HGH - Heartland Group Holdings

[Snoopy]

Time to update the Heartland hunger for 'capital flow' table for the last six years:

Financial Year	Capital Notes Issued during FY	New Shares Issued during FY	Total Shares on the Books EOFY	Net Money Raised During FY (excl. Capital Notes)	Dividends Paid	ROE
2013	0 m	0 m	388.704m	$0m	$13.951m	7.2%
2014	0 m	75,562 m	463.266m	$64.774m	$19.930m	8.0%
2015	0 m	6,624 m	469.980m	$9.163m	$30.188m	9.9%
2016	0 m	6,579 m	476.469m	$6.798m	$37.690m	10.7%
2017	$22.000m	40.215m	516.684m	$50.991m	$41.977m	10.4%
2018	$150.000m	43.463m	560.147m	$71.726m	$47.895m	9.6%
Total Cash Raised	$172.000m			$203.452m
Total Cash Returned					$191.631m

Notes

1/ The Australian 2017 'Subordinated Unsecured Capital Notes' issue for $A20m, which at $NZ1= =$A0.909c is equivalent to $NZ22m, was confirmed on April 7th 2017, and therefore issued in FY2017.
2/ ROE figures calculated using normalised earnings based on equity on the books at the end of the financial year.

If you add up the amount of capital that 'funding stakeholders' (bondholders and shareholders) have put into the business over the last six years, it exceeds the total dividend flow that Heartland has paid out over that same time period by $190m. Note that the six year time period I have chosen deliberately excludes the establishment capital raising that was used to create Heartland in the first place.

Winner commented on viewing the HBL AGM broadcast:

"That shareholder who asked why his dividend had not increased this year got short changed in the answer he got."

"We are growth mode and we’re holding more back for growth was the response in a rather gruff tone ....so there you stupid shareholder."

I would pose the follow up question: If you have paid out a 'net nothing', is it even possible to hold more earnings back?

The table shows, Heartland have been quite adept at raising new capital to the extent that all of the capital paid out as dividends (and $12m more) over the last six years has now been 'reclaimed'. And that figure does not include the money raised as capital notes!

Heartland management has been quite clever at pandering to the dividend hounds. Probably there are several holders of Heartland today who would not invest in Heartland if there was no dividend on offer, Some of the generous dividend is reclaimed immediately via the DRP. The rest is taken back later (not necessarily from the same individuals it was paid to) via share cash issues and bond issues. The net effect is that in the six years ended June 30th 2018, Heartland has paid out a net nothing. Yes the underlying business base has grown over that time, even if no net cash has been generated. Does this matter? As long as there are confident funding stakeholders willing to put up more cash, the Heartland business will continue to grow, But as soon as Heartland loses the confidence of its funding stakeholders, the cash needed to expand the business will dry up and growth will stop. And we all know what would happen to the share price if that were to happen. This is the primary reason I don't invest in Heartland. A great business will generate lots of cash. Heartland (still) generates none.

Time to review one of the least popular overviews among Heartland's loyal shareholders: Heartlands hunger for stakeholders 'capital in' verses their generosity in paying stakeholders out.

Financial Year	Capital Notes Issued during FY	Capital Notes Gross Interest to Bondholders	New Shares Issued during FY	Total Shares on the Books EOFY	Net Money Raised During FY (excl. Capital Notes)	Dividends Paid	ROE
2013	0 m	0 m	0 m	388.704m	$0m	$13.951m	7.2%
2014	0 m	0 m	75,562 m	463.266m	$64.774m	$19.930m	8.0%
2015	0 m	0 m	6,624 m	469.980m	$9.163m	$30.188m	10.2%
2016	0 m	0 m	6,579 m	476.469m	$6.798m	$37.690m	10.8%
2017	$22m	$0.253m	40.215m	516.684m	$50.991m	$41.977m	11.1%
2018	$150.000m	$1.100m + $5.289m	43.904m	560.588m	$71.726m	$47.895m	10.2%
2019	$125.000m + ($22m) + $52m	$0.3767m + $6.750m + $1.082m	8.750m	569.338m	$16.655m	$50.599m	11.1%
Total Cash Raised	$327.000m				$220.107m
Total Cash Returned		$14.851m				$242.930m

Notes

1/ The Australian 2017 'Subordinated Unsecured Capital Notes' issue for $A20m, which at $NZ1= =$A0.909c is equivalent to $NZ22m, was confirmed on April 7th 2017, and therefore issued in FY2017. It was repaid in October 2018 (FY2019).
1b/ On September 17th 2017 (during FY2018), $150m of unsubordinated notes were issued.
1c/ On 12th April 2019 (during FY2019) a further parcel of $125m of unsubordinated notes were issued.
1d/ On 8th March 2019 (during FY2019) $A50m of unsubordinated notes were issued by Heartland Australia at $NZ1 = $A0.960, and is equivalent to $NZ52m of funding at issue date.

