ARV - Arvida Group

[Basil]

Looking into this a bit deeper - Much of ARV's lending is floating and is based on the Bank Bill rate + a margin + separate line fees, (2022 half year report).
From that report funding costs ranged, up to 4.5%.
Have a look at this graph representing what's happened to the inter bank bill rate since 30 September. 
https://www.interest.co.nz/charts/interest-rates/bank-bill-rates
That's a scary looking chart for companies funding their operations using floating rate debt.

From the bank facility update the other day we know bank lending as at 31/03/2023 is $500m and $220m of that is hedged at 2.8%, (they didn't disclose for how long). By simple deduction therefore, $280m is unhedged. 
Looking at that graph, in FY22, for the vast majority of the year the bank bill rate was less than 1%. whereas the current spot rate is 5.5%, a whopping 4.5% more!

I estimate bank funding costs for FY24 will be a headwind of circa $280m of unhedged debt x 4.5% higher rate = $12.6m more than FY22 solely due to interest rate increases.
In addition, based on total debt as at 31 March 2023, $500m + $125m bonds = $625m compared to average debt in FY22 of $408m, (average of opening and closing external debt from balance sheet), if debt stays the same on average in FY24 as the opening balance they will be carrying ~ $220m more debt on average this year relative to FY22..  This would appear to be a mixture of bonds $125m raised at 2.87% and bank funding which I presume is the hedged amount at 2.8% so I assume the extra $220m debt being carried on the balance sheet has an average cost of 2.84% = annual extra of $220m x 2.84% = $6.25m

Extra debt burden funding costs of $6.25m + higher interest rates (assuming bank bill rate stays where it currently is for the whole year of $12.6m = $18.85m funding cost headwinds in FY24.  That's 2.6 cps estimated impact on earnings.  In addition, I can see from the investor news that while resale margins are strong, new sale margins are not and that's a trend I expect to see continue in FY24 which much higher construction costs impacting the development margin further. One broker forecast I saw for eps in FY24 yesterday, was 11.7 cps.  I think that's very optimistic.
I'm only doing this analysis because I have a lot of the bonds.  I think they can probably reasonably comfortably meet their new debt service covenants, but I totally get why they have wound back their development program a lot as they should.

One of the key strengths of ARV is due to the age of the villages after the Arena acquisition, (for example the Peninsula Club was N.Z.'s first ever retirement village, originally a timeshare village back in the day when that was popular), there is substantial embedded value (E.V.) in the shares of $1.34 per share as at the half year.  EV is the difference between current unit prices and what is repayable to exiting residents after deferred DMF fees are withheld when they leave the unit. If the average churn, (please excuse the expression but that's what it is), is every 10 years ARV can release about one tenth of that EV every year, approx 13.4 cps simply by running their villages, enjoying natural churn and doing no new developments.

The fact that they look set to earn a lot less eps in FY24 doesn't say much for the value of their development program with the lowest development margins in the sector or the operational losses from running the villages and head office costs overhead recovery.

I think the two key reasons the shares have the deepest discount to NTA in the sector are, the extensive use of unhedged floating rate funding and their weakest development margins in the sector.   

If the board, in due course can't see the merits of buying their own shares back at ~ half price as compared to buying excess land in Warkworth at full price, I'd have to conclude that their inappropriate non-shareholder centric focus will remain a serious handbrake on the company going forward.
Conclusion:  There are some very good reasons the shares are cheap, somewhat different reasons in some ways to OCA but good reasons, nonetheless.

I think provided people are extremely patient they should do okay in the long run with the shares at under $1 but I do note the bonds have a higher yield to maturity at 7.2% with good supply in the market at that level, than the shares at 5.6%.  Each to their own, I prefer the bonds at this level.
External interest bearing debt of $625m, including bonds as at 31/03/2023 looks okay to me compared to $3.6 Billion of assets reported (as at 30/09/2022)

[winner (n)]

Agree with you Basil in 'There are some very good reasons the shares are cheap'

Dig deeper and I fear more gremlins will come out

Maybe without Forbar cheerleading them the share price would be even lower than it is.

[Shareguy]

Looking into this a bit deeper - Much of ARV's lending is floating and is based on the Bank Bill rate + a margin + separate line fees, (2022 half year report).
From that report funding costs ranged, up to 4.5%.
Have a look at this graph representing what's happened to the inter bank bill rate since 30 September. 
https://www.interest.co.nz/charts/interest-rates/bank-bill-rates
That's a scary looking chart for companies funding their operations using floating rate debt.

From the bank facility update the other day we know bank lending as at 31/03/2023 is $500m and $220m of that is hedged at 2.8%, (they didn't disclose for how long). By simple deduction therefore, $280m is unhedged. 
Looking at that graph, in FY22, for the vast majority of the year the bank bill rate was less than 1%. whereas the current spot rate is 5.5%, a whopping 4.5% more!

