HGH - Heartland Group Holdings

[Snoopy]

The trend below is required to track higher for five years with one setback allowed.

Financial Year	Net Sustainable Profit (A)	Shares on Issue EOFY (B)	eps (A)/(B)
2012	$26.606m + 0.72($5.642m + $3.900m) =$30.476m	388.704m	7.84c
2013	$6.912m + 0.72($22.527m+ $5.101m)= $26.804m	388.704m	6.90c
2014	$36.039m	463.266m	7.78c
2015	$48.163m - 0.72(0.588m) = $47.743m	469.980m	10.2c
2016	$54.164m - 0.72(1.136m) = $53.346m	476.469m	11.2c

Result: Pass Test

One necessary hurdle has been lept over in a quest to see if Heartland is a suitable candidate to apply the Buffet growth model, as espoused in "The Buffettology Workbook" by daughter in law Mary Buffett.

Eagle eyed readers will note that I have revised some of my assumptions on what one off items are taxable or not.

Financial Year	Net Sustainable Profit (A)	Shares on Issue EOFY (B)	eps (A)/(B)
2014	$36.039m + $0.056m = $36.095m	463.266m	7.8c
2015	$48.163m - $0.588m - $0.098m = $47.477m	469.980m	10.1c
2016	$54.164m - $1.136m - $0.322m = $52.706m	476.469m	11.1c
2017	$60.808m - 0.72x$1.2m - $0.628m - $0m = $59.316m	516.684m	11.5c
2018	$67.513m + 0.72x$1.3m - ($4.8m + $0.6m) -$0.156m - $0m = $62.893m	560.587m	11.2c

Notes

1/ Property plant and equipment sale loss of $56k added back into FY2014 result.
2/ Profit of $588k from investment sale and $98k from Property Plant and Equipment sales removed from FY2015 result
3/ Profit of $1.136m from investment sale and $322k from Property Plant and Equipment sales removed from FY2016 result
4/ Profit of $0.628m from investment sale removed from FY2017 result. A $1.2m insurance write back that made the impaired asset expense for FY2017 unusually low and hence artificially inflated profits has been removed from the FY2017 result (refer FY2018 annual report).
5/ Profit of $0.156m from investment sale removed from FY2018 result. The after tax effect of $1.3m in 'one off costs' (system integration $0.5m, legacy system write off $0.3m and corporate restructure $0.5m) have been added to the FY2018 profit. Profits from the sale of the 'bank invoice finance business' of $0.6m and $4.8m recovered from a legacy MARAC property loan have been removed from the FY2018 profit.
6/ I have been unable to locate property plant and equipment sales profits/losses for FY2017 and FY2018.

Result: Pass Test

SNOOPY

[Snoopy]

The table is required to have an ROE figure of >15% for five years in a row, with one setback allowed.

Financial Year	Net Sustainable Profit (A)	Shareholder Equity EOFY (B)	ROE (A)/(B)
2012	$26.606m + 0.72($5.642m + $3.900m) =$30.476m	$374.798m	8.1%
2013	$6.912m + 0.72($22.527m+ $5.101m)= $26.804m	$370.542m	7.2%
2014	$36.039m	$452.622m	8.0%
2015	$48.163m - 0.72(0.588m) = $47.743m	$480.125m	9.9%
2016	$54.164m - 0.72(1.136m) = $53.346m	$498.341m	10.7%

Result: Fail Test

Pre-empting the grizzlers, the thinking behind this test is that an ROE of 15% is well above the cost of capital of most firms. A lower ROE than this means that it is possible that some of the businesses under the Heartland umbrella are earning a return less than their cost of capital. This means that there is less certainty that capital in the future will be efficiently deployed, and consequently less certainty about the profit oulook. This doesn't mean that one should not invest in Heartland though. It just means that you should use a method other than the 'Buffett Growth Model' to evaluate the business.

Financial Year	Net Sustainable Profit (A)	Shareholder Equity EOFY (B)	ROE (A)/(B)
2014	$36.095m	$452.622m	8.0%
2015	$47.477m	$480.125m	9.9%
2016	$52.706m	$498.341m	10.6%
2017	$59.316m	$569.595m	10.4%
2018	$62.893m	$664.160m	9.5%

This shows a major weakness of Heartland, with return on Equity a long way short of target guidelines. The relatively low ROE is exaggerated by raising capital throughout the year, through the simplified calculation method I have used. But this is as it should be in my opinion, as constantly raising new capital from shareholders is another undesirable corporate trait.

