HGH - Heartland Group Holdings

[winner69]

It was intended as a tongue in cheek post.

Apologies

I have edited my post to make it of more general nature

[Snoopy]

a view of a quite a few it seems

When investors start talking like this is it a modern day ‘shoeshine boy’ moment

Interest rates are low for a reason.

Such a strategy might be OK today but one day in the future one will need to quickly implement the good old ‘capital preservation’ plan

You are advocating an alternative of buying bonds with interest rates at all time lows as a capital preservation strategy? Or alternatively putting your money in the bank in a term deposit that will take a haircut in a serious downturn because NZ is one of the few countries where bank deposits are not insured and so not capital guaranteed?

SNOOPY

[Beagle]

Yes I was going to make a comment regarding equities and the conundrum of TRINA (There really is no alternative to equities). I have had significant fixed interest investments mature in the last few weeks and more next week and have been busy adding too and buying a number of quality companies and I haven't finished yet by any means. There really is no alternative with interest and bond rates where they are today.

[winner69]

You are advocating an alternative of buying bonds with interest rates at all time lows as a capital preservation strategy? Or alternatively putting your money in the bank in a term deposit that will take a haircut in a serious downturn because NZ is one of the few countries where bank deposits are not insured and so not capital guaranteed?

SNOOPY

No Snoops

The 'capital preservation' trick sometime in the future is using the liquidity of the equity markets to sell up the once high yielding shares when the share price inevitably starts to fall

[Snoopy]

The underlying debt of the company (debentures and other loan supporting borrowings removed) is the first factor in an attempt to assess the underlying shareholder owned skeleton upon which all the receivables that are loaned ultimately sit.

According to the full year (FY2019) statement of financial position the debt excluding borrowings is:

$22.498m + $7.532m + $10.372m = $40.402m (1)

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To calculate the total underlying company assets we have to (at least) subtract the finance receivables from the total company assets. I would argue that you should also subtract the 'Investment Properties' (the rump of the problem property portfolio) and the unspecified 'Investments' (held on behalf of policy beneficiaries) from that total:

$4,926.404m - ($3,029.231m +$1,318.819m + $11.132m + $354.928m) = $212.294m

We are then asked to remove the intangible assets from the equation as well:

$212.294m - $72.679m = $139.615m (2)

----


Now we have the information needed to calculate the 'underlying company debt' (skeletal picture) net of all Heartland's lending activities [ (1)/(2) ]:

$40.402m/$139.615m= 28.9% < 90%

Result: PASS TEST

The historical picture of this ratio is tabulated below.

	FY2012	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018	FY2019	Target
Underlying Gearing Ratio	20.2%	14.7%	40.5%	58.4%	37.4%	37.6%	39.4%	28.9%	< 90%

The underlying debt of the company (debentures and other loan supporting borrowings removed) is the first factor in an attempt to assess the underlying shareholder owned skeleton upon which all the receivables that are loaned ultimately sit.

According to the full year (FY2020) statement of financial position the debt excluding borrowings:

$36.262m + $12.303m + $17.012m + $20.456m = $86.033m (1)

-----

To calculate the total underlying company assets we have to (at least) subtract the finance receivables from the total company assets. I would argue that you should also subtract the 'Investment Properties' (the rump of the problem property portfolio) and the unspecified 'Investments' (held on behalf of policy beneficiaries) from that total:

$5,318.136m - ($3,045.195m +$1,538.685m + $11.132m + $413.340m) = $309.784m

We are then asked to remove the intangible assets from the equation as well:

$309.784m - $72.813m = $236.971m (2)

----


Now we have the information needed to calculate the 'underlying company debt' (skeletal picture) net of all Heartland's lending activities [ (1)/(2) ]:

$86.033m/$236.971m= 36.3% < 90%

Result: PASS TEST

The historical picture of this ratio is tabulated below.

	FY2016	FY2017	FY2018	FY2019	FY2020	Target
Underlying Gearing Ratio	37.4%	37.6%	39.4%	28.9%	36.3%	< 90%

SNOOPY

[Snoopy]

This is an assessment method of looking at the underlying earning power of Heartland Group Holdings, compared to the interest bill they face while making their earnings. Updating for the full year result FY2019:

The EBIT figure is not in the financial statements. So I will use 'interest income' as an indicator for EBIT, once I have taken out the selling and administration costs

EBIT (high estimate) = $334.330m - $85.589m= $248.741m

Interest expense is listed as $136.747m.

