HGH - Heartland Group Holdings

[Snoopy]

'Business Relationship' lending fell by 16% in FY2019 to $559.4m (Annual Review FY2019 p9), and I expect this trend to continue into FY2020 and FY2021. This means I am projecting the 'Business Relationship' loan book to be down to:

$559.4 x 0.84 x 0.84 = $395m

That number corresponds to the receivables book shrinking by $165m. We are told ROE for these loans is between 0% and 11% (AGM2019 Presentation p15). If the closed out loans averaged an ROE of 6%, this would represent a drop in Heartland profit from FY2019 levels of:

$165m x 0.06 = $10m

I am predicting that when some of the lending through intermediaries starts to shrink, Heartland will renew their interest in writing business relationship loans directly. So I see no further shrinkage in profit from this category between FY2021 and FY2022.

Heartland have partnered with at least three intermediary 'FinTech' lenders. Heartland lending through intermediaries increased by $101.7m up 34% on the previous year to $425m at EOFY2019. This represents 38% of all categorised 'business lending' at balance date. That percentage is set to increase as the more traditional -but lower margin- in house 'business relationship lending' book is run down, Heartland's intermediaries are often lenders who have their own independent on line lending platforms. These providers don't need a physical office that customers can visit. Heartland is in fact pushing forward their own business loan expansion targets through these FinTech partners. The three partners they are on record as working with are as follows (see Annual Review FY2017, p13):

1/ 'Spotcap Australia and New Zealand' This company changed ownership on 6th September 2019 for $A9.3m (ZIP HY2020 p6) and is now managed as a division of ASX listed Zip Co. (ASX:ZIP). The purchase included $NZ7m of NZ based receivables and $A23m of Australian SME receivables. 'Spotcap' has been active in Australia since 2015 and active in New Zealand since January 2017. The average Australian loan has a size of $35,000 and has a duration of nine months. A potential New Zealand customer is required to have an 18 month trading history and a turnover north of $200,000. Loans available are in the $10,000 to $250,000 range. There were $A36.9m of receivable loan assets on the books as at 31st December 2019 (ZIP HY2020 Presentation p22). The competitive advantage that Spotcap claim to have is the IP related to their 'Proven SME credit decisioning platform'. However this IP is not owned. It is licensed perpetually from 'Spotcap Global', the Berlin-based FinTech that offers “lending as a service” decision systems around the world.

2/ 'Fuelled' is a New Zealand based start up that has been trading since 2015. The problem that 'Fuelled' was created to solve was to answer the question

"What happens when cashflow gets tight?"

'Fuelled' sees uncollected invoices as having value. So they will lend a company money before an invoice is paid to 'tide them over'. The relationship is purely between the company and 'Fuelled', not with the debtor. Any such transaction is confidential, no personal guarantees are required and costs are simple and transparent. (For example, an outstanding $10,000 invoice can receive $9000 from 'Fuelled', along with a fee of $471 for 30 days cover). 'Fuelled' partners with Xero and MYOB. It can use a customer's own on line information in the cloud to determine how much funding it can provide. This detailed information means that a request in the morning can turn to cash that afternoon. Heartland Bank has a 25% shareholding (a value less that $1m at the time of subscription) in 'Fuelled' bought on 20th February 2017. This investment funded 'Fuelled''s own equity/balance sheet and provided a credit line as well.

The vehicle that runs 'Fuelled' is on the NZ Company's register. "FUELLED LIMITED (5344042) Registered".

https://app.companiesoffice.govt.nz/...panies/5344042

The company last filed a return on 26th March 2019 and is now overdue to file the FY2020 return. It is under threat of de-registration as I write this.

Rechecking the NZ companies database, a tax return was filed in June 2020. This tax return shows Heartland Bank Limited as a 25% shareholder.

I cannot connect to the company website (www.fuelled.co.nz).

The fuelled website is still dead as of October 2020. I can't find any web reference to joint founder Tapio Sorsa, later than June 2017.

Heartland note in their FY2018 presentation that they have made a gain on the sale of Heartland's 'invoice finance business' of $0.6m. I am not clear if this transaction is related to 'Fuelled' or not.

3/ 'Harmoney' (not a spelling mistake)

(Note that Harmoney and other consumer loans are reported on by Heartland separately outside of the header 'Business Intermediated Loans').

So what does this picture suggest for profitability in FY2021?

