TGA - Thorn Group

[Klogg]

I know there's been some time spent on this already, so I'm sorry to re-visit, but I'm having trouble understanding one thing:

On page 41 of the annual report (at the bottom) it states:
"Finance lease receivables are recognised at the present value of the minimum lease payments less impairment losses. The present value is calculated by discounting the minimum lease payments due, at the interest rate implicit in the lease."

So first, they provision what they deem suitable.
Then, the amount expected to receive in each year by the interest rate implied in the finance lease.

So, using some solid numbers:
If the repayment in the 2 years time (e.g. FY18) totaled $600 and the interest rate on the lease is 25%, this is discounted to get the net present value, being $384 (600/(1.25^2))

Ignoring the effect of the year 1 repayment - does this mean that the book value of the loan will increase by 25% when we hit the next financial year? By this I mean, will the book value of the loan then increase because we're only discounting for 1 year, rather than two?
(i.e. it becomes 600/1.25 = $480)

I thought it was just recognized as interest revenue in the year it was received, rather than increasing the value of the book every year...


EDIT: I'm assuming this relates to the "Unearned Income" on finance leases.

 

[Ves]

So, using some solid numbers:
If the repayment in the 2 years time (e.g. FY18) totaled $600 and the interest rate on the lease is 25%, this is discounted to get the net present value, being $384 (600/(1.25^2))

Ignoring the effect of the year 1 repayment - does this mean that the book value of the loan will increase by 25% when we hit the next financial year? By this I mean, will the book value of the loan then increase because we're only discounting for 1 year, rather than two?
(i.e. it becomes 600/1.25 = $480)

What do you mean by ignoring the effect of the repayment?

Unless I'm misunderstanding you, the client's repayment amount is exactly what cancels out the discounting effect at the end of year.

Ie. the client pays and the balance sheet item is reduced. Some also goes to P & L to account for the interest earned for the period.

It sounds like the Australian Accounting Standards require companies to discount the finance leases to NPV using the implied interest rate so that they only show the amount of what is basically equivalent to the principle owing.

So the amount is on the balance sheet at the inception of a finance lease would be equal to the cost of the asset less whatever probability for impairment they come up with.

And yes, as you pointed out in your edit, the difference between the actual amount receivable, and the discounting, is the unearned income shown in note 5.

 

[Klogg]

What do you mean by ignoring the effect of the repayment?

Sorry, I worded myself badly. I mean that if we focus on the book value of the year 2 amount owed in the finance lease.

Unless I'm misunderstanding you, the client's repayment amount is exactly what cancels out the discounting effect at the end of year.

This part I get. But if I'm discounting over a number of years (e.g. a four year lease), does that mean as it moves from a four year to a three year lease, I increase the book value as the discounted portion is worth more because the time-frame changes? (adjusting, of course, for the part that has already been paid)
Or does this just increase the Unearned Income line item?


And thanks for your help - I feel like I'm confusing myself sometimes... so what hope can anyone else have of understanding what I post, lol.

 

[Ves]

This part I get. But if I'm discounting over a number of years (e.g. a four year lease), does that mean as it moves from a four year to a three year lease, I increase the book value as the discounted portion is worth more because the time-frame changes? (adjusting, of course, for the part that has already been paid)
Or does this just increase the Unearned Income line item?

At the start of the lease, let's call it year 0, the total outstanding amount is $600. Let's ignore the impairment to keep it simple.

Only $384 will be shown as the NPV on the balance sheet, because $216 is unearned interest income.

At the end of year 1 the client will have paid $300.

What effectively happens $144 of this will be taken off the balance sheet as a principal payment. A further $156 will go to the P & L as interest revenue (which at the same time would reduce the $216 in unearned interest income to $60).

So at the end of year 1, $300 is sill to be received. $240 in principal (384 - 144) and $60 in interest (216 - 156)

In year 2, balance sheet is zero. Interest revenue on P & L is $60.

And thanks for your help - I feel like I'm confusing myself sometimes... so what hope can anyone else have of understanding what I post, lol.

No worries, it's a good refresher course for me. And I'm just as liable as most people to confusing myself at the best of times.

 

[Ves]

PS: I'm not a financial accountant. I haven't dealt with lease accounting in many years.

So if someone else is an expert, I'm willing to step aside, that's just my basic understanding.

 

[McLovin]

Does a loan amortisation schedule help you understand what's going on, Klogg?

The point of discounting is really just to match the interest to the repayment schedule, as the interest is only calculated on the remaining loan outstanding, not the initial principle.

 

[Ves]

Does a loan amortisation schedule help you understand what's going on, Klogg?

Thanks for that mate, I'm pretty sure my interest calculations aren't exactly right, but hopefully between the schedule and my explanation Klogg can see what's happening.

 

[Klogg]

Does a loan amortisation schedule help you understand what's going on, Klogg?

The point of discounting is really just to match the interest to the repayment schedule, as the interest is only calculated on the remaining loan outstanding, not the initial principle.

