HGH - Heartland Group Holdings

[percy]

The share price is currently $1.71...,
which means he is still wrong.!!..lol.

[Snoopy]

Do you think its ROE will improve in the coming years from current 11.4%?

There is a tendency to think of Heartland as a small nimble bank able to capitalise on new opportunities faster than their competitors. The 'digital strategy' has great potential to cut costs from parts of the system and boost ROE. But how stable is the 'core business base' that is the springboard for Heartland's new initiatives? I discuss this in my post 8524 "Strong Market Position Discussion : FY2016". The question becomes will the new initiatives create enough improvement to cope with some legacy business decline, as well as satisfying shareholder needs for growth? I discuss this in my post 8532 "Strong Market Position FY2016: Further Discussion and Conclusion".

My prediction was for a total loan book growth of $3.7m. Not much when the total loan book size was $628m (actually <1%)! While there is a good chance Heartland may do better than this, a prudent investor would not invest on the basis of all ducks lining up. I don't see a compelling case for reinvesting any of my ANZ and WBC funds into Heartland.

SNOOPY

[Snoopy]

I still have an issue with how wide your range is $1.14 to $1.70 are about 50% apart! It'd be hard to be wrong.

My price range looks at the expected price deviations you might expect over a 5 to 6 year period trading on the market. This is why it is so broad. I can narrow my range down by looking at where the price might be 66% of the time if you like. That would be a 10% deviation around the average (another rule of thumb).

	Bottom of Business Cycle	Average	Top of Business Cycle
66% Percentile Price Range	$1.28	$1.42	$1.56
95% Percentile Price Range	$1.14	$1.42	$1.70

As a share investor, my aim would be to increase my holding when a share is in the bottom half of its trading range and reduce my holding when trading in the top half of the trading range.

Of course:
1/ Just because a share is in the top half of the trading range, that doesn't mean the price can't go higher.
2/ Just because a share is in the bottom half of the trading range, that doesn't mean the price can't go lower.

I am not going to pretend I can pick short term price flucuations. I am trying to take an overall longer term wider view. Not pick an optimim price for a particular trade, but buy in at a price that should provide superior returns in the medium to long term. As for what the share price is doing 'right now', I really don't care.

SNOOPY

[Snoopy]

The share price is currently $1.71...,
which means he is still wrong.!!..lol.

No it just means the price has gone into my 96% percentile range, up from the 95% percentile range. A 1c variation in share price is immaterial and well within what might be expected of 'market noise'. It is not worthy of comment, and I sentence myself to one lashing for doing so.

SNOOPY

[Snoopy]

I still have an issue with how wide your range is $1.14 to $1.70 are about 50% apart! It'd be hard to be wrong.

My $1.42 can probably be best thought of as the price I might pay for shares if there was no public market for Heartland shares and the whole group was privately owned. Bring on a public market for shares. Then any share becomes subject to the daily vicissitudes of interest rates, what happens to other banks, and even the rantings of Donald Trump. So if you see Heartland trading at $1.70 (the price as I write this) this could be because:

1/ there is underlying net growth that I have not incorporated in my modelling. OR
2/ in a time of very low interest rates, new shareholders are prepared to accept a lower yield than myself, because someone want's an instantaneous yield 'now', whereas I am after a business cycle yield in a climate where dividends can both rise and fall over time.

In my judgement, there are no public announcements yet that suggests the reason is 1/

On the second point 2/, I refer to my post 8629 "Preamble: The Discount Rate Factor". This shows I am working on an 'acceptable' gross yield of 7.5% at my $1.42 valuation. If someone else is prepared to accept 6.5% then the fair value share price changes as follows:

$1.42 x (7.5/6.5) = $1.64

Perhaps they are willing to accept a 6% gross yield? In that case the share price such an investor might pay becomes:

$1.42 x (7.5/6.0) = $1.78

None of these share prices predictions are 'right' or 'wrong'. They are simply reflective of the gross yield the investors of the day are prepared to accept. I won't accept a gross yield, on average, of less than 7.5% given the inherent risks of a second tier financial company. So my mean business cycle valuation won't be changing from $1.42. It follows that I have absolutely no interest in acquiring shares at $1.70, even if I think in the short term the share price might go higher. In casino terms that would be akin to 'betting against the house' as the odds stack up more and more against you. It doesn't preclude a short term win. But in the medium to long term, it is a losing strategy.

SNOOPY

[Beagle]

They're good value compared to their peers Snoopy. I'm sticking with my peer group comparison of $1.83 although note that BOQ and BEN have had some nice moves up last week so might have to review that when HBL gets to $1.83.

[Snoopy]

Industry Group Risk

From AR2016 note 18c, the greatest 'business group' risk in dollar terms is agriculture, with $628.202m worth of assets. This represents an increase of $90.916m over the previous year.

