TGA - Thorn Group

There is a mention of TGA in yesterday's communication from FNArena, which I paste in the postscript below.

The general feeling that I get from this and other "opinions" is that 2013 and 2014 will flat for TGA's EPS growth, and then relatively new initiatives kick in to send the EPS on its wonted upward trajectory. Analysts (and players in the market) are herd animals who reflect each others' thoughts, and hence "consensus" carries less significance than one may think. TGA may surprise in 2013, but as there are sufficient words pasted below to stretch the attention span of many followers of this thread, I'll return to that in a later-day post, but any views on 2013 and 2014 EPS would be welcome. One thing you can be sure of is that TGA has a detailed budget for 2013 that will prove to be surprisingly accurate, and they probably have extended this to cover 2014 with a lower level of confidence.

POSTSCRIPT

In terms of finding the next ASG Group, I have come to the conclusion that Thorn Group ((TGA)) looks like a genuine candidate. The specialist niche lender and provider of consumer credit has equally been derated over the past twelve months and with the share price now between $1.40-$1.50 the Price-Earnings ratio (PE) is only at 7.3x and the dividend yield at 6.9%. The balance sheet seems in good shape and so are cash flows. Highly regarded management is working towards diversification, away from the Radio Rentals operations that have served the business and its shareholders so well since 2007.

Price deflation for flatscreen TVs and PCs is now hurting growth while new initiatives are still of insufficient size to fully compensate for this, but analysts (and management) are confident that FY14 and beyond look promising, at the very least. Nothing in the share market comes without risks and it is possible that FY13 might well disappoint in terms of (negative) growth. As shown in prior examples, such risks can be mitigated through buying the shares as close to dividend support as possible, while free cash flow projections virtually guarantee there will be no cuts to dividend payouts.

In case the share price shows no net progress in years to come, the yield is projected to rise from 6.9% this year (until March 2013), to 7.2% in FY14, to 7.5% in FY15.

I expect FY13 not to be as bad as the analysts have forecast. Given the customer growth of 3-4% this year in a subdued economic environment, I can't see how it'll be flat... If anything, there will be atleast 3-4% increase.

In addition to that, a greater portion of the leases are now finance leases and as such, dont report their profits within the first year as I understand it. As that's the case, the benefits of customer growth experienced this year within this space will span across the next year and possibly further, depending on when customers signed off on the agreement.

I can't see any growth in the 20% range as has been the case in recent times, but anything from 5-10% is what I'd expect - assuming they can't deliver any cost efficiencies.

For FY14... well I'm not even going to try and guess that one.

Klogg said:

In addition to that, a greater portion of the leases are now finance leases and as such, dont report their profits within the first year as I understand it. As that's the case, the benefits of customer growth experienced this year within this space will span across the next year and possibly further, depending on when customers signed off on the agreement.

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Finance leases report a profit in the first year based on the sale price of the good being leased. For instance, if TGA buys a TV from China for $400 then leases it to a customer with a fair value it assesses at say $1,000 it will generate a $600 gross profit in the first year. Also as the lease gets older it earns less revenue for the company (like a mortgage).

McLovin said:

Finance leases report a profit in the first year based on the sale price of the good being leased. For instance, if TGA buys a TV from China for $400 then leases it to a customer with a fair value it assesses at say $1,000 it will generate a $600 gross profit in the first year. Also as the lease gets older it earns less revenue for the company (like a mortgage).

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I keep getting the two mixed up... Are the furniture and whitegoods under operating or finance leases?

Klogg said:

I keep getting the two mixed up... Are the furniture and whitegoods under operating or finance leases?

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They can be either but are still mainly operating.

"Rent, Try, $1 Buy" is the finance leasing. "Rent, Drive, Buy" will be too.

I should add to my previous post that the cash flow is the same for each period, it's just the mix of receiveable v interest that changes as the lease matures.

McLovin said:

They can be either but are still mainly operating.

"Rent, Try, $1 Buy" is the finance leasing. "Rent, Drive, Buy" will be too.