I am predicting that when some of the lending through intermediaries starts to shrink, Heartland will renew their interest in writing business relationship loans directly. So I see no further shrinkage in profit from this category between FY2021 and FY2022.

'Business Intermediated' lending is projected to grow in FY2020.

But I think that by FY2021, it will shrink back down 10% below FY2019 levels (down to $425.4m x 0.9 = $383m, a decrease of $42m). My reason for believing this is that there will be lower tradie activity in FY2021, and sensible tradespeople will have transferred to IRD backed ultra low interest loans, at least in NZ. The silver lining of this is that by existing Heartland customers effectively refinancing with the government, many bad debts to Heartland will be avoided. Business Intermediary loans have an ROE of between 11% and 15% (AGM2019 Presentation p15). If we assume the average margin is 13%, this will represent a loss of profit for Heartland in FY2021 of:

$42m x 0.13 = $5.5m

The kind of business loans sought by Heartland tend to be short term. So I am not expecting the general reduction in business loans to have a compounding effect year on year.

Business intermediated loans totalled $425m at EOFY2019. By HY2020, just six months later, they had increased by $69m. But then the rate of increase slowed for an overall increment of $74m for the full financial year. This is nevertheless a very impressive $74m/$425m = $500m or a 17.4% increase of 'business intermediated loans' overall over one year.

The incremental increase in the intermediated loan book, using an indicative ROE of 13% (p15 AGM Presentation FY2019) gives an indicative incremental NPAT contribution for FY2020 of:

$74m x 0.13 = $9.6m

To shrink back down to EOFY2019 levels, intermediated business would have to drop by $74m/$500m = 14.8%. So my forecast decline of 10% from FY2019 levels is equivalent to a decline of: 10% +14.8% = 0.9 x 0.852 = 0.767 or 23% from FY2020 levels.

AFAIK almost all intermediated lending is done through 'Spotcap' and possibly Auckland based 'Partpay' (acquired by Spotcap parent ASX:Z1P in August 2019). The NZ side of this business will be facing the same competition as Heartland's O4B from 'IRD Bank' which they will not be able to compete with. There appears to be no equivalent ATO scheme for Australian businesses in Australia. This could indicate more opportunities in Australia over FY2021. But Australian small business has been hit very hard. So I am reluctant to revise upwards my forecast until evidence of Australian small business bouncing back from Covid-19 comes through. From p42 of AR2020 from the ASX listed Zip Co. Ltd.

"Spotcap saw drawdowns drop off in the final quarter of the year (1st April to 30th June) as the impact of COVID‑19 hit SMEs across Australia and New Zealand. Volumes started to increase towards the end of June across a number of resilient industries and the business is well placed offering both standard and SME Guarantee Scheme backed loans to eligible SMEs."

The above quote I would class as 'green shoots of evidence', as opposed to 'evidence'. Let's see what actually happens.

SNOOPY

[Snoopy]

I have humoured everyone by cutting straight to the 'answer'. But this is a situation of considerable uncertainty as to which (or any?) scenario of the ones I have produced is realistic. To understand just how realistic any of these scenarios might be, you have to know what information i put into the model to come up with the answers I did. If I tell you that, and you realise that the profit projections I gave were a result of merely 'turning the handle on the sausage making machine' without any further input from me, then that will allow better judgement as to whether any of the profit projections that I have made make any sense. The table below shows the revenue changes that I have assumed for FY2021 and FY2022 that have changed from the 'base case' (EOFY2019). I am saying nothing about FY2020. I am 'looking through' the current year result because it is likely to be distorted by the advent of Covid-19. So it won't be a good 'base year' to work from.

