The Investment Case for Dorchester in September 2013
Time to bring together my investigation into the 'financial factors' that sit behind Dorchester.
Leaving aside the suggestion that the term Tier 1 and Tier 2 capital strictly apply only to banks, however you measure things Dorchester was short of capital last year. Management themselves recognized this and post the 31st March balance date there has been a significant injection of equity into the business. And at the same time the somewhat cloudy financial structure of the company was cleared up. I would argue now that even if you regard all capital contained within DPC as 'tier2', capitalization is now more than adequate by any standard. The reason for this is that DPC has an 'acquisition strategy' going forwards. The plan as the CEO has laid out in the budget is to grow organically although he does note in the AGM address to shareholders:
"debt purchase in both markets (NZ/Oz) does present a step out opportunity. We will take a conservative approach to debt purchase. We will not be relying on contributions from this activity to achieve budgeted profits nor will we carry costs in anticipation of securing any debt purchase."
That means the opportunity for a step up in budgeted earnings is there if there are debt ledgers out there at the right price.
As a result of the capital raising the gearing ratio of the underlying business is very conservative (I calculate 33.7%).
The main 'thorn in the ointment' for FY2012 was underlying earnings which were negative (-$0.133m). If nothing else the recapitalized company should see the interest bill drop from last years $2.55m. Underlying borrowings after the capital restructuring is complete were forecast as $13.9m, down from $22.784m as at 31st March 2013 (balance date). That interest adjustment alone should see the company move back into the black.
Profit forecast for the year ended March 2014 is $6m, with probably 80% of that figure coming from business development and 20% from a reduction in underlying debt. That represents an ROE of:
$6m/ $67.4m = 8.9% or $6m/ ($67.4m-$26.2m) = 14.6% if you take out projected intangible assets at the time of the recapitalization. I am not sure which is the most appropriate figure of the two to use. Any views?
Business is projected to increase in FY2015 where a $10.5m profit is budgeted for. Dorchester operates in a competitive market, and the individual gains in contribution from which which division are 'blacked out' in the CEOs 'Profit Forecast with Organic Growth and M&A' slide. Essentially the message is 'trust us, we know what we are doing'. From what has been revealed the business plan looks sound and achievable. Net tangible asst backing though is only
($67.4m-$26.2m)/479.342m = 8.6cps
So at 22cps market price today you are paying a significant asset premium for management expertise. Projected dividend yield will only be 40% of gross profit, and there will be no imputation credits due to previous years losses. $6m projected profit spread around 479.342m shares is 1.3cps. While a projected 0.5cps dividend is welcome, the gross dividend yield with the share price at 22c is only 2.3%. IMO the current share price cannot be justified on projected dividend yield alone.
With earnings projected to jump to $10.5m in FY2015 that dividend yield jumps to 4%. I would say at 22c the market has already priced in further growth above that. Whether you think investing at 22c is justified will depend on just how lucrative you think the longer term growth strategy will be. I don't see any hurry to buy into this company at 22c. But I will be putting DPC on my watch and wait list.
SNOOPY
How much capital is enough for DPC?
Quote:
Originally Posted by
Snoopy
But I will be putting DPC on my watch and wait list.
My above analysis of DPC is largely based on the post fund raising balance sheet of DPC as outlined in the pro-forma balance sheet slide presented to shareholders at the AGM on 23rd August 2013. However, to an extent this is a moot observation because the Chairman has clearly signalled that DPC is on the acquisition trail.
From the Chairman's AGM address:
"While there will be a range of views on what gearing or equity ratio is appropriate for a financial services company such as Dorchester, the Boards’ view is that there is some $50m of borrowing capacity to fund merger and acquisition opportunities."
Simple subtraction from the $67.4m of shareholder equity on the pro-forma balance sheet leaves $17.4m. I interpret that to mean that $17.4m is sufficient equity to 'cover' the existing working assets of the company comprising:
Finance Receivables of $31.4m, Reverse annuity mortgages of $17.7m, Financial assets including Funds Under management of $16.8m. These total financial working assets, that are ultimately owned by other parties not DPC add up to $65.9m.
$17.4m/$65.9m = 26.4%
This is in accordance with the >20% 'Tier 1' capital standard imposed by UBS and First NZ Capital on PGGW Finance, before PGGW finance amalgamated with Heartland bank.
Of course if you subtract out the $26.2m of intangible assets on the books then DPC would be in net negative shareholder asset position. I guess that is a strong argument to show that it is not appropriate to strip out intangible assets in this situation?
SNOOPY