I should add to my previous post that the cash flow is the same for each period, it's just the mix of receiveable v interest that changes as the lease matures.

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Yeah, that's what I thought, just forgot which is which.

So my point was - given that the customers are opting for furniture/whitegoods (which are mainly on operating leases) the accounting methods won't be attributing the majority of profits to the first year, and will therefore spill over to the 2nd/3rd.

Poor explanation, but you get my point... eventually, lol.

Thanks for the help there McLovin.

Klogg said:

Yeah, that's what I thought, just forgot which is which.

So my point was - given that the customers are opting for furniture/whitegoods (which are mainly on operating leases) the accounting methods won't be attributing the majority of profits to the first year, and will therefore spill over to the 2nd/3rd.

Poor explanation, but you get my point... eventually, lol.

Thanks for the help there McLovin.

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No worries, I getcha.

You can actually see how much gross profit they earned on their finance lease sales from the accounts. It's about $11m. It was about the same the year before too.

McLovin said:

They can be either but are still mainly operating.

"Rent, Try, $1 Buy" is the finance leasing. "Rent, Drive, Buy" will be too.

I should add to my previous post that the cash flow is the same for each period, it's just the mix of receiveable v interest that changes as the lease matures.

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There is a note in the recent annual report that reads "The consolidated entity classifies Rent Try Buy ® contracts as finance leases where the term of the contract is 36 months and the asset rented has an estimated useful life equal to the contract length." The ". . . estimated useful life . . ." words are important, and I missed them on first reading, which left me confused.

If the estimated life of a bed is thirty years, I presume it would not qualify as a finance lease, even though it had a $1-buy option. Cars then would presumably be operating leases for the first 12 months, because their estimated useful life is longer than that. PCs, laptops and the like probably do have an estimated useful life of about three years. Consequently, a PC would fall under a finance lease, and a bed would fall under an operating lease.

On the EPS growth trajectory, I am more bullish than the analysts, and for now I am using 8% for YE 30/03/2013 and 10% for YE 30/03/2014. I'll come back to this in another post.

On Morning Star metrics, as I have pointed out before, I regard the 11c for 2007 as being far too high. Half that would be about right. This affects the historical CAGR. I am happy with the 19c for EPS, on the understanding that this is a diluted EPS. The ROE of 19.9% is correct, but misleading, as it always is in a year of capital raising, because it uses the end-of-year equity, so do not let the 19.9% conduce you to think that TGA's profitability is slipping. If you used average equity, you get a better metric. A crude ROAE (return on average equity) gives 23.68%, a more sophisticated averaging technique may drop this a bit, but it would be well north of 20%, which is very good.

Pioupiou said:

There is a note in the recent annual report that reads "The consolidated entity classifies Rent Try Buy ® contracts as finance leases where the term of the contract is 36 months and the asset rented has an estimated useful life equal to the contract length." The ". . . estimated useful life . . ." words are important, and I missed them on first reading, which left me confused.

If the estimated life of a bed is thirty years, I presume it would not qualify as a finance lease, even though it had a $1-buy option. Cars then would presumably be operating leases for the first 12 months, because their estimated useful life is longer than that. PCs, laptops and the like probably do have an estimated useful life of about three years. Consequently, a PC would fall under a finance lease, and a bed would fall under an operating lease.

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I could be wrong but if the useful life exceeds the lease term then it's a hire purchase agreement which is accounted for in the same way.

Either way, leasing a bed, with a bargain purchase option, shifts all of the risk and reward to the lessee so I don't know how it could reasonably remain on TGA's balance sheet as a rental asset.

ETA: On second look maybe they do...Note 7(L).

Seems a little counter-intuitive. Especially when the standard only says useful life matching the lease term is one factor that may cause the lease to be classified as a finance lease.

McLovin said:

I could be wrong but if the useful life exceeds the lease term then it's a hire purchase agreement which is accounted for in the same way.

Either way, leasing a bed, with a bargain purchase option, shifts all of the risk and reward to the lessee so I don't know how it could reasonably remain on TGA's balance sheet as a rental asset.

ETA: On second look maybe they do...Note 7(L).

