Sunland's ray of franking sunshine

As is often the case with Australian companies who venture overseas, these offshore ventures can prove less successful than originally imagined.

This was the case for Sunland Group (SDG), whose global expansion included international operations in Dubai. Expansion in Dubai resulted in large losses for SDG, which could be considered a result of poor timing that could not have been predicted, especially given the Global Financial Crisis that followed.

However, it is important to realise that these events are now behind SDG, and the remaining projects in Dubai have been written off and actually appear as a ‘negative asset’ of $6.3 million on the SDG balance sheet.

As always, adversity creates opportunity. After the GFC SDG traded at a large discount to net tangible asset backing (NTA), and even now trades at $1.73, a discount to the NTA of $1.87. While no longer a large discount, it is still nonetheless a discount to NTA.

More compelling than the discount to NTA is the large franking balance that SDG has managed to accumulate over the years of running the business. The franking balance is $71.5 million, which would allow for the payment of $166.83 million of dividends before earning any future profits. With 181.7 million shares outstanding, this equates to the payment of $0.918 of dividends per share on a share price of $1.73.

This is a very large dividend relative to the SDG share price and I would presume that there is some possibility of this franking coming out over time. This could be very attractive to many shareholders.

SDG has just announced a full-year result of $13.6 million on a total equity position of $347.8 million. This represents a return on total assets of 3.9%, which is not a satisfactory return on assets and can be viewed as a ‘bottom of the cycle’ or ‘turnaround’ return.

I would expect that past international expansion and more recent consolidation and refocus should ultimately lead to a turnaround and significantly higher return on equity. A return on assets almost double this should be achievable over time. Unlike many property companies, SDG has little to no debt so that risks associated with debt are non-existent. Taking on manageable amounts of debt may actually assist in return on equity.

SDG has as its largest shareholders a family which is heavily invested in the stock and that has a strong alignment of interests in seeing the SDG business, profitability and its share price recover. As a fund I like to invest alongside the owner of a business where my interests are aligned, and SDG represents just that opportunity.

So, in summary, adversity in the sharemarket often represents opportunity and I have held a position in SDG at a large discount to NTA in the expectation that the discount to NTA will reduce, profitability for the business will return, and improve, and hopefully at some stage management and the board of directors will find a way to ‘unlock’ the franking credits tied up on the SDG balance sheet.

Karl Siegling is Portfolio Manager at Cadence Capital.