Between Ves' explanation and the amortisation schedule I get it now. Thanks, much appreciated

(Funny part is, I initially thought about it this way, then read the footnote and confused myself...)

 

[Klogg]

Interesting set of HY numbers.

First, the ASIC Investigation:

The ASIC investigation goes on, with an additional amount of $8.3m in prepayments being refunded (0.3m of interest, so time held must be very short)

TGA ancitipates a fine, but no provision. As a comparison, I checked out the CCV fine:

The Company has offered, and ASIC has accepted, an Enforceable Undertaking (EU) in relation to the
matters investigated. In accordance with the EU, the Company will remediate certain customers who
applied for and were granted small amount credit contracts via the Cash Converters website in the
period 1 July 2013 to 1 June 2016. The total amount of remediation is $10.8 million. The Company has
also agreed to pay related infringement notices in the amount of $1.35 million. The Company has been
given an extensive release by ASIC, and entry into the EU is without admission of wrongdoing. The EU
is available to be reviewed on a public register maintained by ASIC.

Based on this figure, 10% of total amounts would be a sensible estimate, and including the $8m in prepayments would likely be overly conservative, but add it in nevertheless.
Total would be:
- $8.3m for prepayments
- $3.1m for Henderson Poverty Index modifications
- $2.8m for closed accounts (?)

Total $14.2m.

Given all of this has been accounted for, the additional provision for a fine at 10% would be $1.42m... Not really a material amount, all things considered.


Second, the accounts:
It seems that the additional costs around the changes to loan origination and investigation are taking their toll through Employee costs and costs of providing finance leases. These two alone have increased more than the $4.1m decrease (more on this in a second) in Consumer Leasing impairment and D&A. The real question here is whether they're temporary or permanent - gut feeling tells me they're a bit of both, given they have technology processes ongoing to change origination processes.

The impairment in the Consumer Leasing book is also a little concerning. There is a $4m drop in impairments, whilst the delinquency rate is now at 8%... an increase on previous figures. I know they've had a lot of fat built into these impairments, but they've chopped it quite quickly. I guess that's the benefit of building it in in the first place.
(For the record, actual impairments in CL was $7.9m, impairments $7.1m. Perhaps they see impairments dropping as a result of longer contract lengths, but one would think longer duration means increased credit risk)

Finally on T&DF - it seems they've lost their path a bit. Not a huge impact, but a drop in the book here indicates they're a little unsure of the target customer.


Overall, I'll continue to hold as the above are mitigated by the price paid and overall returns once temporary matters are resolved. Of course, there's a risk that they go on longer than I anticipate, but that's a risk I need to account for I guess.

 

[craft]

The impairment in the Consumer Leasing book is also a little concerning. There is a $4m drop in impairments, whilst the delinquency rate is now at 8%... an increase on previous figures. I know they've had a lot of fat built into these impairments, but they've chopped it quite quickly. I guess that's the benefit of building it in in the first place.
(For the record, actual impairments in CL was $7.9m, impairments $7.1m. Perhaps they see impairments dropping as a result of longer contract lengths, but one would think longer duration means increased credit risk)

Hey Klogg

I'm suspecting they transferred the 3.1M provision for the HPI issue from the consumer leasing general provision, as its a subcomponent. Not sure where the 3.1 provision is on the balance sheet yet. In total it might not be as dramatic as first appearance??? Just guessing haven't had a chance to dig yet.

Lending standards are clearly being forced upwards by regulators so perhaps there's a justification for a small lowering of provisions on credit quality???? but I wouldn't think 4m

 

[Klogg]

Hey Klogg

I'm suspecting they transferred the 3.1M provision for the HPI issue from the consumer leasing general provision, as its a subcomponent. Not sure where the 3.1 provision is on the balance sheet yet. In total it might not be as dramatic as first appearance??? Just guessing haven't had a chance to dig yet.

Thanks craft. It seems the half year accounts don't provide that information (or am I overlooking it??). I can't find the bridging information from previous Net Receivables to current Net receivables (i.e. gross new loans and any provisions applied).

 

[oldblue]

No news since November but the continual slide in the shareprice doesn't bode well. Is it just an expectation of pending poor results or is there something more to this?

 

[InsvestoBoy]

I bought some TGA today, only my second non ETF/LIC investment ever! I know I'm taking a bit of a risk buying in while it's falling so heavily.

Is there any interest in this stock around here still? Some really interesting reading from the previous posts.

What attracted me is the "Business Update" section of the profit guidance they posted on the 21st. Seems like it's so hard these days to find a company investing for future growth, where most companies are returning capital via share buybacks or worse dividends funded by borrowing. So I really liked that.

Business update
Thorn Group is implementing several major new initiatives to drive its business performance.
These include an investment in the Radio Rentals store network with several stores relocating under the new RR format into popular high footfall shopping centre locations with exposure to larger consumer bases and higher demographics, the progressive establishment of metro location warehousing and distribution hubs to better service customers, the closure of a number of underperforming stores, and a restructuring program which has resulted in a reduction of 53 jobs.