Result: Fail Test

SNOOPY

[Snoopy]

What we are looking for here is the ability to raise margins at above the rate of inflation over some time period longer than two years back to back.

Financial Year	Net Sustainable Profit (A)	Gross Interest Revenue (B)	Net Profit margin (A)/(B)
2012	$26.606m + 0.72($5.642m + $3.900m) =$30.476m	$205.142m	14.9%
2013	$6.912m + 0.72($22.527m+ $5.101m)= $26.804m	$206.349m	13.0%
2014	$36.039m	$210.297m	17.2%
2015	$48.163m - 0.72(0.588m) = $47.743m	$260.488m	18.3%
2016	$54.164m - 0.72(1.136m) = $53.346m	$265.475m	20.1%

Result: Pass Test

Financial Year	Net Sustainable Profit (A)	Gross Interest Revenue (B)	Net Profit margin (A)/(B)
2014	$36.095m	$210.297m	17.2%
2015	$47.477m	$260.488m	18.2%
2016	$52.706m	$265.475m	19.9%
2017	$59.316m	$278.279m	21.3%
2018	$62.893m	$309.284m	20.3%

Before the glitch this year it looks like a one way increasing trend. A very commendable result.

Result: Pass Test

SNOOPY

[Snoopy]

This is the summary for those millennials who are 'attention span challenged'. Warren Buffett's scanning of the 'growth potential' of a company can be summarized in four quick questions.

Q1/ Does Heartland Bank have a top three market position in the markets in which it chooses to operate? (Ref: my post 8523)
A1/ Yes

Q2/ Does Heartland Bank have a 'normalised profit' increasing 'earnings per share trend'? (Ref: my post 8493)
A2/ Yes

Q3/ Does Heartland Bank have a record of earning a superior ( >15% ) return on shareholder equity? (Ref: my post 8495)
A3/ No

Q4/ Does Heartland Bank have the capability of operating at increasing Net Profit margins? (Ref: my post 8510)
A4/ Yes

Overall Conclusion

Heartland is not able to satisfy all the requirements to apply Warren Buffett's compounding growth model. This does not mean that Heartland is necessarily a poor investment going forwards. It just means that Heartland must be analyzed in a different way.

The conclusion I have come to today mirrors my FY2016 perspective conclusion.

We have been here before, so I will repeat myself in response too.

Using ROE as a measure, Heartland is very definitely a below average business.

From my perspective as a potential 'growth' investor, this problem is serious. Part of the problem is regulatory. The reserve bank is requiring banks to back up their lending with more capital than has historically been required. Other banks address this hurdle by issuing such things as 'bank bonds', an alternative source of 'Tier 1' capital. Heartland has talked about doing this in the past, but so far has not issued "Heartland Bonds'. If they did, then return on shareholder equity could potentially be boosted. Yet with only a BBB credit rating, would there be enough corporate interest in Heartland Bank Bond to get an issue away?

If there is a case for investment in Heartland today, I feel as though it will be as a dividend play.

Contrary to two years ago Heartland does have a plan to issue Heartland Bonds mainly in Australia. This may drive ROE up for the overall Heartland Group in the future. However, today is today, and I feel it more conservative to consider Heartland as a pure 'dividend play'.

Heartland fails the 'Buffett Test' by virtue of falling at hurdle three. But it may yet prove a good investment from a dividend perspective. Let's see.

SNOOPY

[Snoopy]

Year	Dividends Paid 'per share'	Significant Event During Year'
FY2013	1.5cps(sp) + 2.0cps	17th December 2012: Heartland becomes a bank
FY2014	2.5cps + 2.5cps	1st April 2014: Seniors 'Reverse Mortgage' Business Acquired
FY2015	3.5cps + 3.0cps	10th September 2014: invests in Harmony P2P startup
		28th October 2014: Credit rating upgraded from BBB- to BBB (Fitch Ratings)
FY2016	4.5cps + 3.5cps
FY2017	5.0cps + 3.5cps
FY2018	5.5cps + 3.5cps
Average FY2015 to FY2018 inclusive	8.00cps

I have chosen to use the last four years of operation as indicative, as these years include the full contribution of the Reverse Mortgage Portfolio, a critical component of Heartland going forwards.

