Rex Shettlewood, Guest Writer
Dehring, Bunting and Golding, in which Scotiabank now has a 68 per cent controlling interest, is to absorb the operations of the smaller Scotia investments. - File
The latest financial results of Dehring, Bunting & Golding (DB&G) reflects relative stability in earnings despite showing a year-on-year decline in net profits.
Despite this, the stock price has retreated 33 per cent since the start of the year, closing at $18.74 on May 17, not reflecting fundamental valuations of the firm and its future prospects for growth.
DB&G reported net profits of $702.96 million at its year-end to March 31, 2007, a 20.3 per cent decline on the $881.32 million in 2006, attributed mostly to a decline in gains recognised from securities trading of $332.56 million.
This occurred as the company took the decision in 2006 to transfer assets from the 'held-to-maturity' investment category of its balance sheet to the available-for-sale category, unlocking value over the year of $221.1 million and being fully reflected on the profit and loss accounts.
Other revenue streams performed admirably given the state of the current market environment. Net interest income increased by some 10.5 per cent or $81 million despite falling interest rates.
The firm's loan portfolio was seen to have experienced a 38 per cent growth over the previous year to now total $3.7 billion,and foreign exchange gains increased by 55 per cent or $69 million.
Fees and other incomes declined, however, by 14 per cent or $32 million.
"The results should be taken in the context of some extraordinary gains which were recognised in 2006 and which did not reoccur in 2007," DB&G's outgoing chief executive, Peter Bunting, commented in a media release issued with the audited year-end results.
"Further, if the increase in investment revaluation reserve is taken into account, then the total return to shareholders would equate to $1,017 million or an approximately 29 per cent return on the equity position at the start of the fiscal year. This is a very solid performance."
DB&G, based on its core earnings history over the past eight quarters, has seemingly sought to maintain value to shareholders, not only via stable dividends but also through the unlocking of profits via the sale of assets.
By year-end 2006, the company had released from its balance sheet more than $200 million in value, and yet was able to amass $737.4 million in reserves at the close of the year, up from a mere $106.6 million at the end of the first quarter.
For the current year in review, despite a weak stock market performance, DB&G was able to recognise significant growth in fair value, possibly due to growth in value of bonds held.
As at financial year-end, the company reported an investment revaluation reserve of $1.051 billion, having closed the first quarter at $444.8 million.
total year-end earnings
If a mere $200 million were to be transferred to the held-for-trading category and profits booked, this would have unlocked an additional 65 cents in earnings, to bring the total yearend earnings per share for DB&G to $2.92, and reveal added value in the firm for common shareholders, as seen when applying a forward PE multiple of 8x justifying a fundamental price of $23.35.
It is quite justifiable however to
now assume a more aggressive multiple of 10x given the formalised acquisition by Scotiabank and the pending acquisition by DB&G of Scotia Jamaica Investment Limited (SJIM).
At the higher multiple, a fundamental price of $29.20 is realised, a 56 per cent premium when compared to the current discounted market price.
The market is left to ponder why
the sudden change in investment strategy of the firm, sterilising a large profit source for DB&G, and whether this is a paradigm shift in investment style or merely a short term strategy being utilised to unlock greater returns to the group at a later date.
What does the SJIM acquisition mean for DB&G? Of key significance when evaluating the immediate impact and future implications of the acquisition are: SJIM's current valuation, its historic and current performance, asset base and room for more efficient utilisation
Based on the circular explaining the proposed acquisition of Scotia Jamaica Investment Management Limited, SJIM has been valued by independent auditors at $2.747 billion.
Some 113,936,126 DB&G shares will be exchanged for SJIM at a price of $24.11 each. The exchange price, reflects the six month average cost price of DB&G's stock units on the Jamaica Stock Exchange during the period ending March 31, 2007.
Item 4 of the circular further states that: "The additional shares to be issued to BNSJ will result in Scotia Group's direct and indirect percentage shareholding in DBG increasing from 68.54 per cent to 77.01 per cent.
Although the minority shareholding in DB&G will correspondingly be reduced from 31.46 per cent to 22.99 per cent, the acquired value of SJIM in DB&G ensures that the value per DB&G share is not diluted by the proposed transaction.
It is also expected that the synergies expected from the acquisition and amalgamation will result in increased DB&G shareholder value, and that the value of the stock will increase as a result of the transaction.
In December 2006, BNS finalised it's acquisition of 68.54 per cent of DBG shares at a disputed price of $21.08.
The current price of $24.11 translates roughly to a price/earnings multiple of approximately 12 for the additional share units being used in the transfer, with an estimated book value of $21, assuming that SJIM earns net profits of about $224 million this year.
Quite a deal, some may say. However, is there more to the story than meets the eye? Are these levels of earnings possible and why would Scotiabank pay a premium?
Instructively, using rough calculations, SJIM contributed about $233 million in after tax profits to Scotiabank's bottom line as at yearend 2006.
With the reported first quarter financials for SJIM indicating a 54 per cent increase in net profits, it seems safe to assume that the new drive to increase productivity of the segment should see even higher profits in 2007, moreso under the direct management of DB&G. Further, 77.01 per cent of all profits will accrue to Scotia Group on finalising the acquisition.
As at January 31, 2007, SJIM is reported to have total assets of $19.6 billion, the majority of which is in BOJ/GOJ securities. Also, SJIM has approximately $47.6 billion in funds under management, of which $18 billion is on balance sheet repurchase agreements while $29.6 billion represents assets held in trust and pension funds managed by SJIM.
Investors holding DB&G shares should be comforted by these developments, as well as the following.
Taking the above factors under consideration, assuming flat returns for DB&G in 2007 and the unlocking of gains in the revaluation reserves totalling at least $200 million and with the inclusion of an approximate $250 million in net profits via SJIM in the first year, DB&G could easily attain earnings of 280.76 cents using fully diluted shareholdings of 423.195 million units. Applying a forward PE multiple of 10X places the stock easily at $28.76, a 46 per cent premium at the close of trade on May 17.
With projections like these, it leaves little to question the statement made by the Board of DB&G, that the acquisition of SJIM would result in DB&G becoming a significantly larger entity with the ability to leverage greater economies of scale and compete more aggressively in the wealth management arena.
Still to be answered is whether DB&G will remain a publicly listed company, and whether BNS will opt later to de-list DB&G and issue preference shares, or choose to swap DB&G shares for additional shares of Scotia Group Jamaica.
Rex Shettlewood is research manager at Mayberry Investments Limited. Email: rex.shettlewood@mayberryinv.com