So (EBIT)/(Interest Expense)= ($248.741m)/($136.747m)= 1.82 > 1.20

Result: PASS TEST

The historical picture of this ratio is tabulated below. It looks to be getting better and better.

	FY2012	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018	FY2019	Target
EBIT/ Interest Expense	1.15	1.22	1.44	1.52	1.65	1.79	1.82	1.82	>1.2

This is an assessment method of looking at the underlying earning power of Heartland Group Holdings, compared to the interest bill they face while making their earnings. Updating for the full year result FY2020:

The EBIT figure is not in the financial statements. So I will use 'interest income' as an indicator for EBIT, once I have taken out the selling and administration costs

EBIT (high estimate) = $346.802m - $106.794m= $240.008m

Interest expense is listed as $130.129m.

So (EBIT)/(Interest Expense)= ($240.008m)/($130.129m)= 1.84 > 1.20

Result: PASS TEST

The historical picture of this ratio is tabulated below. It looks to be getting better and better.

	FY2016	FY2017	FY2018	FY2019	FY2020	Target
EBIT/ Interest Expense	1.65	1.79	1.82	1.82	1.84	>1.2

This is turning into a very solid picture of ever improving interest cost cover over the years,

Working Note

A thought did cross my mind that, with the adoption of IFRS16, I should adjust my calculation this year. IFRS16 has caused the 'operating expenses' that I have used above to decrease. This is because what was last year a straightforward 'tax deductible lease payment' has been removed from the expenses and replaced with:

1/ An extra depreciation charge on an IFRS16 created 'Right to Occupy' asset. (Found under Note 6 to be $2.324m}
2/ An extra interest charge on the 'IFRS16 created', and 'Right to Occupy asset offsetting' 'Capitalised Lease Contract' liability. (I can't find this. Is it subsumed in Note 3, 'Interest Expense', 'Other Borrowings' of $35.888m? )

I feel inclined to add that 'Right to Occupy' Asset depreciation (1/ above) back onto the operating expenses (effectively lowering the EBIT I have estimated) , and make an adjustment -downwards- on the interest expense denominator in my ratio calculation by taking into account 2/. But should I do this? I feel it will take a real accountant to answer that question!

SNOOPY

[Ferg]

Hi Snoopy

Interest on right to use lease liabilities is at the bottom of page 38 of $570k. I think that is what you are seeking.

Regarding how to treat this, options:
1) forever adjust to how it used to be based on sensible pre-IFRS16 accounting per your suggested replacements;
2) do not adjust in future but instead adjust prior year numbers, or
3) use the raw numbers as is, with a footnote noting the change in methodology.

Option 2 may not be possible given the lack of data.


Option 3 is easiest. If you use Option 3 it might be worth noting the impact on the ratio - it may not be material - my back of the fag packet suggests the ratio of 1.84 becomes maybe 1.85.

Option 1: adjusting the $130m for the $570k assumes it is part of the $130m which, in the absence of contradictory information, suggests this may be correct. An alternative is that it sits under operating expenses given it is not related to lending but I cannot see any reference to how it is treated. FYI I believe the payments on these leases were $2,005k per page 9 which would be the "lease expense" using the old methodology (prior year was 1,807k per page 21). This value of $2,005 also reconciles with the movement in the lease liabilities & right to use assets year on year.

I trust that helps.

[Snoopy]

Hi Snoopy

Interest on right to use lease liabilities is at the bottom of page 38 of $570k. I think that is what you are seeking.

Regarding how to treat this, options:
1) forever adjust to how it used to be based on sensible pre-IFRS16 accounting per your suggested replacements;
2) do not adjust in future but instead adjust prior year numbers, or
3) use the raw numbers as is, with a footnote noting the change in methodology.

Option 2 may not be possible given the lack of data.


Option 3 is easiest. If you use Option 3 it might be worth noting the impact on the ratio - it may not be material - my back of the fag packet suggests the ratio of 1.84 becomes maybe 1.85.