Year	Dividends Paid 'per share'	Significant Event During Year'
FY2013	1.5cps(sp) + 2.0cps	17th December 2012: Heartland becomes a bank
FY2014	2.5cps + 2.5cps	1st April 2014: Seniors 'Reverse Mortgage' Business Acquired
FY2015	3.5cps + 3.0cps	10th September 2014: invests in Harmony P2P startup
		28th October 2014: Credit rating upgraded from BBB- to BBB (Fitch Ratings)
FY2016	4.5cps + 3.5cps
FY2017	5.0cps + 3.5cps
FY2018	5.5cps + 3.5cps
FY2019	5.5cps + ?.?cps
Average FY2015 to FH2019 inclusive	8.33cps

I have chosen to use the last four and one half years of operation as indicative, as these years include the full contribution of the Reverse Mortgage Portfolio, a critical component of Heartland going forwards.

SNOOPY

[Snoopy]

Plugging in a representative yield, one that represents the ups and downs of the banking cycle of Heartland in its current form, we can now arrive at our 'Capitalised Dividend Model' valuation

(Representative Dividend per Share) / (Acceptable Gross Yield) = Share Price (an algebraic manipulation of: Dividend per Share / Share Price = Yield )

8.0c / (0.72 x 0.075) = $1.48

A reminder here that NTA was

($569.595m - $71.237m) / 516.684m = 96 cps

at balance date. This means my fair valuation is at a good premium to net tangible asset value. This is a credit to management, working from the rag tag of assets that they started with.

This $1.48 valuation is measured at the average point in the business cycle. One might argue that we are now riding high in the business cycle and that this $1.48 valuation is consequently too low given today's circumstances. I wouldn't argue with that. But, ever the bargain hound, neither would I look at buying any shares myself until that share price drifts down to that $1.48 level.

Plugging in a representative yield of 7.5%, one that IMO represents an appropriate risk for the ups and downs of the banking cycle of Heartland in its current form, we can now arrive at our 'Capitalised Dividend Model' valuation

(Representative Dividend per Share) / (Acceptable Gross Yield) = Share Price (an algebraic manipulation of: Dividend per Share / Share Price = Yield )

8.333c / (0.72 x 0.075) = $1.54

A reminder here that NTA was

($664.160m - $74.401m) / 560.587m = $1.05 cps

at balance date. This means my fair valuation is at a good premium (+46%) to asset value.

This $1.54 valuation is measured at the average point in the business cycle. My rule of thumb is that over the business cycle the actual share price will fluctuate between 80% and 120% of capitalised dividend fair value. This gives a target range of $1.23 to $1.85. Given where we are in the business cycle, $1.73 looks fair value today. Given the sweet spot in the business cycle today for shares, I think $1.85 over the next twelve months is a target that Heartland could get to. I don't see compelling value at $1.73 though. But if the share does drift back towards my fair value mid point of $1.54, that might be the time to -finally- add HBL to my portfolio.

SNOOPY

[winner69]

Tried to get a Heartland mistake fixed today.

Internet banking broken, the new App broken and the nice guy at the other end of phone has to write things down because the whole system broke ...and he promises to rectify the mistake when he can so I don’t gave to worry

The nice guy did let slip the system is a bit unreliable

Oh well .....Oracle works fine I’m told

[Marilyn Munroe]

Oh well .....Oracle works fine I’m told

Nothing wrong with Oracle as a relational database management system. It's the bits between you and the database that are likely the problem

I was trying to do online banking with Heartland this morning and got Apache error pages. Apache is is a widely used web server with a good reputation for reliability so it is unlikely that is the problem.

One of the problems dealing with Oracle is Larry. If he wants to buy another Hawaiian Island and decides you are the customer who is going to pay for it you are in trouble.

Boop boop de do
Marilyn

PS. Off topic ramble: The Coalition Government missed a golden opportunity with the Chief Technology Officer appointment omni-shambles. They should have used the salary to hire top relational database or system analyst talent with the remit to walk into development meetings with a baseball bat on their shoulder to discourage bureaucrats and suppliers from repeating c---k ups like Novapay or Incis.

[Beagle]

Tēnā koe,
Internet banking and the mobile app are currently unavailable while we resolve a technical issue.
We'll post updates here when we have them.
Thanks for your patience,
The Heartland Team.

Perhaps loading Maori as a tab at the top of the home page so the whole website can be viewed in Maori has blown Oracles systems lol.

Not sure why they can't actually give me a greeting in English that I understand...is that too much to ask ?

[Beagle]

Internet banking up and running again, that's good.