Seems a little counter-intuitive. Especially when the standard only says useful life matching the lease term is one factor that may cause the lease to be classified as a finance lease.

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I am not a leasing guru. All that I know is that the annual report states that rental items are contracted via operating leases. Further, the annual report states what I wrote earlier, which implies that if the useful life exceeds the term of a Rent-Try-Buy contract, TGA does not treat it as a financial lease. I telephoned two stores (one in Geraldton and one in Adelaide), but the women I spoke to did not understand the terminology (operating lease or finance lease). What they said was that a PC would be leased under a mandatory-36-month lease, and a bed would be a more flexible term, because ownership remains with TGA. If one wanted to buy the bed after 18 months, it would cost a fair amount, but if one wanted to do so after 36 months, one would get it for $1. I interpret this to mean that a PC would be contracted under a finance lease, and a bed under an operating lease.

Wikipedia in reference to Australia reads "A lease is classified as a finance lease if it "transfers substantially all the risks and rewards incidental to ownership of an asset." (AASB 117, p8) There are no strict guidelines as to what constitutes a finance lease, however guidelines are provided within the standard." If Rent-Try-Buy contracts include a make-good provision, then TGA could argue that risk has not substantially been transferred to the lessee. The Rent-Try-Buy deal also includes a free relocation provision, within the service area, a service that suggests the burden of ownership has not passed from TGA.

I suppose if one wanted to know, one could ring up TGA in Bankstown and confirm this.

Thanks for your posts this week Pioupiou, I haven't had the chance to directly thank you, but reading them with interest.

Pioupiou

You are right in that they don't, for some reason, include those longer useful life assets as finance leases. I find it strange, from a substance v form perspective. I spent most of my time working overseas (not as an accountant though) and, iirc, the inclusion of an option to purchase at a bargain price would automatically make this a finance lease under IAS. I am familiar with AASB 117 and it's not as clear cut; it lists several criteria with the caveat that either one criteria or multiple criteria can be evidence of a finance lease, including the useful life/lease life criteria. Unfortunately, it doesn't say which criteria are standalone and which need to be in unison with other criteria.

I guess as long as they're not changing how they classify leases there's no real issue.

McLovin said:

Pioupiou

You are right in that they don't, for some reason, include those longer useful life assets as finance leases. I find it strange, from a substance v form perspective. I spent most of my time working overseas (not as an accountant though) and, iirc, the inclusion of an option to purchase at a bargain price would automatically make this a finance lease under IAS. I am familiar with AASB 117 and it's not as clear cut; it lists several criteria with the caveat that either one criteria or multiple criteria can be evidence of a finance lease, including the useful life/lease life criteria. Unfortunately, it doesn't say which criteria are standalone and which need to be in unison with other criteria.

I guess as long as they're not changing how they classify leases there's no real issue.

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Accounting rules abroad are different, one or two that I read would have implied that TGA's leases would be interpreted as financial leases. I seem to recall that one blurb hinted that the USA may do away with the concept of operating leases. John Hughes loves operating leases - they appeal to his conservative nature, and align EBIT more with cash flow. The nebulous nature of the rules here allow him to account for these things the way TGA does.

That is that matter done to death. The next thing that interests me is a REASONED guesstimate of what the EPS is going to be in future. I think cautious John is being coy, and saying little that is numerically substantial. I'll see what I can glean from the annual reports on this.

Will exit TGA today.
This is not going on with it and showing lack of demand.
Better prospects around from a short term technical view.

tech/a said:

Will exit TGA today.
This is not going on with it and showing lack of demand.
Better prospects around from a short term technical view.

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Tech, just out of curiousity, what % of your trades turn out favourably?
(I don't mean anything by this, just curious)

Varies dramatically with the market.
With it currently bombing my win rate is less--its around 40% at the moment.
In a bull---ish market its in the 70 to 80%---discretionary trading.

But its not really about win rate to me its return in risk.

I really like to see a stock move immediately in the direction Im trading.
If it doesnt Ill move my mental stop up to meet the falling price---TGA Stalled so
I only waited a few days.