Option 1: adjusting the $130m for the $570k assumes it is part of the $130m which, in the absence of contradictory information, suggests this may be correct. An alternative is that it sits under operating expenses given it is not related to lending but I cannot see any reference to how it is treated. FYI I believe the payments on these leases were $2,005k per page 9 which would be the "lease expense" using the old methodology (prior year was 1,807k per page 21). This value of $2,005 also reconciles with the movement in the lease liabilities & right to use assets year on year.

I trust that helps.

Thanks for your work on this Ferg. I am heartened by your back of fag packet calculation that shows this 'issue' I am concerned with only affects the second decimal place of single digit result of the ratio I am looking at. However, as I am sure you are aware, there are other businesses with relatively large leased asset portfolios where IFRS16 makes a huge difference to the published accounts. So I hope you don't mind if I try to increase my understanding on this IFRS16 matter, using Heartland as an example.

I think I am correct in saying IFRS16 is all about reporting what has happened. As far as anyone at an operational level, paying the bills on a day to day basis in any of these IFRS16 affected companies: Nothing has changed.


You say:

"Adjusting the $130m for the $570k assumes it is part of the $130m which, in the absence of contradictory information, suggests this may be correct"

When talking about the 'interest on the right of use assets' of $570k being part of the $130,129m of interest expense, I would say this is beyond doubt. If this were not so, it would mean that the 'interest expense' total would not include all interest expended! That would seem to be an untenable reporting position.

But here is where my interpretation of the situation becomes a little wobbly. If I am correct in my assertion that 'nothing operationally has changed', where does the 'Interest on right to use lease liabilities' on the bottom of page 38 of HGH Accounts for FY2020 of $570k come from? Pre IFRS16, the company just paid the appropriate operating lease expenses every year and they appeared on the books as one of many annual expenses. There was no 'interest to be paid' on this operating lease expense - was there? It seems to me like this extra $570k of interest bill has materialized out of nothing. How can this be?

You say

"This value of $2,005 (the payment of lease liabilities in the Consolidated Statement of Cashflows) also reconciles with the movement in the lease liabilities & right to use assets year on year."

But if you:

1/ Take the 'Depreciation of Right of Use Assets' figure of under Note 18 'Other Balance Sheet Items' of $2.324m at face value AND
2/ Try to adjust that by adding in the extra $570k of new interest expenses on the finance lease then it doesn't reconcile: $2,324m + $570m = $2,894m.

In fact the two comparative totals are 44% out. How do you explain that?

SNOOPY

[Ferg]

Here are my workings supporting my statement "This value of $2,005 also reconciles with the movement in the lease liabilities & right to use assets year on year":

HGH Lease Liabilities - Old Method
A) Pay Lease		Debit		Credit		Source	Notes
	Lease Expense P&L	2,005				p9	Last year $1,807 p21
	Bank Account			2,005
HGH Lease Liabilities - New Method
B) Lease Liability Position		Debit		Credit		Source	Notes
1/7/19	ROU Asset	10,728				p13, p38
	Deferred Tax Asset	274				p13 says $0.3m
	Retained Earnings Adj.	751				p7, p13
	Lease Liability			11,753		p12
C) 2020 New Leases
	ROU Asset	9,958				p8
	Adj. (DTA/RE?)	180				?	part of $256 per p26?
	Lease Liability			10,138		derived - see reconciliation below
D) 2020 Payments
	Lease Liability	2,005				assumed
	Bank Account			2,005		p9
E) 2020 Interest
	Interest on Leases P&L	570				p38
	Lease Liability			570		assumed
F) 2020 Depreciation
	Depreciation P&L	2,324				p38
	ROU Asset			2,324		p38
Reconciliations:
ROU Assets:
	Opening Balance	10,728				p13, p38
	Add New Leases	9,958				p38
	Less Depreciation	-2,324				p38
	Closing Balance	18,362				p8, p38
ROU Liabilities:
	Opening Balance	11,753				p12, p13
	Add New Leases	10,138				derived
	Less Payments	-2,005				p9
	Add Interest	570				p38
	Closing Balance	20,456				p8, p38

[sb9]

Got my DRIP shares allocated this morning at $ 1.24695055 a piece, very happy