$628.202m/ $3,461.292m = 18% of all loans


Regional Risk

From AR2016 note 18b, the greatest regional area of credit risk in dollar terms is 'Rest of the North Island' , with $888.080m worth of assets. This represents:

$880.080m/ $3,461.392m = 25% of all loans

The 'Rest of North Island' loans (which excludes Auckland and Wellington) have risen 12.5% in numerical terms over the year, outstripping the growth of the previous largest region Auckland which only grew by 2% in gross loan amounts (Auckland still covers 24.5% of all loans) . This is a significant change for all other years where Auckland has been the largest market. Given 'Agriculture' loans have grown by 17% over the year, this 'growth' could reflect the compounding of agricultural interest charges into existing loans. According to AR2016 p7, dairy represent 7% of Heartland's total loan book.

0.07 x $3,461.392m = $242m

At an interest rate of 8%, assuming no interest was actually paid, this would increase the value of the Heartland loan book by:

$242m x 0.08 = $19.3m

Since the actual agricultural loan balance increased by $90.9m, we can assume that more net new agricultural loans were taken out, rather than just rolling over the dairy loan book. This is very much a contrast to traditional market leader ANZ.NZ who kept their total rural loan book static over the similar period. Looked at just in agricultural terms, you could say that Heartland are compounding their own problems for the future. But because the loan book in total has grown, reducing Heartland's relative reliance on Auckland is probably a positive.

The multi-year picture is shown below:

	2012	2013	2014	2015	2016
Largest Regional Market	Auckland (30%)	Auckland (30%)	Auckland (25%)	Auckland (26%)	Rest of North Island (25%)
Largest Industry Group Market	Agriculture (24%)	Agriculture (21%)	Agriculture (16%)	Agriculture (17%)	Agriculture (18%)

An update on how the half year has shaped up to the previous full year result. The information below has been extracted from the half year report for FY2017.

https://shareholders.heartland.co.nz...port-final.pdf

Our test requirement is:

Highest single new customer group exposure (as a percentage of shareholder funds) <10%

Regional Risk

From reference Note 12b, the greatest regional area of credit risk in dollar terms is Auckland, with $838.352m worth of assets. This represents:

$838.352m/ $3,718.790m = 23% of all loans

So 'normal service has resumed' with the former concentartion champion, 'Rest of the North Island' back down to :

$822.142m/ $3,718.790m = 22% of all loans.

Auckland at 23% of all loans is high, yet still below historical concentration levels. But I don’t rate that concentration of loans in Auckland as being an issue. Particularly so when ‘Auckland’ is such a varied catch all group. Does 'Auckland' capture the Harmony investment stake too? Anyone know?

Industry Group Risk

From reference Note 12c, the greatest 'business group' risk in dollar terms is Agriculture, with $712.072m worth of assets. This represents:

$712.072m/ $3,718.710m = 19% of all loans

This is slightly up on FY2016, when agriculture was

$628.202m/ $3,461.292m = 18% of all loans

These figures are quite high and continue trending in the wrong direction for HY2017. Given that Heartland is nominally a specialist agricultural lender I wouldn't be too concerned. But if agricultural loans go above 20% of the total (or dairy representing about half the agricultural loans above 10%), then I would sound an alarm bell. How much compounding interest without any cash payments can Heartland take on the books? A 13% jump in the value of that rural portfolio in just 6 months is not insignificant. This situation will need careful watching when the FY2017 result details are released IMO.

SNOOPY

[Snoopy]

They're good value compared to their peers Snoopy. I'm sticking with my peer group comparison of $1.83 although note that BOQ and BEN have had some nice moves up last week so might have to review that when HBL gets to $1.83.

This sounds like 'greater fool' investing to me. There is no need to evaluate the true worth of the investment if 'the rising trend' means there is always someone else to sell to. No doubt there is significant money to be made when an investment goes from being 'plain overvalued' to 'incrementally overvalued'. The trick to making money is to make sure you don't become the 'greatest fool'. Good luck.

SNOOPY

[Valuegrowth]

Thank you so much Snoopy for your time and information. I really appreciate. Good luck!

There is a tendency to think of Heartland as a small nimble bank able to capitalise on new opportunities faster than their competitors. The 'digital strategy' has great potenmtial to cut costs from parts of the sytem and boost ROE. But how stable is the 'core business base' that is the springboard for Heartland's new initiatives? I discuss this in my post 8524 "Strong Market Position Discussion : FY2016". The question becomes will the new initiatives create enough improvement to cope with some legacy business decline, as well as satisfying shareholder needs for growth? I discuss this in my post 8532 "Strong Market Position FY2016: Further Discussion and Conclusion".

My prediction was for a total loan book growth of $3.7m. Not much when the total loan book size was $628m (actually <1%)! While there is a good chance Heartland may do better than this, a prudent investor woudl not invest on the basis of all ducks lining up. I don't see a compelling case for reinvesting any of my ANZ and WBC funds into Heartland.

SNOOPY

[Arbroath]

This sounds like 'greater fool' investing to me. There is no need to evaluate the true worth of the investment if 'the rising trend' means there is always someone else to sell to. No doubt there is significant money to be made when an investment goes from being 'plain overvalued' to 'incrementally overvalued'. The trick to making money is to make sure you don't become the 'greatest fool'. Good luck.

SNOOPY

i sold 30% of my holding at $1.68 and then watched them trade to $1.71 within his minutes. Still got the other 70% but think the valuation is getting stretched so will likely sell more if they show more strength.