HGH - Heartland Group Holdings

[Snoopy]

And where are they at now ....

Time to jump the PGGW Finance hurdles as imposed by their banking syndicate of the day (November 2009). How does Heartland stand up against them? I have gone to the latest half-year report for the
period ended 31st December 2011 (HY2012) to pull out the following figures:

(Note to readers: I haven't attempted to analyze a financial institution like this before. So I could be talking out of a hole in my WW1 goggles. Please feel free to put an alternative interpretation on the
judging criteria and correct me.)

Let the analysis begin!

SNOOPY

[Snoopy]

Let the analysis begin!

1/ EBIT to interest expense > 1.2

EBIT is not listed as that, so I have had to improvise. On p10 (Interim
Statements of Comprehensive Income) we find the 'Interest Income'
figure and I have subtracted from that the selling and administration
costs also on p10.

EBIT = $101.770m-$35.691m= $66.079m

Interest expense is listed as $62.64m.

So (EBIT)/(Interest Expense)= ($66.079)/($62.64)= 1.05 < 1.2

Result: FAIL TEST

SNOOPY

[winner69]

That seems a pretty thin margin of safety vSnoopy ..... EBIT only $3m odd above interest expense

Wouldn't want mch to go wrong

Is the 1.2 a benchmark of good performance or one that is seen as a minimum acceptable level .... like you I know vey littlr about finance companies ..... whats the norm

[percy]

I think we are all very pleased with the quarter ended 31/3/12,[management a/cs] announced on 10/4/12 .This quarter would give a better indication of future profit. Operating profit for the quarter was $5.3mil compared with the first two quarters combined profit of $3.6mil.The figures up to 31/12/11 were quiet frankly hopeless,and a lot of people thought why bother. All hurdles have been jumped,and banking licence would appear to be on track,and profit now looks to be worth the effort.Finance companies borrow at one figure and lend at a different figure.To get cheap funds it pays to have the word bank in your name.To lend at a higher figure it pays to have the word finance in your name. So we are looking at Heartland Bank borrowing money to be lent by Marac finance.! The difference from what you borrow to what you lend is your margin.Borrow $1mil at 6% and lend at 14% your gross profit is 8%,or $80,000 less your overheads.It is a funny fact that banks/finance companies usually make greater profits when interest rates are higher.Of course the bank that stays in business is the one who gets their loans repaid.

[Arbitrage]

LOL ... 60c ??? ... Yeah right ... ... I hope not as my pyrimid is yet to be fully complete as sellers have been pretty thin on the ground (unless you're buying huge packets of course) ...

editted: Increased margins = music to my ears (just need NPX and FPA to do the same!)

59 cents this morning.

[RazorX]

60 cents @ 12:35 She is grinding up slowly.

[Snoopy]

That seems a pretty thin margin of safety vSnoopy ..... EBIT only $3m odd above interest expense

Wouldn't want much to go wrong

Is the 1.2 a benchmark of good performance or one that is seen as a minimum acceptable level? .... like you I know very little about finance companies ..... whats the norm?

I can't answer if (EBIT)/(Interest Expense) < 1.2 is some kind of 'norm'. All I can do is outline the circumstance in which this hurdle was set:

1/ PGG Wrightson Finance was quite a well respected finance company in its own right at the time. Their answer to NZX queries on their liquidity at the time almost smacked of boasting how good their reinvestment rate was (80%+).
2/ PGG Wrightson, the parent firm, was heavy with debt and in need of a cash issue (hence the prospectus)
3/ The hurdle was set by a banking syndicate who wanted their money back.

My inkling is that the 1.2 figure might contain some margin of safety. But I don't really know. Still as a small investor in HNZ, wouldn't you want some margin of safety?

SNOOPY

[Snoopy]

This quarter would give a better indication of future profit. Operating profit for the quarter was $5.3mil compared with the first two quarters combined profit of $3.6mil. The figures up to 31/12/11 were quiet frankly hopeless.

I take your point about HNZ being a work in progress Percy. Consequently your argument that the last reported half year report should not be taken as indicative of future half years has merit.

Let's say we are heading for a full year profit of $20m. How does that stack up in context? It turns out, not that well when considered in light of the Tier 1 and Tier 2 lending covenant test.

Criterion 5/ Minimum Equity Contribution:
Tier 1 Risk Share Lending (basic equity capital and disclosed reserves) > 20%,
Tier 2 Risk share lending (this applies to undisclosed debts, and provisions against bad debts) > 30%.

There is no mention of Tier 1 or Tier 2 in the Heartland HY2012 interim report. I am not sure how to apply this test. Perhaps someone will confirm or correct my opinion?

I think the loans have to be grouped into both 'Tier 1' and 'Tier 2' categories. Once this is done then enough equity capital has to be set aside to cover 20% of the gross lending value of 'Tier 1' loans and
likewise 30% of the 'Tier 2' loans. Add these two required amounts of capital together and the figure should not exceed the actual underlying capital on the company balance sheet.


The 'best case' scenario is that all loans are Tier 1. $1,985.55m of loans are outstanding. 20% of that figure is:

0.2 x $1,985.55m = $397.0m

From p3, Heartland has total equity of $360m, which is insufficient no matter what the tier classification of the loans. Even if $20m of profit is booked to boost shareholder capital, there would still be a shortfall of capital of $17m assuming no growth in the loan portfolio.

Result: FAIL TEST

SNOOPY

[Snoopy]

Sp action smells of banking license decision coming soon.

For an alternative opinion this looks more like noise to me as the SP moves up and down with the market. I think if a banking licence was imminent the share would be trading a lot closer to asset backing. A banking licence as I see it would have two benefits.

1/ An increase in the number of term deposits taken in, due to customer perception the company has become safer.
2/ A decrease in borrowing costs because of reserve bank approval.

But what is the quantitative effect of this in terms of profit? I don't know.

SNOOPY

[Snoopy]

60 cents @ 12:35 She is grinding up slowly.

I am appearing as the voice of caution on this thread not because I don't think Heartland will succeed (I think on balance it will). But I want investors to keep in mind other possible options of Heartland either falling over or coming back to shareholders for more capital.

If current asset backing sits at 90c, and current market norms are to value finance companies at asset backing there is another way of looking at that 60c shareprice. One might say 60c reflects a 2/3 chance of success and a 1/3 chance of failure. A 1/3 chance of failure is not insignificant to those shareholders who want to retain capital. OTOH you could say a 60c to 90c move would be quite a good return if things go well.

I see HNZ as a genuine investment with a decent risk return arbitrage. But a ticket to print money this is not.

I can see myself coming back to HNZ after the 2013 full year results come out. If things continue to go well and I invest then I would be looking at a much lesser return than those buying in today. But I will also face a much lesser risk of losing all my capital! In the meantime HNZ looks like too risky an investment for the likes of me. I will put it out there are a challenge for others to convince me otherwise!

SNOOPY