I estimate bank funding costs for FY24 will be a headwind of circa $280m of unhedged debt x 4.5% higher rate = $12.6m more than FY22 solely due to interest rate increases.
In addition, based on total debt as at 31 March 2023, $500m + $125m bonds = $625m compared to average debt in FY22 of $408m, (average of opening and closing external debt from balance sheet), if debt stays the same on average in FY24 as the opening balance they will be carrying ~ $220m more debt on average this year relative to FY22..  This would appear to be a mixture of bonds $125m raised at 2.87% and bank funding which I presume is the hedged amount at 2.8% so I assume the extra $220m debt being carried on the balance sheet has an average cost of 2.84% = annual extra of $220m x 2.84% = $6.25m

Extra debt burden funding costs of $6.25m + higher interest rates (assuming bank bill rate stays where it currently is for the whole year of $12.6m = $18.85m funding cost headwinds in FY24.  That's 2.6 cps estimated impact on earnings.  In addition, I can see from the investor news that while resale margins are strong, new sale margins are not and that's a trend I expect to see continue in FY24 which much higher construction costs impacting the development margin further. One broker forecast I saw for eps in FY24 yesterday, was 11.7 cps.  I think that's very optimistic.
I'm only doing this analysis because I have a lot of the bonds.  I think they can probably reasonably comfortably meet their new debt service covenants, but I totally get why they have wound back their development program a lot as they should.

One of the key strengths of ARV is due to the age of the villages after the Arena acquisition, (for example the Peninsula Club was N.Z.'s first ever retirement village, originally a timeshare village back in the day when that was popular), there is substantial embedded value (E.V.) in the shares of $1.34 per share as at the half year.  EV is the difference between current unit prices and what is repayable to exiting residents after deferred DMF fees are withheld when they leave the unit. If the average churn, (please excuse the expression but that's what it is), is every 10 years ARV can release about one tenth of that EV every year, approx 13.4 cps simply by running their villages, enjoying natural churn and doing no new developments.

The fact that they look set to earn a lot less eps in FY24 doesn't say much for the value of their development program with the lowest development margins in the sector or the operational losses from running the villages and head office costs overhead recovery.

I think the two key reasons the shares have the deepest discount to NTA in the sector are, the extensive use of unhedged floating rate funding and their weakest development margins in the sector.   

If the board, in due course can't see the merits of buying their own shares back at ~ half price as compared to buying excess land in Warkworth at full price, I'd have to conclude that their inappropriate non-shareholder centric focus will remain a serious handbrake on the company going forward.
Conclusion:  There are some very good reasons the shares are cheap, somewhat different reasons in some ways to OCA but good reasons, nonetheless.

I think provided people are extremely patient they should do okay in the long run with the shares at under $1 but I do note the bonds have a higher yield to maturity at 7.2% with good supply in the market at that level, than the shares at 5.6%.  Each to their own, I prefer the bonds at this level.
External interest bearing debt of $625m, including bonds as at 31/03/2023 looks okay to me compared to $3.6 Billion of assets reported (as at 30/09/2022)

Great post Basil. You could be on the money here.

[Hectorplains]

That's an interesting and considered write up, Basil.  Appreciate your insights. 

Not that it matters but... I think Selwyn might have pipped Peninsula to the post in 1953 with NZ's first village title.

[winner (n)]

Jeez $625m debt at March ...that's about $170m more than a year ago .....and they  keen to borrow more

If $625m ar March debt ratio over 30% and getting up RYM levels

[Basil]

Thanks for your kind words guys.
Its actually a bit worse than what I posted because their hedged funding of $220m @ 2.8% is a rate that's subject to "plus margin and line fees", (which are not separately disclosed being commercially sensitive), but as a best guess I would expect their hedged rate funding to be costing them a bit north of 4% all inclusive. The thing is when this hedging finishes, whenever that is, they'll be exposed to ~ $500m of debt that's potentially costing them somewhere around 7% with the bank bill rate at 5.5% + margin and line fees so they really need to get on top of this.

Obviously they will be hoping that the bank bill rate has already peaked and will soon be coming down a lot and they could be right because the way Adrianne Orr of RBNZ is taking such an incredibly hawkish approach, we're probably headed into a serious recession and he'll probably need to be cutting interest rates sooner rather than later.

Good old not for profit Selwyn, been around since the 1950's as you say mate.  My late Mum worked there for many years in the 1960's and told me they do some fabulous work.  She used to tell me about the tremendous loneliness a lot of old people feel.  I see the Selwyn Foundation part fund 40 drop-in centers for people over 65.  WOW, that's awesome!  https://www.selwynfoundation.org.nz/charity/  I see there's a way to leave them some money in one's will.
Bit more about the extent of and seriousness of the degree of loneliness for some older folks here https://www.selwynfoundation.org.nz/charity/social-isolation-loneliness/

[winner (n)]

Hey Basil ... when you do your interest sums do you break it down into what's expensed (in P&L) and what's capitalised (added to investments)

Seems the split is about 50/50

I assume the capitalised portion does impact current profits but in due course reduces the gains on sales made

[Basil]

Yeah I just commented to Shareguy by PM that I expect a lot of this interest to be capitalized as part of the normal accounting rules for new developments, so we won't see quite a bit of it in the P&L.  Its hard to know how much as they don't disclose the purchase price of the recent blocks of land acquired.  I haven't done any work on the split.  Yes quite right, the capitalized interest costs will impact development margin going forward...another material headwind to new village development costs.  Who knows though, maybe they think they can use some of that Paddison farm and flick the bulk of it off and get most of their money back ?  https://www.bayleys.co.nz/1270562
https://www.localmatters.co.nz/business/land-next-to-golf-club-looks-set-for-senior-living-village/

To be fair, they did more than okay flicking-off excess land from Waikani recently, (subsequent events interim accounts sale of Waikani land ~ $24m November 2022).  Maybe they repeat that and do well or maybe they get egg on their face this time...only time will tell but there's no question the holding costs are very high at this point in time, much higher than they have ever experienced before.

