Building on some of the themes we’ve discussed leading into reporting season, in this note I’d like to highlight insights we’ve gleaned in week two, including hints of economic stress in Genworth’s (GMA) and Bendigo (BEN) reports, and our read through on two companies we hold, Henderson Group and HFA Holdings (HFA).
Just 12 short months ago you probably wouldn’t have thought banks and resources would now be refuges from small and mid-cap stocks, but in short that’s the situation. Economic concerns haven’t meaningfully detracted from CBA’s result, commodity prices have bounced back, and expectations previously built into many growth stocks have, in some cases, dramatically come back down to earth.
We believe this dynamic – the sloshing back and forth of large amounts of capital – will likely continue because structurally the ASX major indices are so resources and financials-heavy. In contrast with the US where, even allowing for the perspective of ‘tech firms reign supreme’, there is much greater breadth and far less concentration in the headline indices. It means Australian investors, in particular, need to be aware and prepared for sudden changes to market valuations. At Clime we use active management with a clear focus on our valuation framework within purposeful sub-portfolios to navigate this environment.
Damen’s piece on the wealth effects of property highlighted depressed housing consumer sentiment despite record low interest rates as a sign that property prices may be peaking. The obvious casualties of a downturn are banks, REITs and retailers of household goods. This week we saw more signs of this in GMA’s and BEN’s reports.
Genworth (GMA) provides lenders mortgage insurance (LMI) and Bendigo & Adelaide Bank (BEN) is a diversified second-tier lender. Both sit on the riskier end of the financials spectrum and they’re more likely to reflect economic stress earlier than the big four.
While from low absolute levels, GMA reported a 21% increase in delinquencies on average with the worst in WA due to the mining downturn. This translated to a 41% increase in claims cost for GMA. Management now expect lower recoveries in WA with softness for at least another 18 months.
The outlook more broadly is weak, as shown by employment trends and the bottoming interest rate cycle.

Figure 1. Key housing metrics
Source: GMA
BEN’s 1H17 result disappointed with lower net interest margin (NIM, down 6bps), which was offset by aggressive mortgage lending growth (+14%, twice system growth), and higher impairments expenses (up 93% on 1H16).
In our view, BEN is one of the worst-placed banks if economic conditions deteriorate. Aggressive loan growth in housing, coupled with a weak Common Equity Tier 1 (CET1) ratio of 8% sees it well below that of the majors. It also generates 15% of earnings from Homesafe, a reverse mortgage business where BEN assumes residential real estate risk as customers draw down equity in their homes. BEN has historically booked mark to market gains, however this could easily reverse in the event of falling property prices. And finally BEN still has a $130m exposure to Great Southern Loans, which may prove difficult to recoup.

Figure 2: BEN results summary
Source: BEN
In more positive news Henderson Group (HGG) and HFA Holdings (HFA) reported solid results that gave us comfort as shareholders.
Henderson Group (HGG)
HGG shares have been depressed since Brexit, however we believe there is plenty to like about the proposed merger with US-focus Janus Capital Group.
FY16 results were good in the context of UK equity market turbulence in 2016. Underlying pre-tax earnings were slightly ahead of expectations, falling 3% to GBP212 as a result of lower performance fees. The majority of HGG’s funds have outperformed over the last 3 years, which we believe will be supportive of future inflows.

Figure 3: HGG results summary
Source: HGG
Henderson’s planned merger with US-focused Janus Capital Group is in our view an excellent move. They are highly complementary businesses with comparable AUM and contrasting exposures by geography and asset class.
The more geographically diversified entity should remove the “Brexit” stigma attached to HGG, and expected cost synergies represent 16% of current earnings. This is before potential revenue synergies from an enhanced distribution network. The company also has a strong customer-first culture and reputation which is very important in this industry.
Despite an improving outlook, HGG continues to trade at a discount both on a multiples basis and intrinsic value. Including disclosed merger benefits we think it’s worth well over $4.

Figure 4: Combined Henderson and Janus Assets Under Management (AUM) and exposures
Source: HGG
HFA Holdings (HFA)
On the smaller end the market-cap spectrum, Fund of Hedge Funds manager HFA Group continues to trade at what we believe is an unreasonable discount. The basic proposition is simple: HFA’s $314m enterprise value (A$344m market cap adjusted for net cash of A$30m) is just 8 times annualised EBITDA of A$38m (note HFA reports in $US)
Because HFA has US$112m of deferred tax assets, no debt and minimal depreciation expenses, EBITDA translates strongly to free cash flow. This is why HFA’s dividend policy is set against EBITDA rather than reported earnings.
The crux of our investment thesis is HFA is trading at a free cash flow yield of about 13% and an unfranked dividend yield of 10%. It has significant cash reserves for growth or capital management initiatives, either of which will likely grow earnings per share, in our view. We think the stock is worth $3.
The 1H17 result was lacklustre, with slightly better than expected fee income due to performance fees, which we don’t include in our forecasts. Lower EBITDA was impacted by costs related to an increase in headcount. Unfortunately, there is little in the result to inspire the broader market. Given current prices we would like to see a buy-back initiated to generate earnings per share growth and increase value to holders.

Figure 5: HFA results summary
Source: HFA
Positively, HFA continues to deliver consistent performance, which should be attractive to institutional investors around the world in the low interest rate environment.

Figure 6: Lighthouse Funds performance
Source: HFA

Figure 7: Lighthouse Assets Under Management and Advice (AUMA)
Source: HFA