By keeping losses very small and often it will be at B/E (The loss) so its brokerage,
I can still have a good R/R.

That is about 2.6:1 at the moment.
Takes a bit to increase and decrease due to number of trades now completed.

Im happy to have a string of B/E or very small losses and a string (smaller) of winners punctuated through the months.

As it is for the fundamental guys its all about the numbers.
DIFFERENCE IS

Im constantly honing my numbers and not crunching someone elses.
I suppose "Technically" as in trading technically---I am! Stops risk and price action.
I can have through my trading determine MY numbers I cant on others.

tech/a said:

Varies dramatically with the market.
With it currently bombing my win rate is less--its around 40% at the moment.
In a bull---ish market its in the 70 to 80%---discretionary trading.

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In current conditions, I would've thought 40% is quite good.

Thanks for the info.

Klogg said:

In current conditions, I would've thought 40% is quite good.

Thanks for the info.

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Just to possibly help you see where Im coming from
Risk is normally very tight.
on TGA 4c.
Trades above 2R return are a lot less than those under ---not sure of figures.
Losses of 1R are rare (Less than 50%) as I normally come up to meet a falling
stock off an initial buy.

What is terribly low are those 5+R trades
That would be 20c in TGA's case.

Pioupiou said:

. . . BLAH BLAH . . .

On the EPS growth trajectory, I am more bullish than the analysts, and for now I am using 8% for YE 30/03/2013 and 10% for YE 30/03/2014. I'll come back to this in another post.

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I spent a few hours today writing the tail end of a 20-page report I have written on TGA for myself, and it has not changed my view on EPS growth - see above. I have so much riding on TGA that I cannot afford not spending a great deal of time thinking about it, and putting things in writing is a great way to order the mind. The stuff below postulating EPS growth is verbose, but I am not inclined to invest time in shortening it for the benefit of those whose formative years post date the introduction of instant coffee.

Thorn's management tends not to broadcast what they expect to happen in future, even though normal budgeting gives them an accurate picture of the current year's financial performance, because of the recurring nature of Thorn's revenue and the statistical predictability of its customer base. Thorn is onto a good thing, and it prefers to keep as silent about that as possible, which gives rise to the following words in its annual report:

“Further information about likely developments in the operations of the consolidated entity and the expected results of those operations in future financial years has not been included in this report because disclosure of the information would be likely to result in unreasonable prejudice to the consolidated entity.”

In the recent presentation slides you can see below the dichotomy of wanting to extol Thorn's strengths and expected progress with words like “solid”, “strong”, “increased contribution”, gaining traction”, “resilient”, and then downplaying the outlook:

Group
- Strong core business with substantial recurring revenue streams generating significant operating cash
- Solid capital base to enable expansion & healthy ROCE
- Growth initiatives gaining traction and well positioned for increased contribution
By Division
- Resilient rental business with further opportunities to grow
- Continue to evolve and expand Cashfirst offerings
- Emergence of Thorn Equipment Finance as a key segment
- Solid growth of NCML through new initiatives in business development
Outlook:
- Market factors may slow growth rate
- Continued investment in strategic initiatives will impact short term – but generate longer term rewards

However, being human, management cannot suppress their exuberance and pride, so one can read a great deal into the presentation at http://www.brrmedia.com/event/98189...arshall-general-manager-radio-rentals--rentlo

As was the case for YE 30/03/2012, the growth in profitability will spring from operation leases. This is where Radio Rentals/Rentlo is doing well, particularly with furniture. This is where I have focused my attention in my attempt to guess what might happen to TGA's EPS in YE 30/03/2013. I assume the other business on balance remains static – contributing the same cents to the EPS. The expected slight (“slightly” is the word used in the EOY presentation) decline in the contribution of financial leases to profit should be covered by other units improving. The direct importation of TVs has to a degree mitigated the decline in those profits by $800K. I assume NCML will recover the loss of the ATO's business ($400 to EBITDA), and toss a bit in to assist covering the decline in finance lease business. I do not know the appropriate number to use, to adjust for the higher interest in YE 30/03.2012 that will not be repeated - I used $800K.

