HGH - Heartland Group Holdings

[Snoopy]

Snoopy, The banking licence for heartland was granted last year. The company has stated that this has improved their profit and has given guidance. I think it would be much more accurate to assume the midpoint of their forecasts or the 1st quarter report as an input for profit. I suspect HNZ would beat ANZ once this is taken into account.

Fair point Noodles. I shall estimate an end of year return on assets for FY2014, based on more up to date information.

The first quarter result was an after tax profit of $8.668m. Multiply that by four and I get $34.672m. The end of year guidance was for NPAT of between $34m and $37m. So Heartland are on track to achieve this. NPAT after tax of $34-$37m translates to EBIT of $48-52m, assuming no term debt and a 30% tax rate.

I think it is also fair to assume that while Heartland is re-balancing their loan book and simultaneously paying out high dividends the total assets of the company on balance sheet are unlikely to change much by the end of FY2014. So I intend to use the EOFY2013 total assets as a proxy for the EOFY2014 total assets, and will take Heartland's own profit forecasts at face value. If I do this the operating margin on total assets I forecast as follows:

$48 to $52m / $2,504.627m = 1.9% to 2.1%

Interestingly that high figure is very close to what ANZ and Westpac are currently achieving in their own respective New Zealand operations. ANZ and Westpac are held internationally in very high regard. So if Heartland can match their performance by this metric, I would regard that as a considerable achievement. Assuming that Heartland can go even better than this in future years is probably too optimistic. So if a return on assets invested of 2.1% is as good as it gets for Heartland, what does this say about the likely Heartland share price going forwards?

SNOOPY

[Snoopy]

So if a return on assets invested of 2.1% is as good as it gets for Heartland, what does this say about the likely Heartland share price going forwards?

The return on assets invested of 2.1% corresponds to a NPAT of $37m. Based on 388.7m Heartland shares currently on issue, that equates to earnings per share of:

$37m/ 388.7m = 9.5cps

Based on a PE of 10, which I think is appropriate for a small bank at the top of their earnings curve, that sees Heartland fully valued at 95c. To suggest it is worth more would be to assume it will significantly outperform ANZ and WBC, which IMO is an unrealistic expectation. The 95c also assumes a clean asset book, and Heartland is still working through their assets to clean them up. Until this happens Heartland will always trade at a discount to full value. I am therefore forced to conclude that 85c is a very fair price for HNZ.

SNOOPY

[noodles]

Based on a PE of 10, which I think is appropriate for a small bank at the top of their earnings curve.
SNOOPY

Snoopy. Your assumption that Heartland is at the top of the their earnings curve is the key to your valuation. The AGM was very vague about where growth will come from for FY15. Acquisitions and product development were referred to. I suppose they don't want to give too much away.

For me, I'd be happy for HNZ to make the upper end of forecasts. This alone should spark a rerate. After that, I'd want to see some evidence that they can grow their loan book in FY15.

[noodles]

One notes our friend(s) is(are) back dropping small parcels at the end of the day so the closing price seems to go nowhere while the VWAP is usually above the close. Okay, maybe just a crackpot conspiracy theory but what's the statistical likelihood of this happening?

It didn't happen today. Vwap 85.7 close 86

[Snow Leopard]

The return on assets invested of 2.1% corresponds to a NPAT of $37m. Based on 388.7m Heartland shares currently on issue, that equates to earnings per share of:

$37m/ 388.7m = 9.5cps

Based on a PE of 10, which I think is appropriate for a small bank at the top of their earnings curve, that sees Heartland fully valued at 95c. To suggest it is worth more would be to assume it will significantly outperform ANZ and WBC, which IMO is an unrealistic expectation. The 95c also assumes a clean asset book, and Heartland is still working through their assets to clean them up. Until this happens Heartland will always trade at a discount to full value. I am therefore forced to conclude that 85c is a very fair price for HNZ.

SNOOPY

So not a raging buy as far as you are concerned then?

I agree that 85/86c is the price for HNZ, but that the value is higher which is why I hold, not only for the dividends, but for the eventual sustained appreciation in the share price.

Best Wishes
Paper Tiger

[Wolf]

The sell depth seem's to be getting chewed through

[Snoopy]

Snoopy. Your assumption that Heartland is at the top of the their earnings curve is the key to your valuation.

