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Treasure Chest: Upside On Offer For AFG

Treasure Chest | Sep 22 2021


FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. Mortgage business Australian Finance Group is holding plenty of cash, which if used to acquire greater distribution could result in substantial share price upside, Morgans believes.

-Plenty of cash on the Australian Finance Group balance sheet at end-FY21
-Mortgage activity remains elevated despite new lockdowns
-Acquired distribution could translate into a substantial valuation lift

By Greg Peel

Australian Finance Group ((AFG)) operates a mortgage broking business in Australia in two segments: AFG Wholesale and AFG Home Loans. The company is involved in mortgage origination and management of home and commercial loans and distribution of own-branded home loan products. It also offers SME business loans for a wide range of operational requirements.

AFG Securities is the company’s in-house lending division.

The stock is covered by three brokers in the FNArena database who each maintained their Buy or equivalent ratings on the stock in the wake of AFG’s full-year earnings report released in August.

At the release, management noted AFG Securities enjoyed an 80% increase in lodgements in the second half to June FY21 from the second half FY20, bearing in mind last year was impacted by the initial national lockdown. Yet, despite renewed lockdowns, management also noted activity had remained elevated in early FY22.

Morgans (Add) is forecasting 104% growth in settlements for the AFGS business from FY21 to FY22. Citi (Buy) expects the lockdowns to weigh in the first half FY22 before settlements rebound in the second half.

Citi believes strong competition will continue in the mortgage market but lower funding costs can offset in FY22, and a subtle mix-shift will help manage net interest margins. AFG plans to shift its focus towards near-prime (prime being highest quality) loans and SMSF loans.

Macquarie (Outperform) suggests valuation is supported by net cash and trailing receivables. And that’s where the story gets more interesting.


Morgans estimates that net of working capital requirements, AFG was holding $67m of unrestricted cash on its balance sheet at FY21 year-end. This equates to 25c per share and is included in the broker’s $3.40 target price. The broker believes this cash could be put to good use, in increasing AFG’s distribution.

In 2019, AFG moved to acquire mortgage aggregator Connective Group for just that purpose. While the ACCC had no issue, the deal had to be approved by the court before end-August this year.

It wasn’t. It wasn’t rejected, the court just never got around to it. With the deal no longer likely to proceed, Morgans expects AFG will now be looking around for another opportunity.

Morgans believes $67m can buy more than a 5% increase in profit before any revenue or cost synergies. In terms of revenue synergies, the broker suggests $67m can buy AFG increase in total residential settlements in the order of 50%. Assuming AFGS’ percentage share of total AFG residential settlements remains unchanged, this can ultimately result in a 50% increase in AFGS net interest income with all else constant.

Morgans believes such an increase in net interest income on its own can result in a 25% increase in AFG’s group profit. Add in cost synergies and that number could potentially be 35%.

Crunching those numbers implies to Morgans a potential valuation increase to in excess of $4.25 per share (last trade $2.77).

For now, the broker is not changing its forecasts, and retains a $3.40 target.

Macquarie’s current target is $3.18, while Citi has $3.60.

Increased distribution implies increased credit risk, in what remains a plague-ridden environment which could yet threaten the mortgage market, but APRA has shown during the pandemic that it can provide capital and regulatory reporting exemptions to banks which flow through to non-bank lenders by way of loan deferrals not being treated as 90-day arrears.

In other words, notes Morgans, it can therefore be argued that the funding risks associated with the AFGS business have now reduced assuming that the federal government has the fiscal capacity and willingness to provide support to non-bank lenders during times of crisis going forward.

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