Market Watch : Defusing a Time Bomb
The stock market has been taking no prisoners among financial stocks for about a year now. The assumption by investors is that every financial company is just a time bomb of decayed assets waiting to explode.
In the ranks of alleged bombs that have yet to go off is Broad Inc., the Los Angeles-based life insurer and annuity giant. While the stock has been cut down to $3.875 a share now from $11.625 early in the year--a 67% drop--Broad last week reported fourth- quarter net income of 29 cents a share, up 16% from a year ago.
For the full fiscal year ended Sept. 30, Broad earned $33.4 million, or $1.02 a share, compared to $26.1 million, or 80 cents, in its shortened (10-month) fiscal 1989.
So at $3.875 a share, Broad stock sells for just four times annual earnings and just 39% of stated book value per share--the theoretical value of its assets if all debts were paid off.
Wall Street can’t argue with Broad’s business. Through its nationwide SunAmerica subsidiary, Broad continues to do a brisk trade selling conservative, tax-deferred annuities, a retirement savings vehicle that’s caught on big with baby boomer investors.
But that sales success, and the earnings it has produced, continue to take a back seat to investors’ paramount concern: How healthy is Broad’s portfolio of investments--the things it has purchased with its annuity investors’ dollars?
Broad argues that 50% of its $9.4-billion portfolio carries little or no credit risk. That half is invested mostly in U.S. Treasury securities and securities of U.S. government agencies.
Another 38% of the portfolio is in investments that Wall Street still considers of high quality, including top-rated corporate bonds and mortgages.
The market’s worry is about the 9.6% of Broad’s portfolio invested in more speculative assets, including junk bonds and real estate. If that $911-million chunk of the portfolio were to become completely worthless, it would more than wipe out Broad’s capital, leaving the firm bankrupt.
But not even the most pessimistic analysts expect every junk bond and every piece of real estate to become worthless. Far more realistic is that some percentage of the investments will fail, and that even those failures will pay back some of what they owe--perhaps 30 cents on the dollar.
What Broad is trying to show Wall Street is that the firm has been aggressively setting aside reserves for potential problems, and that it will continue to do so in 1991, to the tune of $40 million. Most significantly, even with those reserve set-asides, Chairman Eli Broad promises that his company will show net income growth of 20% to 25% in fiscal 1991.
What’s more, Eli Broad believes that he will have reserved enough by the end of 1991 to fully insulate his portfolio from whatever other problems may develop after that. “We do not want to go into 1992 having to provide anything additional” to reserves, he says flatly. If he makes that goal, Broad Inc. could be well on its way by 1992 toward annual net income of $2 a share or better.
At age 57, Eli Broad is no newcomer to the business of balancing risk and reward. He has been a savvy player in high finance for decades, and engineered the 1989 separation of Broad Inc. from home builder Kaufman & Broad Inc. Yet Wall Street obviously doesn’t completely trust Eli Broad’s instincts, or Broad Inc. stock wouldn’t be selling for a mere four times earnings per share.
Investors clearly are concerned that Broad Inc.’s assets will deteriorate far more than what Eli Broad sees. And certainly, anything could happen if the economic slump deepens. Eli Broad says his firm has been “cherry-picking” the loan portfolios of troubled banks, buying solid commercial mortgage loans from banks in need of money. But a solid mortgage today might turn into a problem a year from now. There’s no way to be 100% sure.
Even so, many institutional shareholders in Broad Inc., such as Strong/Corneliuson Capital in Milwaukee, owner of 600,000 shares, say they’ve looked over the portfolio, and they’re on Eli Broad’s side. Yet, as Bill Corneliuson admits, “You ask yourself, ‘Are we missing something, or is the market seeing something that all of we mortals don’t see?’ ”
One of Broad Inc.’s biggest problems is simply that it is based in L.A., home also to insurers First Capital Holdings and First Executive--both of which were major junk bond investors. Broad “is being painted with the same brush,” says Carl Lindberg, vice president at Wilmington, Del.-based Brandywine Asset Management. Lindberg says Brandywine has stuck with its 1.4 million Broad Inc. shares because “we’ve looked at it every which way” and concluded that the market has drastically overreacted. “We’ve torn our hair out on this,” he says.
If the market is right after all, no one will lose more than Eli Broad. He holds the bulk of the firm’s non-traded Class B shares and this year has bought 550,000 more shares of the common stock as it has sunk. Says analyst Frederick Wise at Bear, Stearns & Co. in New York: “I think Eli Broad is a rational man. I don’t think it would be in his interest to just throw money down the toilet.”
BROAD’S ROUGH SAILING
How shares of Broad Inc. have fallen over the past year, as worries about the financial system have jumped.
Weekly close, New York Stock Exchange trading
Friday: $3.88, up 13 cents