Three Revenue Forecast Scenarios	Pessimistic View (Post 13411)	Middle View (Post 13429)	Optimistic View (Post 13438)
Reverse Mortgage Adjustment	Zero Growth => +6.7% compounding existing loans	2.5% Growth => 6.7% + 2.5% = 9.2% compounding of loans	8% Growth => 6.7% + 8% = 14.7% compounding of loans
Motor Vehicle Finance Adjustment (New)	45% reduction in new three year contracts => 15% reduction in annual revenue (FY2021) reducing to a 7.5% reduction in annual revenue (FY2022)	45% reduction in new three year contracts => 15% reduction in annual revenue (FY2021) reducing to a 7.5% reduction in annual revenue (FY2022)	45% reduction in new three year contracts => 15% reduction in annual revenue (FY2021) reducing to a 7.5% reduction in annual revenue (FY2022)
Motor Vehicle Finance Adjustment (Used)	10% reduction (FY2021) with a further 10% reduction (FY2022)	10% reduction (FY2021) with a further 10% reduction (FY2022)	10% reduction (FY2021) with revenue stabalising (FY2022)
Business Finance (Part 1) O4B Adjustment	80% of loans wiped out for two months (FY2021). Reduction in remaining loan balances of 15%[, not compounding (FY2021 & FY2022)	80% of loans wiped out for two months (FY2021). Reduction in remaining loan balances of 10%[, not compounding (FY2021 & FY2022)	80% of loans wiped out for two months (FY2021). Reduction in remaining loan balances of 10%[, not compounding (FY2021 & FY2022)
Business Finance (Part 2) 'Intermediated' and 'Relationship' Adjustment	Relationship: 16% compounding loss over two years to EOFY2021, then stable Intermediated: 10% loss from base level (not compounding)	Relationship: 16% compounding loss over two years to EOFY2021, then stable Intermediated: 10% loss from base level (not compounding)	Relationship: One off 16% loss from base level to EOFY2021 Intermediated: 10% fall over FY2021, before recovering all of that fall in FY2022
Rural Finance Adjustment (None)	Zero Growth	Zero Growth	Zero Growth
Harmoney and Other Consumer Lending Adjustment	Collapse of Harmoney over a two year period	Harmoney halved in size from FY2021	Harmoney halved in size from FY2021

None of the above information is new. It has all been disclosed in various previous posts of mine. But something is added by reproducing all of this information together in one place.

The results from FY2020 at last being in the public domain has allowed me to fine tune my Scenario model. I am continuing to use FY2019 as my 'base year' from which the changes outlined in the table below are made.

Three Revenue Forecast Scenarios	Pessimistic View	Middle View	Optimistic View
Reverse Mortgage Adjustment (Post 13708)	2.5% Growth => 6.7% + 2.5% = 9.2% compounding of loans	8% Growth => 6.7% + 8% = 14.7% compounding of loans	8% Growth => 6.7% + 10% = 16.7% compounding of loans
Motor Vehicle Finance Adjustment (New) (Post 13725)	25% reduction in new three year contracts => 8.333% reduction in annual revenue (FY2021) with an additive a 8.333% reduction in annual revenue (FY2022)	25% reduction in new three year contracts => 8.333% reduction in annual revenue (FY2021) with an additive a 8.333% reduction in annual revenue (FY2022)	25% reduction in new three year contracts => 8.333% reduction in annual revenue (FY2021) with an additive a 8.333% reduction in annual revenue (FY2022)
Motor Vehicle Finance Adjustment (Used) (Post 13715)	10% reduction (FY2021) with a further 10% reduction (FY2022)	10% reduction (FY2021) with a further 10% reduction (FY2022)	10% reduction (FY2021) with revenue stabilizing (FY2022)
Business Finance (Part 1) O4B Adjustment (Post 13770)	80% of loans wiped out for two months (FY2021). Reduction in remaining loan balances of 15%, not compounding (FY2021 & FY2022)	80% of loans wiped out for two months (FY2021). Reduction in remaining loan balances of 10%, not compounding (FY2021 & FY2022)	80% of loans wiped out for two months (FY2021). Reduction in remaining loan balances of 10%, not compounding (FY2021 & FY2022)
Business Finance (Part 2) 'Intermediated' and 'Relationship' Adjustment (Post 13771)	Relationship: 16% compounding loss over two years to EOFY2021, then stable Intermediated: 10% loss from base level (not compounding)	Relationship: 16% compounding loss over two years to EOFY2021, then stable Intermediated: 10% loss from base level (not compounding)	Relationship: One off 16% loss from base level to EOFY2021 Intermediated: 10% fall over FY2021, before recovering all of that fall in FY2022
Rural Finance Adjustment (Post 13747)	Rural Relationship Loans - minus 8%, Livestock Loans - minus 5%	Rural Relationship Loans - minus 8%, Livestock Loans - minus 5%	Rural Relationship Loans - minus 8%, Livestock Loans - minus 5%
Harmoney and Other Consumer Lending Adjustment (Post 13749)	Collapse of Harmoney over a two year period	Harmoney halved in size from FY2021	Harmoney halved in size from FY2021

SNOOPY

[Beagle]

I added recently at $1.20 and more at $1.27 both cum divvy. Even at $1.30 I think they have a lot of potential on a look through Covid recovery basis. Wouldn't mind some more...

