I am going to base my earnings estimates on the normalized profits of Heartland in FY2019, before this Covid-19 thing hit
Heartland FY2019 (Normalised Profit): $73.617m+ 0.72x($1.8m+$1.3m+$1.1m) -$1.936m -$0.173m =$74.532m
I am going to use FY2019 as my 'base case' because that result contains no impact of Covid-19.
Notes on Normalising Profit
1/ I have adjusted for the $4.2m in costs associated with listing on the ASX. Specifically this included $1.8m of corporate restructure and ASX listing costs, a $1.1 million dollar break fee due to the early repayment of a Tier 2 Australian Subordinated bond and $1.3m in foreign currency costs also related to the corporate restructure (See 'Annual Review FY2019 p40).
2/ I have removed the $1.936m fair value movement of investment property gain, and the $173k gain on sale of investments.
The adjustments I make below are based on what I believe will be a fairly significant changes in 'borrowing attitudes' and 'business opportunities' going forwards.
Reverse Mortgages
Jeff has a fairly bullish view on the growth prospects for reverse mortgages going forwards, at least for FY2020 By contrast I believe the reverse mortgage market will be flat by FY2021. My reasoning for this is that in a rising property market, oldies can feel good about taking out a reverse mortgages because the value of their home is increasing consummately and their overall wealth is not going down. By contrast, when property prices fall, not only is any capital they spent on a reverse mortgage lost. The interest charges very obviously burrow into the oldies remaining savings as well. I am not saying that all reverse mortgages for capital expenditure will stop. If a pensioner needs capital for a hip replacement or to purchase unfunded cancer drugs or to visit a faraway relative they will still borrow. But they might not borrow to update their car, or for an annual holiday in the sun. Many of the oldies have frugality built into their character. It is a psychological mindset that I think will see reverse mortgage growth stall.
Motor Vehicle Finance Adjustment
So what does this picture suggest for profitability in FY2021?
As at December 2019 the motor vehicle finance book at Heartland was $1,124m. Let's guess new vehicle sales were $500m of that. So a 45% reduction would see a loss of:
0.45 x $500m = $225m worth of finance business in turnover.
Motor vehicle finance has traditionally had some of the best margins at Heartland. Heartland's AGM presentation had an ROE north of 15%. In recessionary times I am going to stick to the 15% figure. This means the earnings that Heartland will miss out on due to plunging new car finance deals will be around:
0.15 x $225m = $34m
Of course the annual hit won't be this much, as finance typically has a three year cycle. So the FY2021 hit will be about 1/3 of that, $11.4m.
I am guessing the FY2022 impact will be only half that in FY2021, $5.7m, but unfortunately the financing effect from FY2021 is cumulative into FY2022.
Underlying profit was around $74m in FY2019 (a bit less in FY2020?). So it looks like new car financing alone will knock Heartland's profit down to just shy of $63m, or a 15% drop.
Lot's of figures pulled out of the air here.
Anyone like to comment if I am on the right track?
Business Finance (Part 1): O4B
So what does this picture suggest for profitability in FY2021?
'O4B' was 3% of the Heartland bank loan book in December 2019, with $158m of loans on the books.
Heartland has been earning an ROE of more than 15% on this O4B portfolio.
If O4B sinks, then the annual tax profit loss for Heartland will be about
:
0.15 x $158m = $24m
That is likely an overestimate as O4B also offers partially secured loans of up to $250,000 (well beyond the $100,000 limit of the NZ government scheme) and secured and unsecured loans into Australia. Those boundaries are beyond the IRD scheme. I would estimate the actual annualised profit hit to be 80% of my calculated figure, or around $19m. I estimate the IRD loan scheme may have brought forward about three months worth of loan applications that otherwise might have gone through O4B. If the IRD scheme is dropped on 12th June as planned, then the impact flowing into FY2021 may only be a couple of months. That equates to a reduction in FY2021 profit of $19m x 2/12 = $3.2m.
If the remaining 'outside of government scheme boundary' loans profit of $5m were to sink by 10%, then that would knock $0.5m off annual profits going forwards.
