Western Australian property developer Finbar Group Limited (ASX: FRI) is forecasting a net profit of $25.5 million for the year ending 30 June 2015. The company also announced a final dividend of 6 cents per share to bring the total dividend for the year to 10 cents.
The profit guidance is down on last year's result of $36.5 million, although total dividends are equal to 2014 at 10 cents. Property developers undertake projects that last multiple years and so timing can affect any individual year's profit result. The company has suggested that this explains the fall in profit from last year saying.
"This result represents a solid year of profitability in a year where the timing of the construction and completion cycle provided less assistance to the reported net profit."
Indeed, such timing impacts are more pronounced with larger projects and Finbar has now reached a size where it is undertaking multi-year developments worth hundreds of millions of dollars. For example, the company is about to begin selling units in the largest single stage project it has done, the 38 level Civic Heart project with a value of more than $400 million.
Encouragingly, Finbar took the opportunity to inform the market that it holds pre-sale contracts of $402 million, up from $239 million last year and the highest level in the company's history. These pre-sales will be converted into revenues and earnings over the coming months and years.
Just following the news, Finbar was trading at $1.27 giving it a market capitalisation of $292 million. At 31 December 2014, the company had debt less cash of $54.8 million and so based on the $25.5 million profit guidance, Finbar trades on an enterprise value to net profit multiple of 13.6x. Meanwhile, the stock has a large fully franked dividend yield of 7.8% and currently trades at a 26.1% premium to its net asset value as at 31 December 2014.
For income-seeking investors, Finbar looks like an attractive option with few other ASX listed stocks able to offer such a high yield. However, investors should consider the sustainability of current dividends and often such a high yield indicates that the market expects dividends to fall in the future.
My view is that the reason for the market discount in this case is twofold.
- Property developers use debt to fund large projects that take years to complete and Finbar is no exception. If the property market were to collapse today, it could lead to major losses for the company as it would have spent hundreds of millions of dollars on buildings that it could not sell. Fortunately, Finbar appears to have a fairly conservative debt level relative to both its market capitalisation and net assets, but the problem is that under such a scenario, its market capitalisation would plummet and banks might call in their debts. The company would then be forced to raise capital at suppressed prices leading to massive dilution for existing holders.
- Finbar is based in Perth, a city which has grown on the back of the mining boom. The fear is that the business environment will be much worse in the future for Finbar, now that commodity prices are falling and fewer projects are going ahead. However, the latest Australian Bureau of Statistics data shows the population of Western Australia is still growing, up 1.6% year on year for the December 2014 quarter.
Foolish takeaway
Part of the reason that Finbar has such a high dividend yield is that the market believes the business is facing significant risks. The flip side of this is that if the risks do not eventuate then current prices represent a bargain. However, I also believe that current prices do not fully protect the downside if things turn sour for Finbar and so overall I will not buy the stock.
Having said that, I think Finbar is a well-run operation. It has an exclusive arrangement with its key contractor, Hannsen, which also owns over 2% of Finbar stock. This along with the fact that Finbar undertakes many projects as joint ventures, means that risks are shared with suppliers, and profit margins are strong. Also, the company is growing its property investment portfolio – rental income was $13.6 million in 2014, offering a slightly more robust revenue stream in the event of a downturn.