[sb9]

I added recently at $1.20 and more at $1.27 both cum divvy. Even at $1.30 I think they have a lot of potential on a look through Covid recovery basis. Wouldn't mind some more...

Same here, picked a big lot at 1.17 week before FY results and another big parcel at 1.28 CD recently, should get close to 1.50 in the short term I reckon.

[Snoopy]

While your sell decision was probably made long before Covid-19 arrived on the scene Cyclical, your assessment of $1.27 as 'fully priced value' may yet prove correct. What I see going forwards is a fairly dull finance company, a bit more risk averse than in the past and consolidating around their reverse mortgage offering. Oh and rural lending will just 'chug along'. I see SBS entering the REM market in NZ as adding credibility to the Reverse Equity Mortgage business model. I don't doubt the difficult position of many small businesses throughout NZ. But new small businesses will spring up and someone has to fund them. I don't want to bang the same drum endlessly. But I think it might be instructive to see my three 'future scenarios' stacked up alongside each other.

Three Profit Forecast Scenarios	Pessimistic View (Post 13411)		Middle View (Post 13429)		Optimistic View (Post 13438)
	FY2021	FY2022	FY2021	FY2022	FY2021	FY2022
Baseline Reference Profit	$74.5m	$74.5m	$74.5m	$74.5m	$74.5m	$74.5m
Reverse Mortgage Adjustment	$23.7m	$36.8m	$33.0m	$51.8m	$54.1m	$87.3m
Motor Vehicle Finance Adjustment (New)	($11.4m)	($17.1m)	($11.4m)	($17.1m)	($11.4m)	($17.1m)
Motor Vehicle Finance Adjustment (Used)	($11.3m)	($22.6m)	($11.3m)	($22.6m)	($11.3m)	($11.3m)
Business Finance (Part 1) O4B Adjustment	($6.3m)	($3.6m)	($5.3m)	($2.1m)	($5.3m)	($2.1m)
Business Finance (Part 2) 'Intermediated' and 'Relationship' Adjustment	($15.5m)	($15.5m)	($15.5m)	($15.5m)	($10.9m)	($5.4m)
Rural Finance Adjustment	$0m	$0m	$0m	$0m	$0m	$0m
Harmoney and Other Consumer Lending Adjustment	($3.6m)	($7.6m)	($3.6m)	($3.6m)	($3.6m)	($3.6m)
Total Forecast NPAT	$50.1m	$44.9m	$60.4m	$65.4m	$86.1m	$122.3m
No. Shares on Issue	581.0m	581.0m	581.0m	581.0m	581.0m	581.0m
Earnings Per Share	8.6cps	7.7cps	10.4cps	11.3cps	14.8cps	20.1cps

In the middle case, $1.27 would represent a PE of 11 by FY2022. That might be as good as it gets for the next few years. Yet a dividend of 10cps would be a gross dividend yield of 11%. That has be be pretty attractive against getting less that 2% in a term deposit.

For nztx and Beagle, I am forecasting a 'total profit hit' on business loans to be $19.1m (pessimistic), $17.6m (medium) and $7.5m (optimistic) by FY2022. So I am not trying to downplay your concerns. - they are real.

Time to look at what my 'revised scenario assumptions' look like in terms of dollars.

Three Profit Forecast Scenarios	Pessimistic View		Middle View		Optimistic View
	FY2021	FY2022	FY2021	FY2022	FY2021	FY2022
Baseline Reference Profit (FY2019)	$74.5m	$74.5m	$74.5m	$74.5m	$74.5m	$74.5m
Reverse Mortgage Adjustment (Post 13708)	$33.0m	$51.8m	$54.1m	$87.3m	$62.0m	$101.0m
Motor Vehicle Finance Adjustment (New) (Post 13715)	($6.3m)	($12.6m)	($6.3m)	($12.6m)	($6.3m)	($12.6m)
Motor Vehicle Finance Adjustment (Used) (Post 13715)	($11.3m)	($22.6m)	($11.3m)	($22.6m)	($11.3m)	($11.3m)
Business Finance (Part 1) O4B Adjustment (Post 13770)	($6.3m)	($3.6m)	($5.3m)	($2.1m)	($5.3m)	($2.1m)
Business Finance (Part 2) 'Intermediated' and 'Relationship' Adjustment (13771)	($15.5m)	($15.5m)	($15.5m)	($15.5m)	($10.9m)	($5.4m)
Rural Finance Adjustment (13747)	($3.5m)	($3.5m)	($3.5m)	($3.5m)	($3.5m)	($3.5m)
Harmoney and Other Consumer Lending Adjustment (13719)	($3.6m)	($7.6m)	($3.6m)	($3.6m)	($3.6m)	($3.6m)
Total Forecast NPAT	$61.0m	$60.9m	$83.1m	$101.9m	$95.6m	$137m
No. Shares on Issue	581.0m	581.0m	581.0m	581.0m	581.0m	581.0m
Earnings Per Share	10.5cps	10.5cps	14.3cps	17.5cps	16.5cps	23.6cps