Likewise if the residual O4B loan profit balance of $19m- $3.2m = $15.8m were to reduce by 10%, that would wipe $1.6m off annual profits.
Now putting these three effects together, the expected annual profit decreases from the base year of FY2019 are as follows:
FY2021: -$3.2m - $0.5m - $1.6m = -$5.3m
FY2022: - $0.5m - $1.6m = -$2.1m
Business Finance (Part 2): Business Intermediated & Business Relationship
So what does this picture suggest for profitability in FY2021?
'Business Relationship' lending fell by 16% in FY2019 to $559.4m (Annual Review FY2019 p9), and I expect this trend to continue into FY2020 and FY2021. This means I am projecting the 'Business Relationship' loan book to be down to:
$559.4 x 0.84 x 0.84 = $395m
That number corresponds to the receivables book shrinking by $165m. We are told ROE for these loans is between 0% and 11% (AGM2019 Presentation p15). If the closed out loans averaged an ROE of 6%, this would represent a drop in Heartland profit from FY2019 levels of:
$165m x 0.06 = $10m
I am predicting that when some of the lending through intermediaries starts to shrink, Heartland will renew their interest in writing business relationship loans directly. So I see no further shrinkage in profit from this category between FY2021 and FY2022.
'Business Intermediated' lending is projected to grow in FY2020.
But I think that by FY2021, it will shrink back down 10% below FY2019 levels (down to $425.4m x 0.9 = $383m, a decrease of $42m). My reason for believing this is that there will be lower tradie activity in FY2021, and sensible tradespeople will have transferred to IRD backed ultra low interest loans, at least in NZ. The silver lining of this is that by existing Heartland customers effectively refinancing with the government, many bad debts to Heartland will be avoided. Business Intermediary loans have an ROE of between 11% and 15% (AGM2019 Presentation p15). If we assume the average margin is 13%, this will represent a loss of profit for Heartland in FY2021 of:
$42m x 0.13 = $5.5m
The kind of business loans sought by Heartland tend to be short term. So I am not expecting the general reduction in business loans to have a compounding effect year on year.
Rural Finance Adjustment
Rural finance at Heartland is transitioning between 'all of business funding' to funding seasonal assets. The former is far less profitable than the latter. So while I am expecting the rural loan book as a total receivable value to shrink, I am picking the Rural finance profit to remain flat,
Harmoney and Other Consumer Lending
Harmoney' reported their first profit, after an accounting standard change, of $7.22m over FY2019. Included in these calculations were a recognition of tax loss assets of $4.85m and deferred R&D expenses of $4.74m. Before these adjustments, 'Harmoney' lost $233,000 in the year to March 2019. At EOFY2019, 'Harmoney' had $367m of financial receivables on the books. The main profit that Heartland makes from Harmoney is not from the fraction of the Harmoney NPAT that they are entitled to via their partial ownership of Harmoney. No the profit comes from the provision of funds to Harmoney to run their loan book. If Heartland fund the loan book to the extent of their shareholding, then Heartland's share of this receivables book amounted to:
0.131 x $367m = $48m
At a 15% return on this loan money, this level of lending would produce:
0.15 x $48m = $7.2m of annual profit.
I predict that Harmoney will not survive the post Covid-19 and will be wound down in an orderly way mid way through FY2021. Other consumer lending should be OK.
|
FY2021 |
FY2022 |
Baseline Reference Profit |
$74.5m |
$74.5m |
Reverse Mortgage Adjustment |
$0m |
$0m |
Motor Vehicle Finance Adjustment |
($11.4m) |
($17.1m) |
Business Finance (Part 1) Adjustment |
($5.3m) |
($2.1m) |
Business Finance (Part 2) Adjustment |
($15.5m) |
($15.5m) |
Rural Finance Adjustment |
$0m |
$0m |
Harmoney and Other Consumer Lending Adjustment |
($3.6m) |
($7.6m) |
Total Forecast NPAT |
$38.7m |
$32.2m |
No. Shares on Issue |
581.0m |
581.0m |
Earnings Per Share |
6.7cps |
5.5cps |
I am hoping the real results won't be as gloomy as this.