HGH - Heartland Group Holdings

[thebusinessman]

That pop up could be an accessibility feature. Was there a photo or illustration on that page?Sometimes they add these on websites and they are read out loud by the software for people who are blind or have impaired vision. Generally used to describe what is in photos or other graphics.

JAK's onto it. A computer looks at the image to try and figure out what it is for screenreaders etc, hence the disclaimer so that your local blind shareholder knows it's not an official caption. Picture is blue, like ocean, some white circular "trails" made by "fish". A pretty good guess really.

[Muse]

As a suite of things (the final dividend, aspects of the 2H FY23 result, FY24 guidance, and 5 year ambition on cost to income and NPAT growth aspirations) I'm pretty content where Heartland sits and where it's heading. As always you take the good w/ the average and bad, which I'll come back to.

THE GOOD
** Was pleased with the final dividend - it was a line call between 5.5 and 6cps.

** Outstanding growth (+20%) in reverse mortgages and 4.5% growth in non RM receivables on FY22.

** Continued leadership position in raising deposits relative to the rest of the wider NZ banking industry (must try better next time Winner69). 2H result showed no NIM compression despite 1) ongoing lift in deposit and wholesale funding rates; 2) subnote issue in the 2H which was probably 50bps more expensive than had it gotten away before March; and 3) growing proportion towards higher quality & lower NIM earning receivables impacting on mix. I reckon some of the key business units - particularly RMs - saw NIM increase in the 2H relative to the first half when rates spiked quickly and HGH were unwilling or unable to pass it on to its variable rate customers. Outlook on NIM is reasonably stable w/ minor mix influences.

** I keep a detailed credit risk index on the detail and mix of its receivables and it continues to improve in quality

** FY24 guidance at the midpoint implies $119m in underlying earnings or up 8.2% (note underlying EPS may not grow to the same extent given dilution from DRP - new shares issued under the DRP from FY18-FY23 has averaged 7.23m pa...last 2yr ave is 5.7m).

** Consensus amongst the 3 main brokers that cover HGH provide for FY24-FY26 uEPS of 16.4, 17.9, & 19.2. Consensus is about $1m below the midpoint of FY24 guidance. Consensus DPS for the next 3yrs of 12.17, 13.17, 14.07 - all 100% imputed (gross yield for a 33% taxpayer at the 179 close price of 9.44%, 10.2%, 10.9%).

** Continued reduction in cost to income (CTI) with a goal to reducing it to 35%. If achievable, that will play a large part in stabilising and growing ROE over the long term and growing NPAT and dividends. Management and the market would be better to think of overheads as costs to NIM, not income.

** Aspirations to double uNPAT in 5 years. Delighted to have management thinking big - if its achievable or not I don't know but I suspect if it is - a large part of that will come from the Challenger acquisition and growth capital that will be required (more later)

THE AVERAGE
** Messy result. Lots of normalisations - up to investors to come to their own view. A lot to be said for clean results. None the less I can get over some/most of them. No one cried foul last year when management removed the $16.7m gain (from the de-designation of swaps from hedge accounting) from underlying NPAT so it's a bit disingenuous to cast shade on the corresponding accounting loss as that previous transaction unwinds into the P&L. For underlying / operating earnings purposes I'm content to look past M&A costs, non core revaluations on investments like harmoney, and the cost of getting the Australian banking license. The after tax amounts from all those are borne and reflected in the book value. It's the underlying / operating result that most often drives dividends so I give regard to that but come to my own view. But I also am keen that the underlying/operating result is reflective of appropriate provisioning which I discuss below.

** Non performing loans by $ and by % up on FY22 but down from the 1H FY23 result. Skeptically I wonder if that is because they took a few impairments/write offs on the chin in the 2H to clean them down from December 2022.

THE BAD
** The dynamics in the vehicle finance book are a bit bizarre to me. Growing book fast and taking marketshare but earnings going backward at a reasonable clip. Chasing growth too hard or other dynamics at play?

** StockCo continues to underwhelm me. I thought they paid too much at acquisition (a very high P/BV) and repaid the bridging loan used to finance it by undertaking a placement and rights issue which had the net effect of reducing NTA/shr and diluting EPS. Book up something like 2% which really doesn't jibe with the excitement at the time of acquisition. Australian stock numbers are up but from a confluence of factors price and slaughter capacity to process them are down - detail on page 34 of the investment presentation. Hopefully flock numbers and prices revert to mean overtime.

** From a credit impairment perspective (but actual write offs and increased provisions) it was a year of two halves - 1H was outstanding, 2H things caught up and then some. While I think the impairment expenses are about to or below what one would in good faith expect at this point in the cycle there were two things that caught my attention. Management used $5.6m of the $8m economic overlay in FY23. I don't begrudge management for that as provisions are there to be either used or released but I would have thought there would have been a modest top up in the provision.