In respect to operating leases, revenue and profit recognition occurs as customers pay, so there is contractually committed revenue at the start of each year, and then NEW business. I have attempted to calculate the NEW business values for YE 30/03/2012 and YE 30/03/2011, and then extrapolated that growth to YE 30/03/2013. To this end I have added the estimated committed payments streams for YE 30/03/2013., and I arrive at the revenue figures below.

I have assumed that the ratio of expenses to revenue will remain static, except for an estimated $800K in interest paid. I know that Thorn has slimmed its head office count since it merged NCML into its business, but I have assumed this can fund expenses like appointing a GM to manage the loans business centred around Cashfirst.

The figures below are a mixture of extractions from the YE 30/03/2011 and 30/03/2012 financial reports, and extrapolations thereof.

The future minimum lease payments under non-cancellable operating leases are as follows:

- - - - - - - - - - - - - - - - - - - - - -- 2012 - - -- 2011 - - - 2010
Less than one year to expiry - - - 36,091 - - 30,161 - - 27,124
Between one and five years - - - - 9,205 - - - 6,628 - - - 5,897

I'll assume that expiry dates are spread fairly evenly through the year, so in the following year 50% of the value listed flows in as lease payments. For older leases, I'll assume that they are evenly spread over four years and so 25% will flow in as lease payments. This gives:

- - - - - - - - - - - - - - - - - - - - - - - - - - 2013 - - - - - 2012 - - - - - 2011
Carry-over expiring lease revenue - - - 18,045 - - - - 15,080 - - - - 13,562
Carry-over longer lease revenue - - - - - 2,103 - - -- - 1,657 - - - - - 1,474

Total operational lease revenue - -- - 106,864 - - - - 93,562 - - - - 83,098

New operational lease revenue - - - - - 86,716 - - - - 76,825 - - - - 68,062

Other Revenue - - - - - - - - - - - - - - - 94,789 - - - - 94,789 (both years are the same)

Total Revenue- - - - - - - - - - - - - - - 201,653 - - - - 188,351

Costs/expenses- - - - - - - - - - - - - - 159,059 - - - - 148,567
Adjust for interest paid - - - - - - - - - - - (800)

Gross profit - - - - - - - - - - - - - - - - - 43,394 - - - - - 39,784

Tax - - - - - - - - - - - - - - - - - - - - - - 13,018 - - - - - 11,935

Net Profit - - - - - - - - - - - - - - - - - - 30,376 - - - - - 27,849 (9.07% incr of net profit)

The percentage increase in net profit is sensitive – simply altering provisions, or hiring or culling a few people can alter it by one or two percentage points. My original hunch was that it could lie between 8% and 12%, and so for convenience I invented EPS growth of 8% for 2013, 10% for 2014 and 12% for 2015. I'll stick with that, and alter them with each half-year announcement.

For now, my actual diluted EPS metrics until 2012 and guesstimated ones thereafter are:

2007 - - 2008 - - 2009 - - 2010 - - 2011 - -- 2012 - - 2013est - 2014est - 2015 est
5.1c - - 8.3c - - - 9.4c - - 14.9c - - 16.7c - -- 19.0c - - 20.5c - - - 22.6c - -- 25.3c
- - - - 62.75% - 13.25% - 58.51% - 12.08% - 13.77% - 8.00% - 10.00% - 12.00%

Accounting for things like provisions is fairly arbitrary, and TGA's accounting is so conservative, so if 2014 and a year or so thereafter look exceptionally good, then YE 30/03/2013 could easily be made to be 10% or more without raising a questioning eyebrow, because Thorn admits there is over provisioning. Deciding to amortise NCML's customer relationships over 5 years rather than 7 is an example of arbitrariness.

So_Cynical said:

On the subject of TGA it annoys the hell out of me that such a mediocre stock receives so much attention.

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5 weeks and like 15 pages later...TGA is still a mediocre stock and im still amazed at the interest...what is it with the value brigade?...seriously WTF!

:dunno: