $14.792m $4.770m 3.1 >1.25, pass
    All Other Segments $18.368m $1.971m $20.339m $6.666m 2.8 <3.00, fail
    Total $32.987m $2.144m $35.131m $11.436m

    FY2017 EBIT DA EBITDA I EBITDA/I Pass Test?
    Finance Segment $13.744m $0.329m $14.073m $3.719m 3.8 >1.25, pass
    All Other Segments $22.237m $2.534m $24.771m $7.361m 3.3 >3.00, pass
    Total $35.981m $2.863m $38.844m $11.350m

    Eagle eyed bond holders will see that the bonds were issued in August 2016, while FY2016 finished in March 2016. Technically you can't fail a test before the bond is issued. But these TNRHB bonds effectively replaced the TNRHA bonds which had similar covenants. So I think the FY2016 figures are useful for comparative purposes. The 'close fail' of the 'All Other Segments' statistic over FY2016 could have been fixed by allocating more head office costs to the finance division, as an example. Alternatively, because these covenants are subject to renegotiation, TNR could have gained a temporary exemption from their banking syndicate. In any event, nothing was publicised on the subject of TNR/TRA breaking their interest cover covenant at the time. So it must have all worked out

    SNOOPY
    Last edited by Snoopy; 09-09-2017 at 10:16 AM.
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    Default TRAHB Bond Covenant 2: Leverage Ratio

    Quote Originally Posted by Snoopy View Post
    So let's get going.
    p13 of the bond prospectus lists the 'leverage ratio' as being the ratio of:

    Gross Debt / EBITDA < 2.5

    but only in relation to the 'Non Finance Covenant Group'. There appears to be no leverage ratio requirement on the 'Finance' group side of the business. This strikes me as being very odd. I would have thought that the leverage ratio of the finance side of the business would be far more important than the non-finance side. But I will go with it.

    Please note that the segmented Gross Debt and EBITDA figures have been adjusted to allow for an appropriate proportion of head office costs.

    FY2016 Gross Debt {A} EBITDA {B} 'Gross Debt'/EBITDA {A}/{B} Pass Test?
    Finance Segment $119.107m $14.792m 8.05 Test not required
    All Other Segments $232.491m-$119.107m=$113.384m $20.339m 5.57 >2.50, fail
    Total $232.491m $35.131m

    FY2017 Gross Debt {A} EBITDA {B} 'Gross Debt'/EBITDA {A}/{B} Pass Test?
    Finance Segment $158.647m $14.073m 11.3 Test not required
    All Other Segments $384.917m-$158.647m=$226.270m $24.771m 9.13 >2.50, fail
    Total $384.917m $35.131m

    Generally test results as far out as these two, would suggest I have made a mistake. However, as yet I can't find it. The only thing that is indisputable is that comparing 'like with like' statistics, TRA had a lot more leverage on the balance sheet at EOFY2017 when compared to a year earlier.

    SNOOPY
    Last edited by Snoopy; 09-09-2017 at 10:17 AM.
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    Default TRAHB Bond Covenant 2: Leverage Ratio (further discussion)

    Quote Originally Posted by Snoopy View Post
    p13 of the bond prospectus lists the 'leverage ratio' as being the ratio of:

    Gross Debt / EBITDA < 2.5

    but only in relation to the 'Non Finance Covenant Group'. There appears to be no leverage ratio requirement on the 'Finance' group side of the business. This strikes me as being very odd. I would have thought that the leverage ratio of the finance side of the business would be far more important than the non-finance side. But I will go with it.

    Please note that the segmented Gross Debt and EBITDA figures have been adjusted to allow for an appropriate proportion of head office costs.

    FY2016 Gross Debt {A} EBITDA {B} 'Gross Debt'/EBITDA {A}/{B} Pass Test?
    Finance Segment $119.107m $14.792m 8.05 Test not required
    All Other Segments $232.491m-$119.107m=$113.384m $20.339m 5.57 >2.50, fail
    Total $232.491m $35.131m

    FY2017 Gross Debt {A} EBITDA {B} 'Gross Debt'/EBITDA {A}/{B} Pass Test?
    Finance Segment $158.647m $14.073m 11.3 Test not required
    All Other Segments $384.917m-$158.647m=$226.270m $24.771m 9.13 >2.50, fail
    Total $384.917m $35.131m

    Generally test results as far out as these two, would suggest I have made a mistake. However, as yet I can't find it. The only thing that is indisputable is that comparing 'like with like' statistics, TRA had a lot more leverage on the balance sheet at EOFY2017 when compared to a year earlier.
    I guess if anyone is still reading this thread, they might think that I am travelling down a black hole of mindless detail. But actually these covenants have a bearing on whether we bondholders will get our investment capital back at all, should something go 'slightly wrong'. You can bet that if the bank doesn't get all of their capital back in times of distress, then we bondholders will get nothing. So as far as our bond investment is concerned, this discussion is a life or death exercise.

    I am going to re-run some of these numbers based on the actual numbers listed in the segmented analysis, section 6, of AR2017. This removes all my 'reallocation of costs' assumptions that I have used in this analysis so far. To allow the best possible chance of 'covenant success' we want the numerator, in this case the 'Gross Debt' to be as low as possible and the denominator, in this case EBITDA, to be as high as possible. The 'Gross Debt' can be found from the divisional liabilities and can be summed up as follows:

    Non Finance Group Liabilities FY2017 Liabilities FY2016
    Automotive Retail $103.821m $62.625m
    Collection Services NZ $9.246m $13.991m
    Collection Services Aus $0.890m $1.346m
    Insurance $66.503m $27.110m
    Corporate and Other $79.169m $50.668m
    'Gross Debt' Total $259.629m $155.740m

    The average gross debt across the financial year is therefore:

    $259.629m + $155.740m = $207.685m

    Non Finance Group EBT FY2017 DA FY2017 I FY2017 EBITDA FY2017
    Automotive Retail $15.397m ($2.286m)
    Collection Services NZ $6.006m ($0.092m)
    Collection Services Aus $0.239m $0m
    Insurance $0.928m ($0.091m)
    Corporate and Other ($8.095m) ($0.065m)
    Total $14.475m ($2.534m) ($11.350m) $28.359m

    Note that i have maximised EBITDA by assuming that the whole company interest bill is paid by the 'Non Finance Group', which IMO is an assumption unlikely to be true.

    Now we have the numerator and denominator, we can work out the fraction:

    (Gross Debt) / EBITDA = $207.685m / $28.359m = 7.3 > 2.5 (fail)

    Because Autosure was not bought until the last day of the financial year, we could assume that the gross debt increase as a result of that purchase was unrepresentative. Assuming gross debt for insurance did not change during the year gives us a lower average gross debt figure of $187.988m.

    (Gross Debt) / EBITDA = $187.988m / $28.359m = 6.6 > 2.5 (fail)

    Try as I might, and making all sorts of favourable assumptions, I cannot get anywhere near a pass mark on this covenant. I am forced to conclude that our bond capital is at significant risk should trading events not pan out as planned.

    SNOOPY
    Last edited by Snoopy; 09-09-2017 at 11:32 AM.
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    Default TRAHB Bond Covenant 3: Equity Ratio

    Quote Originally Posted by Snoopy View Post
    So let's get going.
    The 'equity ratio' is defined as: (Net worth) / (Total assets)

    I am going to assume that 'Net Worth' is equivalent to 'Divisional Shareholder Funds' in this instance.

    Once again this statistic is to be applied to the 'Non-Finance Covenant Group'. One again I find this very odd. I would have thought the equity ratio was far more important to the finance side of the business. Further muddying the water is that the standard listed is a minimum of 20% that should be applied to 'Dorchester Finance' and 'Oxford Finance', both of which definitely are finance arms! I don't think this bit of the bond prospectus, as written, even makes sense as it is obviously contradictory. But I shall 'battle on' and see what numbers come out.

    Please note that the 'Shareholders Funds' figures have been adjusted to allow for an appropriate proportion of head office costs.