* The second issue that has my attention is on the provisioning as a % of gross receivables. HGH increased its expected aggregate credit loss provision by $1.3m in FY23 to $53.3m, over gross (pre provision) receivables of $6.8bn. Given the credit worthiness of the RM & mortgage books the best way IMO to look at provisioning is to look at the ECL provision as a % of the total gross book less RMs and home loans (in fact, the ECL entirely relates to the non RM/HL book). Provisioning as a % of those receivables actually shrank from 1H FY23 of 1.35% to 1.31% at the close of the FY23 financial year. Yes the my credit index shows a reduction in credit risk but at this point of the cycle I would have thought provisioning would have at least stayed the same. 4bps on a big number is about $1.1m after tax (and reinforces my view that underlying results would/did come in a touch below the low end of the guidance range for the year just been). So not a massive issue - but I suppose the issue is if management have to increase provisioning next year to account for the economic cycle and how that could impact earnings. Heartland at the conference call guided for a similar credit outcome to the year just been (I guess that means similar total credit expense). Consensus credit expense is about $25m so a tad more than FY23 and I wouldn't be surprised if it comes in a touch more than that and underlying NPAT comes in below the midpoint. and I fully expect FY24 to have messy normalisations - more de-designations as the FY22 gain unwinds, more M&A costs, hopefully reversing out a gain on the harmoney valuation, etc. But as a recent purchaser back in March and to some degree even now at the spot price I'm relaxed as the mkt pricing appears reflective of that risk.

CHALLENGER
* No guidance around this acquisition will get approval. If successful, Heartland will gain an ADI / banking license in Australia which would materially decrease its cost of funds and increase NIM.
* While the initial outlay is modest (A$36m +/- changes in book since conditional signing), I do expect a capital raising will be required to fund the acquisition, additional capital required to meet Australian prudential requirements, and growth capital to fund latent and unmet growth from a capital constrained StockCo.

I last purchased in March 2023 at $1.56 and got a bit of flack for it - seems to have been a good yield and capital appreciator so far. And while I think that remains the case even at current levels, I am cognizant there may be a further capital raising if Heartland is granted permission to acquire Challenger, and mindful of the dynamics that played out when Heartland raised capital to acquire stockco last year.

Nice to see it bounce back to the SPP price from last year. The nature of the Australasian banking market is very different to America's and HGH's position with its RM makes it unique again within NZ. That said its clearly impacted by overseas sentiment. I'd imagine there could be occasional few crises of confidence as America's regional banks aren't out of the woods yet and their commercial property portfolios could haunt them for a while yet.

Just my meandering thoughts. As always, do your own research, and come to your own views.

[iceman]

Great post FM. Thanks a lot for sharing

[percy]

Thanks FM..
I guess HGH paid too much for StockCo for the same reasons they paid too much for their REL business.Time.
Buying an established business saves years of having to build up a new business.
Same will apply for Challenger Bank.

[dabsman]

JAK's onto it. A computer looks at the image to try and figure out what it is for screenreaders etc, hence the disclaimer so that your local blind shareholder knows it's not an official caption. Picture is blue, like ocean, some white circular "trails" made by "fish". A pretty good guess really.

Yeah my signature comes up as "Pearl Necklace". Not sure what its trying to imply?

[whatsup]

Gee the readings on Business Desk today re deliquent loans both vehicle and personal loans does not make good reading, is this the tip of the iceberg of worst things to come ?

[Rawz]

Gee the readings on Business Desk today re deliquent loans both vehicle and personal loans does not make good reading, is this the tip of the iceberg of worst things to come ?

Depends on how the economy goes and the unemployment rate

[Muse]

Thanks FM..
I guess HGH paid too much for StockCo for the same reasons they paid too much for their REL business.Time.
Buying an established business saves years of having to build up a new business.
Same will apply for Challenger Bank.

Agree with your point.
They want to do something with the businesses not just run it as is so a bit of that.

One wee clarification I should make re my post last night - when I talked to my credit index and the credit risk improving I should have used more precise/less sloppy language…the mix of receivables is improving (less personal and business lending, more RMs etc), and that relative risk mix is improving. The macro environment is more risky from an overall perspective and the credit risk environment is higher than last year not withstanding the change in mix.

[thegreatestben]

Great posts FM, thank you! I cannot give you any more rep unfortunately despite deserving it.

[ronaldson]

Great posts FM, thank you! I cannot give you any more rep unfortunately despite deserving it.

I don't know how to give a rep so obviously haven't during my time as a poster.

So enlightenment please someone.