This is a follow up to my previous post on RHG. There has since been further takeover activity with the latest offer from Resimac of 49.5c being endorsed by the RHG board. RHG is currently 49c. However this post is not to speculate on the takeover activity, but to update my valuation model now the full year financials have been released.
Please note the disclaimer at the right hand side of the page. The assumptions and figures used in this post should not be taken as financial advice.
As noted in the initial post, RHG is a mortgage book in run-down mode. In determining value, the key considerations are a) interest earned, b) interest paid, c) how fast the book is being run-down and d) overheads. I can't stress enough these are purely my estimations and could be wrong. I went back through half and full year reports in order to determine the historical figures and have updated these figures for the full year results to 30 June. The spreadsheet below shows the updated results:
I keep a bunch of these types of spreadsheets on stocks I follow. They may not make a lot of sense: the aim for these sheets is to condense information for my own purposes, so apologies if they aren't easily read.
The estimated % interest earned and % interest paid have come down over the last six months, consistent with decreasing interest rates in Australia. Estimated Net Interest Margin is 1.9%, which looks about right. Other expenses have stayed fairly flat from 2012 to 2013: impairment costs have increased, offsetting a general reduction in other expenses. Over time I expect overall costs to reduce as the book reduces, although impairments as a % of mortgage assets may actually increase thanks to the 'puddle getting muddier toward the bottom'. Note: impairment expenses were responsible for the jump in costs in 2010. For my projections, I am going to keep things simple: use last years interest received and paid and the long term average rate of reduction in assets, liabilities and other costs. These assumptions are probably over simplifying; however I am not trying to achieve precision, but just get a rough idea of the valuation.
Note I have lumped cash into total assets, along with other assets and I have also lumped liabilities together. This is a bit naughty as it will slightly distort the interest received and paid, but doesn't effect the numbers too much.
I conceptualise RHG as two components. First is the current cash balance (35c ex the recent 3c fully franked dividend and not allowing for further profits since 30 June). Second is the future profits derived from the mortgage book. Future profits will increase the cash pile further. Excluding tax and risk, it doesn't particularly matter for valuation purposes whether dividends are paid. For simplicity, I have just left future profits on the balance sheet.
Okay, based on the historical run-dow rate, the book will pretty much be exhausted by 2018. I estimate a further $44m in total NPAT will be generated. Plug in a 10% discount rate gives an upfront equivalent of 12c. Add this to the 35c and we get 47c. That's actually a bit less than the current price.
Something doesn't seem right.
It bothers me that 'other expenses' aren't reducing at the same rate as the book. But even plugging in a similar rate of reduction to the mortgage book only increases DCF by around 3c. Heck, even completely chopping off other expenses only increases my overall valuation to 58c. Even playing around with the run-down rate of the book doesn't bump up the DCF too much, nor does changing the discount rate. This tells me either I have made a mistake, future variables will be substantially different from historical figures or Resimac/Pepper/Cadence see a brighter future for the business than a pure-run off.
Overall my post-tax valuation has reduced slightly from 49c (52c from my previous post less 3c dividend) to 47c.
I previously sold some shares at 52c (pre the 3c dividend) and continue to hold a number of shares. Although there are some firm takeovers are on the table, outside of franking credits, I'm not convinced of material upside from here.
Kristian
Disclosure: own RHG
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