Also being fair about it, the Paddison farm site does look like a good one with easy access to Auckland down the new bypass set to open later this year.  I can see the attraction for people wanting ready access to the East coast beaches up there for their recreational activities in their retirement while still wanting to retain easy access to Auckland.
 
 

[winner (n)]

Tomorrows the day ARV share price will break through the 100 mark

Cool stuff eh

[winner (n)]

Tomorrows the day ARV share price will break through the 100 mark

Cool stuff eh

Don't fret. ...we'll get there ...today

[Red Baron]

Good old not for profit Selwyn, been around since the 1950's as you say mate.  My late Mum worked there for many years in the 1960's and told me they do some fabulous work.  She used to tell me about the tremendous loneliness a lot of old people feel.  I see the Selwyn Foundation part fund 40 drop-in centers for people over 65.  WOW, that's awesome!  https://www.selwynfoundation.org.nz/charity/  I see there's a way to leave them some money in one's will.
Bit more about the extent of and seriousness of the degree of loneliness for some older folks here https://www.selwynfoundation.org.nz/charity/social-isolation-loneliness/

The Selvyn voundation is better vunded now.    Due to half of its villages being sold to Metlifecare!  Old news I know (01-03-2022), but maybe not everybody does?

https://www.selwynfoundation.org.nz/careers/about-us/news/successful-sale-equips-the-selwyn-foundation-for-major-philanthropy/

RB

[BlackPeter]

Don't fret. ...we'll get there ...today

You are selling at $1, are you?

Anyway - you well might be right ... however, the much more interesting question is - will it go up to something like $1.04 just to bounce back into the so far unbroken downward channel ... or will it break out?

What trigger would you see for a potential break out?

[Arbroath]

I'd say the pivot level is $1.10. Should be sellers 1.08-1.10 after the dip under $1.00

[Basil]

Tomorrows the day ARV share price will break through the 100 mark

Cool stuff eh

Pretty cool you picked that correctly 

[Shareguy]

Further to Basils post(210) I asked the ceo Jeremy for some clarification.

Jeremy's response as follows

Thanks for your email – I will try my best to answer your queries, however during the period between balance date and release of our year end results comments are limited to publicly available information.

 

Last week's announcement to NZX indicated drawn bank debt was $500m and bonds were $125m. Around 35% of drawn debt is hedged. The increased level of debt from FY22 mainly relates to development work in progress and therefore associated interest will be capitalised rather than expensed.

 

As noted in half year reporting and the Investor Newsletter, FY23 deliveries had been pushed into the 4th quarter as a result of an accumulation of delays through Covid and this year's very wet summer. That means at balance date we were carrying a higher level of work in progress and inventory than in FY22. During FY24, the expectation would be that that inventory is sold down reducing debt. We have also updated our delivery guidance for FY24 to a lower delivery target. This should also work to manage working capital levels.

 

An update on interest costs and hedging tenure will be provided in annual reporting.

 

In terms of new sales, we haven't provided guidance on 2H margins or gains. This is because an allocation of development costs needs to occur before those calculations can be made and we can report the results. We have only provided guidance on margins and gains for resales – which as you note, have improved on prior years.

 

Embedded value provides an indication of future cash flows from the current portfolio at the current prices (with changes from new units added or units sold or unit pricing). The Arena portfolio had significant embedded value relative to our existing portfolio. The realisation of that embedded value has helped to increase the resale margin experience being reported since completing the acquisition. The average tenure of villas is around 8-9 years. The average tenure of apartments, serviced apartments and care suites is broadly less. Again the mix of units resold impacts on the amount of embedded value released annually (embedded value between units can vary significantly too).

 

As noted in the Newsletter and reportings since 2020, we have had 3 years of Covid. Over this period very little sector support as been provided to assist with the additional costs incurred. We have also had to absorb government policy that underfunds aged care and has disrupted the care workforce (in addition to many other revenue and cost headwinds). This has not been a period of normal operation. And as highlighted in the Newsletter, we are moving into a more normalised period but expect care performance to continue to be challenged. The outturn from this is a lower care composition going forward.

 

One final point, development margins are best compared against prior years. Comparison of development margins between operators can be misleading unless you make adjustments to align the different calculations. As highlighted in the recent Summerset reporting, they are achieving similar project margins but reporting much higher development margins. An explanation would be a different methodology applied in calculation between the two operators