Further, the Company has merged its Trade & Debtor Finance Division with the Equipment Finance Division to improve efficiencies and management control at a time when the Equipment Finance Division is experiencing strong organic growth requiring significant capital investment.

 

[Boggo]

The other half was was watching some very negative stuff on the idiot box after the news tonight about Radio Rentals interest rate practices. They had a lady on there who apparently was going to end up paying $3200 for a $1400 vacuum, not a good look for RR (TGA) when they were protesting outside parliament house using this as an example of the ripoffs !

 

[galumay]

I hold TGA but with my very clear hindsight I now realise its not the best business in the sector! Thinking about it I should really move the capital elsewhere!

I also hold CCP which is a much better business IMO.

 

[Tightwad]

i saw the tv report too, how many enquiries into this sector do we have to have.. i still hold too but i may sell some if one of my other buys hits a good price. until then the dividend is good.. til they cut it

 

[Klogg]

I hold TGA but with my very clear hindsight I now realise its not the best business in the sector! Thinking about it I should really move the capital elsewhere!

I also hold CCP which is a much better business IMO.

I would argue that since the SACC review, the interest rate caps have increased their competitive advantage. They have economies of scale and can afford to charge such low interest rates on leases, whereas other smaller players cannot (check submissions to the SACC review that just occurred).

Once the uncertainty around ASIC penalties is forgotten, this will be a business that is earning ~$27-28m NPAT, growing its lending books, has sufficient provisioning practices and fairly certain future cash flows.
It's not an amazing business because of the capital requirements, regulatory uncertainty and perception of the entire sector, but at the current price it's a bet with the odds strongly in my favour.

 

[galumay]

Always good to read a positive non-confirming opinion, Klogg!

 

[pinkboy]

The other half was was watching some very negative stuff on the idiot box after the news tonight about Radio Rentals interest rate practices. They had a lady on there who apparently was going to end up paying $3200 for a $1400 vacuum, not a good look for RR (TGA) when they were protesting outside parliament house using this as an example of the ripoffs !

While the example of the vacuum cleaner above is not a good look, it's an accepted practice by many.

Do people realise that if they take out a $300,000 home loan at 30yrs principle and interest at 7% (the long term average over the life of the loan), they pay back $418,000 in interest alone (140%).
Try it and see: https://www.commbank.com.au/digital/home-buying/calculator/home-loan-repayments

Take a look at the predatory practices by Wallet Wizzard (owned by CCP):
https://www.walletwizard.com.au/costs
48% interest rate.

Or what about Nimble.com.au (backed by Heritage):
https://nimble.com.au/faq/how-much-does-it-cost/
66% interest rate to borrow $2,500 over 2 years!

Very simple maths, with so many calculators available to the masses, yet people still fall victim to this practice through their own fault of no due diligence and desperation.

pinkboy

 

[craft]

The other half was was watching some very negative stuff on the idiot box after the news tonight about Radio Rentals interest rate practices. They had a lady on there who apparently was going to end up paying $3200 for a $1400 vacuum, not a good look for RR (TGA) when they were protesting outside parliament house using this as an example of the ripoffs !

Why oh why does somebody who financially needs to rent their domestic appliances think having a 1400-dollar vacuum in the first place is a good idea?


Trying not to make too many aspersions on what people buy and how they finance it – one thing is crystal clear – there is a market for the retail services TGA supplies.


Does TGA gouge? Well if they do I wish they did a better job of it because their return on equity is less than the banks. Unfortunately, if you have a low credit standing you get grouped with other low credit standing people and the major cost in providing financial services to you as a group is the fact that some won’t pay back the money.


Some people want to protect low credit worthy people from themselves – that inevitably means reducing financial services inclusion. Which just leaves going without or getting it given too you. As bad as the expense of being grouped in the low credit pool is, maybe it’s better than going without or relying on handouts – especially if you use the credit facility wisely and improve your credit standing to lower future credit costs.


There are undoubtedly rouges in the industry that don’t give two hoots about lifting their customers up just harvesting the high interest rates on low credit individuals and applying huge pressure to try and control their defaults. As long as TGA is not one of them, they should do O.K as the industry is endlessly tightened, but I doubt they’ll ever completely distance themselves from the stench of the industry which is what makes them cheap.


And I say cheap because I see them as pregnant with near term profit growth as the expanded asset receivable balance starts to mature. Mind you the earnings baby is starting to feel a bit overdue and the punters aren’t going to like the cut in dividend to fund the mismatch between investment in and cash flow from the expanded receivables base – especially with the industry stench around. So it might be down for a while but on my best guess future cash flow assumptions it already gives a decent probable return.

The real risk for TGA is they get their provisioning wrong and have actually been under-pricing product blowing away shareholders equity as future defaults actually unfold.