the pros and cons

No smoke. No mirrors. No accounting shenanigans.
There is simply lots of cash rolling into RHG’s coffers. The
business reported a profit of $69m for the six months to
31 December and delivered cash from operations of $65m,
after paying $35m to the taxman. That’s close to the current
market capitalisation and more than we were expecting
it to make for the full year.
There are two factors working in RHG’s favour. Firstly,
it hasn’t passed on all of the Reserve Bank’s interest cuts.
Last year the company was charging its customers a
margin of approximately 2.2% more than the official cash
rate. Now that margin is above 3%.
The exorbitant rates are forcing customers elsewhere—
20% of the loan book was repaid or refinanced during the
six month period, which is about as much as you would
expect in a full year if the company’s rates were
competitive—but, for the 50% of its customers that are ‘low
doc’, RHG can probably get away with it. These homeowners,
who represent riskier credit for lenders, don’t have many
refinancing alternatives in the current market.
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Secondly, RHG’s funding cost is referenced off the
30-day bank bill rate (the rate banks charge each other to
No smoke. No mirrors. No accounting shenanigans.
There is simply lots of cash rolling into RHG’s coffers. The
business reported a profit of $69m for the six months to
31 December and delivered cash from operations of $65m,
after paying $35m to the taxman. That’s close to the current
market capitalisation and more than we were expecting
it to make for the full year.
There are two factors working in RHG’s favour. Firstly,
it hasn’t passed on all of the Reserve Bank’s interest cuts.
Last year the company was charging its customers a
margin of approximately 2.2% more than the official cash
rate. Now that margin is above 3%.
The exorbitant rates are forcing customers elsewhere—
20% of the loan book was repaid or refinanced during the
six month period, which is about as much as you would
expect in a full year if the company’s rates were
competitive—but, for the 50% of its customers that are ‘low
doc’, RHG can probably get away with it. These homeowners,
who represent riskier credit for lenders, don’t have many
refinancing alternatives in the current market.
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Secondly, RHG’s funding cost is referenced off the
30-day bank bill rate (the rate banks charge each other to
shareholders should take heed of two caveats.
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Some $51m of the company’s $147m in net tangible
assets has been invested in subordinated mortgage debt
or provided as security to lenders. If the mortgage insurers
that have guaranteed the underlying home loans fail—
something that looks increasingly likely—some or all of
these assets could be lost.
Far more importantly, RHG’s four directors have
shown no inclination to return the bounty to
shareholders. We highlighted the apparent shift in
direction in our review of the annual meeting last year
and nothing seems to have changed. No dividend was
declared despite enough cash and franking credits to
pay out at least 10 cents a share.
There has, however, been some good news on this front
as well. Australian Leaders Fund has recently become a
substantial shareholder (they own in excess of 5% of the
outstanding shares) and we estimate members of The
Intelligent Investor own something like 10% of the company.
Hopefully, management of Australian Leaders Fund want
the same thing we do and, between us, we might be able
to make a difference. There are no guarantees, but we plan
on giving you an opportunity to make your vote count.
These issues need to be resolved before shareholders
can realise the value that is obviously on offer. But the
most important thing is that the cash is rolling in. In this
regard, there is plenty of reason for optimism.
SPECULATIVE BUY.