2a/ $A20m of Australian Subordinated Capital Notes were issued at a gross coupon rate of 4.15%. This implies a gross annual interest bill of: $A20m x 0.0415 = $A0.9130m. I am guessing this will have been hedged back to an equivalent $NZ amount at the bond establishment date. This implies an annual NZD payment of: $A0.9130m/0.909= $NZ1.100m. In the first year this bond was established (FY2017) it was active for only 84 days of that year. That means for FY2017, the gross interest payment associated with this bond would be: $NZ1.100m x (84/365) = $NZ0.2531m. This bond was repaid by the end of October 2018. This means the gross interest bill over 2019 was: $NZ1.100m x (123/365)= $NZ0.3767m.
2b/ $150m of HBL010 bonds were issued at a 4.5% coupon rate. This implies a gross annual interest bill of: $150m x 0.045 = $6.750m. However during the year the bond was issued (FY2018), the bond was only on issue for 286 days of the year. This means the implied gross interest bill for that year was: $6.750m x (286/365) = $5.289m
2c/ $125m of HBL020 bonds were issued at a 3.55% coupon rate. This implies a gross annual interest bill of: $125m x 0.0355 = $4.438m. However during the year the bond was issued (FY2019), the bond was only on issue for 89 days of the year. This means the implied gross interest bill for that year was: $4.438m x (89/365) = $1.082m.
2d/ The $A50m fixed note offer was established on 15th March 2019 "with a key Australian institutional fixed income investor". The investor was not identified and neither was the interest rate disclosed. Given this new bond was only issued 3.5 months from the end of the financial year the interest due in dollar terms would be small. Rather than guess, I am going to leave this new bond interest out of my cash flow picture for now.

3/ ROE figures calculated using normalized earnings based on equity on the books at the end of the financial year.

If you add up the amount of capital that 'funding stakeholders' (bondholders and shareholders) have put into the business over the last seven years, it exceeds the total dividend and interest flow that Heartland has paid out over that same time period by $289m. Some might consider that the bonds I have mentioned here are an equivalent of debt rather than equity and so shouldn't be included in this calculation. But these bonds are non bank funding from stakeholders (who could also be shareholders) and, in that sense, they are an alternative to shareholder equity. They are also listed as a 'funding source' in AR2019 note 28 'Concentrations of Funding', whereas banking arrangements are not.

(Note that the seven year time period I have chosen deliberately excludes the establishment capital raising that was used to create Heartland in the first place.)

As the table shows, Heartland have been quite adept at raising new equity capital to the extent that of the capital paid out as dividends over the last seven years, all but $22.823m has been 'reclaimed'. If we add the bond money net of interest returned from non-bank funders, then the net cash non bank stakeholder position changes dramatically to the net $289m that I previously stated was 'sucked up'!

Heartland management has been quite clever at pandering to the dividend hounds. Probably there are several holders of Heartland today who would not invest in Heartland if there was no dividend on offer, Some of the generous dividend is reclaimed immediately via the DRP. Most of the rest has been taken back via cash issues. The table shows, Heartland have been quite adept at raising new equity capital to the extent that of the capital paid out as dividends over the last seven years, all but $22.823m has been 'reclaimed'.

If we add the bond money net of interest returned from non-bank funders, then the net cash non bank stakeholder position changes dramatically to the net $289m that I previously stated was 'sucked up'! later (not necessarily from the same individuals it was paid to) via a combination of share cash issues and bond issues. The net effect is that in the seven years ended June 30th 2019, Heartland has paid out a net nothing. Yes the underlying business base has grown over that time, even if no net cash has been generated. Does this matter? As long as there are confident funding stakeholders willing to put up more cash, the Heartland business will continue to grow, But as soon as Heartland loses the confidence of its funding stakeholders, the cash needed to expand the business will dry up and growth will stop. And we all know what would happen to the share price if that were to happen. A great business will generate lots of cash. Heartland (still) generates none in my view.

SNOOPY

[Chinesekiwi]

Agree with your sentiments.

For us liberal pakehas, we are a bicultural country before we are a multicultural one. In that regard, te reo is one of the country's official languages, and it is perfectly appropriate to recognise the status of tangata whenua as an important part of New Zealand's unique identity.