By far the largest contributor to the profit jump in my 'Scenario 1b' compared with my 'Scenario 1' has been my revised up incremental earnings from the reverse mortgage business. Yes the smaller than expected drop in motor vehicle finance will help too. But what is perhaps more impressive is that this growth has been projected against a significant fall in the profitability of business loans and consumer lending. The decline in all types of rural lending that I have now included has made little difference to the overall picture. My middle case modelling result for FY2021 conforms very closely to Jeff's $83m-$85m forecast for FY2021. So that gives me confidence I am on the right track with my analysis

Trading at $1.33 today, HGH is on a projected PE for FY2021 of 133/14.3 = 9.3. That looks very fair value in what is otherwise a very heated stock market. However, that 'bargain price' is very much leveraged to the reverse mortgage market. And as the pessimistic scenario shows, there is significant downside to my middle case earnings projections if the reverse mortgage market ceases to grow at a rate we have been used to.

SNOOPY

[nevchev]

So we had a decrease in divies due to RBNZ restrictions. With such a good guidance for next year will heartland take up the slack and provide bumber divies when restrictions come off?

[King1212]

Definitely....HGH was my first initial investment share that I bought....never disappointing me....I sold during the crash....n slowly bought back...if it was not covid..in feb 2020...the SP would be $2

Market screener slapped $1.54...u can also see thier earning forecast model there

[value_investor]

I added recently at $1.20 and more at $1.27 both cum divvy. Even at $1.30 I think they have a lot of potential on a look through Covid recovery basis. Wouldn't mind some more...

I agree 100%. Bought in big at $1.02 and topped up again at $1.23. Happy to keep accumulating at these prices and I see this being very healthy this time next year.

Just my opinion, but I don't think this is the big credit crunch that was 2008. HGH is well positioned to rise once things start going back to normal.

[Snoopy]

So we had a decrease in divies due to RBNZ restrictions. With such a good guidance for next year will Heartland take up the slack and provide bumper divies when restrictions come off?

The RBNZ restrictions are still on, because no-one yet knows how bad the economic effects of Covid-19 will be in NZ. When Auckland goes back to level 1 this time, I see that as the 'end of the beginning' of Covid-19. There are many more future effects of Covid-19 to come. The banks have done OK so far because their customers were on subsidised wages and locked down so many temptations to spend their subsidised money was removed. Thus existing loans, taken out well before Covid-19, continued to be paid down. The effect of Covid-19 that matters is the demand for new loans going forwards. Banks and finance companies are yet to feel this to any great degree.

Traditionally Heartland has always been short of capital. So I wouldn't bet on Heartland having excess capital now, after partially skipping just one dividend because of RBNZ rules. OTOH Covid-19 may have changed the loan landscape so they can't loan out money as before. But if that is what it takes to have excess capital on the books, then you don't want such a scenario to happen, as it means growth going forwards is torpedoed. So best not to hope for a bumper dividend going forwards IMO.

I agree 100%. Bought in big at $1.02 and topped up again at $1.23. Happy to keep accumulating at these prices and I see this being very healthy this time next year.

Just my opinion, but I don't think this is the big credit crunch that was 2008. HGH is well positioned to rise once things start going back to normal.

Value_Investor, as the wise old Snow Leopard has said before: Read note 8 of the annual accounts on "Impaired Asset Expense". Lot's of assumptions built into the HGH growth forecasts including 'no more lockdowns', and a 'relatively quick and full recovery by June 2022'. Look at what is happening in other countries and you will see how optimistic these pre-conditions are. I am not saying HGH is not worth investing in at today's prices (I am still in the process of working this out for myself). I am saying you need to invest with a margin of safety, and that includes assuming a 'new Covid-19 normal' applies from now on. But as a "Value_Investor", you already know this, right?

SNOOPY

[nevchev]

https://www.nzx.com/announcements/360898