For Bar Review
Heartland Group (HGH) downgraded its FY24 underlying NPAT guidance -20% at the midpoint, a mix of short-term operational headwinds, costs relating to the purchase of Challenger Bank and additional provisioning. The negative 2023 September quarter New Zealand GDP print, released the same day as the guidance downgrade, underscores the risks for HGH in the face of a weakening consumer environment. Material potential upside remains in the form of lowering Australian borrowing costs when HGH completes its acquisition of Challenger Bank, though the uncertain path for the NZ consumer over the coming months leads us to maintain our NEUTRAL rating with a target price of NZ$1.70.
What's changed?
- Earnings: FY24 lowered to within new guidance range, later years decreased due to lower forecast receivable growth
- Target price: Lowered -15cps (-8%) to NZ$1.70.
NPAT downgrade a mixture of one-offs and ongoing challenges
New FY24 guidance is for underlying NPAT of between NZ$93m to NZ$97m compared to prior guidance of NZ$116m to NZ$122m. The key changes are: 1) the introduction of a NZ$11.5m provision linked to low quality legacy loans in the Motor and Asset Finance divisions, 2) a NZ$8m to NZ$10m negative impact from NIM compression and lower than expected receivable growth, and 3) -NZ$3.5m of expected operational losses from three months owning Challenger Bank. There is an additional -NZ$2.1m (after-tax) of one-off transaction costs relating to the Challenger Bank acquisition.
Modest lending rate increases and competitive deposit market squeezing NIM
HGH's conservative policy on hiking lending rates and increased competition in the deposit market, with competitors no longer having access to the RBNZ's Funding for Lending programme, is hurting its NIM. HGH has limited increases in its lending rates, particularly in its Reserve Mortgage and Livestock divisions, despite upwards pressure from rising deposit rates. NIM is also being suppressed by a decrease in churn in lower rate Motor loans. We forecast NIM to bottom in FY25 before rising as rates moderate.
Completion of Challenger Bank the key focus, timeline pushed back to March 2024
HGH's near-term priority remains the completion of the acquisition of Challenger Bank Australia. HGH had been hoping to receive regulatory approval before the end of 2023. It is taking longer than anticipated and the company is now targeting the end of 1Q CY24. The purchase would grant HGH a deposit takers license in Australia, enabling it to replace higher cost wholesale financing. How quickly HGH is able to lower its cost of funding then depends on the pace it can build its deposit book. HGH expects Challenger Bank to contribute a net NPAT loss of -NZ$3.5m in FY24 but breakeven in FY25.
Downgrade summary
- Operational challenges (-NZ$8m–$10m NPAT impact): HGH has experienced a slowdown in receivable growth, particularly in the Motor and Australian Livestock divisions. The slowdown in Motor is linked to generally lower levels of consumer demand for vehicles and a delay in the purchase of vehicles due to the imminent reversal of the Clean Car Feebate scheme by the new coalition government in NZ. The low level of growth in Australian Livestock is due to adverse weather impacts. HGH has also experienced pressure on its NIM from a combination of higher deposit costs and its cautious approach when raising lending rates.
- Legacy loan provisioning (-NZ$11.5m): The NZ$11.5m provision is split between Motor (NZ$7.5m) and Asset Finance (NZ$4.0m). HGH has a lower level of confidence in the collectability of legacy loans in this division. These loans pre-date HGH’s shift to improve the quality of its loan book. Overall HGH’s FY24 YTD annualised impairment expense is 0.35%, consistent with our forecast.
- Challenger Bank acquisition (-NZ$3.5m): HGH expects to complete its acquisition of Challenger Bank by 31 March 2024. Challenger Bank is currently loss making and forecast to decrease HGH’s NPAT by -NZ$3.5m in FY24, though it is expected to move to breakeven in FY25. In addition, one-off transaction costs incurred in FY24 are expected to amount to -NZ$2.1m.
Earnings revisions
Changes to FY24 earnings are material, though the one-off impacts of the economic provision and Challenger Bank acquisition costs do not flow through to future periods. We modestly reduce earnings expectations in future years due to the softer than expected receivable growth in the Motor and Australian Livestock books, as well as a lower NIM expectation.
inancials: Jun/ 23A 24E 25E 26E Rev (NZ$m) n/a n/a n/a n/a NPAT* (NZ$m) 95.9 95.1 124.9 143.0 EPS* (NZc) 13.5 13.2 17.2 19.4 DPS (NZc) 11.5 11.5 12.0 12.5 Imputation (%) 100 100 100 100
*Based on normalised profits