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HVN – Hardly Normal

The weird and whacky world of Harvey Norman entered a new phase this week.

On the surface, the announcement of a fully franked special dividend of 14 cents per share, matching the full year dividend, was unreservedly good news for shareholders. Indeed, the largest shareholder will find a little post-Christmas bonus of almost $44 million sitting in his bank account on 30 December.

I guess that’s one way to circumvent the problems of having the company executive remuneration program being rejected by shareholders at the annual meeting.

But Harvey Norman is no ordinary company when it comes to how the business is run and for whose benefit.

Profit results in recent years have been substantially skewed by the financial support given to the many franchisees across the business. Retail sales may have slowed as the consumer electronics boom of recent years has waned, but HVN takes a particularly collegial approach to the people that run the shops ensuring that they don’t flop during tougher times.

That’s magnanimous and quite logical, in a communal way, but leaves the company’s shareholders rooted firmly behind the franchisees in the pecking order of beneficiaries.

All well and good if you happen to be the largest shareholder with 29.5% of the stock, but most other shareholders might not see the philanthropy in such relaxed terms.

On more than one occasion, I have written about the absurdly large amount of franking credits accumulated in the accounts. As at 30 June 2014, HVN had $659 million of franking credits that theoretically could fund a special dividend of 89cps for shareholders that have put up with an average dividend payout ratio of around 50% over the last ten years.

The company may have had an epiphany of sorts when it lifted the payout ratio last year to 70% but I wasn’t optimistic that the franking credit pile would be attended to in the near future.

Lo and behold, Christmas arrived early this week as HVN announced it would pay a 14cps special dividend in time for the New Years’ retail sales events.

But of course, nothing is straightforward with HVN. Instead of using debt to pay the special, thereby lifting the company’s gearing ratio from a lowly 18%, it bizarrely asked shareholders to pay for the special themselves with a 1 for 22 rights issue. The price of the rights at $2.50 also seemed odd given the 30% discount to the share price.

So shareholders get diluted by approximately 5% for the privilege of eking out a special dividend that could have been six times larger if all the franking credits had been cleaned out.

The balance sheet could comfortably take on another $1 billion of debt raising gearing to a modest 40% without endangering the business. Interest cover at present is a whopping 11 times.

It’s hard to know what signal the company is trying to send. On the one hand, it has belatedly listened to the criticism about the franking credit situation but its method of sorting it out seems unorthodox and counterintuitive.

The executive remuneration snub by shareholders probably won’t result in any Board changes. But perhaps that would be one place to start to reinvigorate a business that has undoubtedly been successful in the past but is stubbornly locked in those past glory days.

One very long serving board member appointed in 2003 has a mere 3,000 shares. How’s that for confidence in the business?

Taking a cynical view, HVN is just a property play with a bunch of privileged tenants parading as retailers.

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