The problem with Heartland is that it hasn't been in existence in its current form for one business cycle yet. So who can really say where the top of the earnings cycle is? The best I can do is to look across the road to ANZ in New Zealand. They have a similar breakdown in loan allocations in their loan portfolio. IMO that gives some guide as to where Heartland might be going.

The parallel isn't so good in that ANZ are right into mortgages whereas Heartland seem to be trying to exit that market (?). I don't follow the need for a Heartland tie up with Kiwibank regarding mortgages. Went past Heartland Riccarton yesterday. They were advertising two year mortgages fixed at 5.95% via a poster in the window. So perhaps if you went into Heartland and begged, they might still make a mortgage loan to you?

My assessment is that Heartland are now going after business with greater profit margins (car loans, machinery loans. seasonal financing). But in a climate of rising interest rates those are just the kind of loans that are more likely to go bad. All would be well if the Heartland operating margin on assets was somewhere up near where Dorchester is. But it isn't.

The AGM was very vague about where growth will come from for FY15. Acquisitions and product development were referred to. I suppose they don't want to give too much away.

For me, I'd be happy for HNZ to make the upper end of forecasts. This alone should spark a rerate. After that, I'd want to see some evidence that they can grow their loan book in FY15.

According to the first quarter, HNZ are operating at the lower end of forecasts. They can only grow their earnings by:

1/ increasing operating margin, or
2/ increasing their capital base.

I concede that attaining the operating margin level of ANZ is certainly possible. In fact they probably need to do that to make up for the lower quality loan book. So let's assume Heartland can do that which is equivalent to coming in at the higher end of profit forecasts. To drive profits even higher they need to start outperforming the likes of ANZ and Westpac New Zealand. But how much blood can you squeeze from the same stone? This is why I can't see how the Heartland share price can increase if earnings come in at the top end of expectations, while the capital base remains the same.

So now we come to point 2. HNZ need to grow their capital asset base. But they can't do that if all their profits are paid out as dividends to appease shareholders. From where I sit, there is no easy way forwards. That is why I come to the conclusion that Heartland must be close to the top of their earnings cycle.

SNOOPY

[percy]

Higher interest rates means greater margins to banks/finance companies.
People let their home loans get behind,but are more careful with their car loan, as they need their car to get to their work.No work,no money,no food.
HNZ loans to the productive sector means equipment,livestock,better security.Security is income generator.
Mortgage loans.HNZ clip the ticket by referring loans to Kiwi Bank.A commercial arrangement that suits both parties.

[Snoopy]

Higher interest rates means greater margins to banks/finance companies.

If Heartland lend long and borrow short, increased profits will only come from higher interest rates if Heartland don't have to pay out more in higher rates offered to depositors. This year as declared in the annual report there is larger shortfall in term deposits required form the public than last year. So it follows that Heartland will have to pay more for the funds they need, on average, than last year.

People let their home loans get behind,but are more careful with their car loan, as they need their car to get to their work. No work,no money,no food.

Yes, but the low risk car loans are those tacked onto the house mortgage. The fact that you are forced to take out a higher interest rate car loan from Heartland is in itself a measure of such a customer's lower credit rating.

HNZ loans to the productive sector means equipment,livestock,better security.Security is income generator.

Higher interest rates => export demand is cramped => all industry payers in that sector under pressure => no market for second hand capital goods should one of the industry players go bung. Doesn't sound like a low risk lending environment to me.

Mortgage loans. HNZ clip the ticket by referring loans to Kiwi Bank. A commercial arrangement that suits both parties.

So what are you saying? HNZ is achieving scale by going in with Kiwibank and that is leading to lower input (cost of capital to bank) costs?

SNOOPY

[percy]

If Heartland lend long and borrow short, increased profits will only come from higher interest rates if Heartland don't have to pay out more in higher rates offered to depositors. This year as declared in the annual report there is larger shortfall in term deposits required form the public than last year. So it follows that Heartland will have to pay more for the funds they need, on average, than last year.



Yes, but the low risk car loans are those tacked onto the house mortgage. The fact that you are forced to take out a higher interest rate car loan from Heartland is in itself a measure of such a customer's lower credit rating.



Higher interest rates => export demand is cramped => all industry payers in that sector under pressure => no market for second hand capital goods should one of the industry players go bung. Doesn't sound like a low risk lending environment to me.



So what are you saying? HNZ is achieving scale by going in with Kiwibank and that is leading to lower input (cost of capital to bank) costs?

SNOOPY

Nothing further to add as what I wrote is correct.