[winner69]

snoop

A great business will generate lots of cash. Heartland (still) generates none

a t

Can’t be right Snoops ..... but seeing shareholders have pumped in $220m of new capital to get divies of $242m it must be

[BlackPeter]

Time to review one of the least popular overviews among Heartland's loyal shareholders: Heartlands hunger for stakeholders 'capital in' verses their generosity in paying stakeholders out.

...

A great business will generate lots of cash. Heartland (still) generates none in my view.

SNOOPY

Hmm - based on your criteria do I assume you consider Berkshire Hathaway as a terrible company as well? They only took shareholders money and never returned anything ...

Why do you think that companies assets do not count ...?

[winner69]

Hmm - based on your criteria do I assume you consider Berkshire Hathaway as a terrible company as well? They only took shareholders money and never returned anything ...

Why do you think that companies assets do not count ...?

I think you have misunderstood what Snoops is trying to say but i’ll leave it to him to explain

[percy]

Posters should google "How banks create money."

[Snoopy]

Hmm - based on your criteria do I assume you consider Berkshire Hathaway as a terrible company as well? They only took shareholders money and never returned anything ...

Berkshire Hathaway doesn't pay any dividends. But they don't come back to shareholders multiple times asking for new capital either. It is the ability to generate cash internally so that a business can fund their own business expansion that I look for. Berkshire Hathaway has a track record of doing that. Heartland does not. To fix this situation Heartland could stop paying dividends. It does look like the amount of money they pay out in dividends would be enough to fund their expansion plans. But Heartland choose not to do this.

I don't see Heartland paying dividends as a problem necessarily. With our imputation credit system, it is tax efficient for Heartland to pay dividends. Whereas with Berkshire Hathaway in the US, if they did the same then their US shareholders would be 'double taxed'. But it does look like Heartland are trying to have their cake and eat it with the current dividend and capital raising policy. They are stringing investors along with the illusion that they have a sustainable dividend payout. But this is only true if they can raise the capital they need for expansion in other ways. And that will only be possible if capital markets are supportive. Right now capital markets are supportive. But cut off the capital funding tap and the sustainability of that dividend must come into question.

Why do you think that companies assets do not count ...?

Not quite sure where you are going with this. Hasn't the NTA per share growth of Heartland effectively stalled?

SNOOPY

PS I don't consider Heartland a 'terrible company'. If I thought, that I wouldn't have bought my Heartland shares earlier this year! But my purchase was on a modest PE multiple of nearer 10 than 15. The purchase price really does matter with Heartland IMO. The lower the purchase price the less the investment risk going forwards.

What I am saying is that there is an underlying cash flow risk for the business going forwards. That risk can be fixed by shareholders putting their hands in their pockets and answering a rights issue call. I am saying that shareholders holding now should be prepared for a rights issue if capital market conditions change.

[Beagle]

HGH are doing a good job of feeding the dividend hounds that like to eat and those that like to bury their bones for consumption later can elect the dividend reinvestment scheme.

[Snoopy]

HGH are doing a good job of feeding the dividend hounds that like to eat and those that like to bury their bones for consumption later can elect the dividend reinvestment scheme.

FWIW I agree. I am not suggesting that Heartland change their business model. But if capital market conditions change, then it could be that the dividend has to be cut, annoying the dividend hounds. And it could be Heartland have a discounted rights issue that devalues the worth of those 'buried Heartland bones', annoying the DRP brigade. After further thinking this through, I would say that if dividend payments were stopped then the business model would be more robust. But doing that would really annoy the dividend hounds and cause the share price to plunge. So there is no clear better way forwards. Maybe it would have been better with hindsight if Heartland had never paid a dividend. In that situation, the dividend hounds wouldn't be able to complain about losing something they never had. But managing a business with hindsight is always easier. If only it were possible!

SNOOPY

[Snoopy]

Posters should google "How banks create money."

If you go to the 'Heartland Bank Disclosure Statement for 30th June 2019' , note 33 gives a detailed explanation of 'Capital Adequacy'. There is a table in there on 'balance sheet exposures'. This has a breakdown of all the receivables assets on the bank books, the average risk weighting of those assets and a 'risk weighted exposure'. From that Heartland calculates the minimum Common Equity Tier 1 capital required to support the loan book.

But here is the rub. Subordinated capital notes can be recognized at tier 2 capital that can improve the overall capital ratio of the bank. Yet none of the unsubordinated notes that exist today support the capital ratio of Heartland at all. These unsubordinated notes leverage the debt risk of Heartland, but do not increase the size of the finance receivables book that Heartland can support. At least that is how I see things. Have I got it wrong?

SNOOPY