    FY2016 Net Worth (Shareholders Funds) {A} Total Assets {B} 'Net Worth'/'Total Assets' {A}/{B} Pass Test?
    Finance Segment $63.869m $182.975m 34.9% >20%, Pass
    All Other Segments $129.612m-$63.869m=$65.943m $362.303m-$182.975m=$179.328m 36.8% >20%, Pass
    Total $129.612m $362.303m


    FY2017 Net Worth (Shareholders Funds) {A} Total Assets {B} 'Net Worth'/'Total Assets' {A}/{B} Pass Test?
    Finance Segment $54.431m $213.078m 25.5% >20%, Pass
    All Other Segments $171.716m-$54.431m=$117.285m $556.633m-$213.078m=$343.555m 34.1% >20%, Pass
    Total $171.716m $556.633m

    Conclusion? The finance arm is a lot more leveraged than last year. But it is still well within the bounds determined by the banks. So there is nothing for bondholders to worry about here.

    SNOOPY
    Last edited by Snoopy; 09-09-2017 at 10:17 AM.
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    Default TRAHB Bond Covenant 4: Actual Capital Expenditure vs Base Case

    Quote Originally Posted by Snoopy View Post
    So let's get going.
    "In each year , in relation to the 'Non-Finance Covenant Group', capital expenditure is to be no more than 110% of the base case as set out in the annual budget provided to the bank."

    In essence this looks like a 'no surprises' policy. This is almost impossible to verify though, as we mere shareholders/bondholders have not been briefed on the TRA annual budget. I imagine that if TRA wanted to spend more than their 110% of budgeted capex, a meeting with the bank manager outlining in detail their revised business plan could be negotiated.

    On p63 of AR2016 we learn:

    "The Group does not currently have any approved capital expenditure commitments at reporting date (2015: nil)."

    According to my maths, 110% of 0 is 0. So it follows that Turners must have sought bank approval for the acquisition of 'Buy Right Cars' and 'Autosure' during FY2017. That is hardly surprising, and brings to an end my analysis of this covenant.

    SNOOPY
    Last edited by Snoopy; 09-09-2017 at 10:32 AM.
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    Default Campbell MacPherson Appraisal

    Quote Originally Posted by Snoopy View Post
    Are they still the compelling investment that I believed the TNRHA bonds were two years ago? Let's see.
    As part of the AGM documentation, an assessment of the bonds was made by independent firm Campbell MacPherson. On page 11 of the CM report they stated:

    --------------

    "The proposed interest rate of 6.5% p.a. is significantly lower than the interest rate on the existing bonds of 9.0%. This primarily reflects:

    1/ A reduction in wholesale interest rates over the past 2 years.
    2/ A reduction in financail risk associated with Turners

    ---------------

    I accept the first point, but not the second.

    It is true that Turners have been well managed over the last couple of years. But the loan business is competitive, with other good operators out there who can win over your customers. What is also true over the last two years is that in the loan industry, the climate has been exceptionally favourable for those loan businesses that survivied the great financial sector collapse. There is an old investment saying that only when the tide goes out you get to see who is swimming naked. Finance companies have been swimming at high tide for the last two years. Just how badly Turners will be affected during the next financial downturn is unknown. But IMO the 'next downturn' risk has not reduced for Turners over the last two years.

    My opinion is reinforced by the relaxed 'Leverage ratio' and 'Interest cover' covenants. This would suggest a more relaxed lending policy. And this implies that company risk has increased from a few months ago.

    The report carries on

    ---------------

    We estimate the market based interest rate on a security with similar chacteristics to the New Bonds should be in the range of 6.0% to 8.5% per annum (representing a premium of 1.0% to 3.5% over Turners FY2016 bank borrowing costs of 5.0%).

    ------------


    Turners 6.5% offered is towards the bottom end of this range. I don't think that is compelling enough, when there is every chance that interest rates will be higher in two years than they are now. If the new interst rate was 7.5%, my answer would have been different. I won't be renewing by TNR bonds as a fixed interest investment. However, I will be renewing -some- of my TNR bonds!

    SNOOPY
    Last edited by Snoopy; 19-09-2016 at 08:51 AM.
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