Tag Archives: cash

I Don’t Understand Why Ausnet Moved 10% Higher After Its Update

Summary Ausnet’s performance doesn’t seem to improve, and the high capex (sustaining + growth) results in a free cash flow negative result. Despite being FCF negative, Ausnet has actually increased the dividend, attracting more income investors. The dividends are currently borrowed by issuing more debt, but with a net debt/EBITDA ratio of in excess of 5, it might be locked out of the debt markets. I still prefer to sleep well at night, and I’m not taking a stake in Ausnet. Introduction Back in June, I warned investors Ausnet’s ( OTCPK:SAUNF ) dividend was at risk because the company had to borrow cash to fund the dividend payments. That’s a red flag for me, and even though a large part of the capex was growth capex, I still don’t feel comfortable investing in such companies. SAUNF data by YCharts Ausnet is an Australian company and you should most definitely use the Australian Stock Exchange to trade in the company’s shares. The ticker symbol in Australia is AST, and the average daily volume is approximately 3.25 million shares while the daily dollar volume is almost $4M. The H1 revenue jump was nice, as was the net profit result The top line looks really good, considering Ausnet was able to increase its revenue by 10% to approximately A$1.07B ($770M). In fact, the income statement looks really good, as not only did the revenue increase by a double-digit amount, operating expenses also fell by approximately 3%. While this doesn’t sound like a big deal, these two factors allowed Ausnet to increase its operating income from A$340M ($245M) to A$455M ($327M), a 34% increase compared to the first semester of the financial year 2015. (click to enlarge) Source: Financial statements The (much) higher operating income also led to a higher operating margin, which increased to 42.5% compared to 35% in H1 2015. The finance costs increased, which is directly due to the fact Ausnet had (and still has) to issue more debt to cover its dividend payments. Thanks to the higher operating income and despite the higher interest expenses, the pre-tax income increased by in excess of 50%. Additionally, the tax bill is much lower as well, resulting in a conversion of last year’s net loss into a net profit. The EPS was almost 11 cents per share. (click to enlarge) Source: Financial statements That’s good, but once you turn the page to have a closer look at the cash flow statements, you’ll start to see why I’m quite worried about Ausnet’s ability to cover the ongoing dividend payments. The operating cash flow was approximately A$284M ($203M), but this still wasn’t sufficient to cover the A$350M ($252M) capex. Yes, the negative free cash flow was lower than in H1 2014, but it’s still negative. And yes, some of the capex is growth capex and doesn’t impact the “sustaining” free cash flow, but still… But the cash flow doesn’t cover the dividend payments Based on the headline numbers, the free cash flow was negative as the total capital expenditures were higher than the incoming operating cash flow. And it doesn’t look like Ausnet is planning to slash the dividend to reduce the total cash outflow from its balance sheet. It has declared another dividend of A$0.04265 per share ($0.03) payable in December, and based on the current amount of outstanding shares, this dividend payment will cost the company almost A$150M ($107M). So I’m worried about Ausnet’s ability to continue to pay a dividend. And I’m not alone with this view. The Royal Bank of Canada (Nov. 18): Dividends are aggressively positioned and balance sheet is going to come under pressure if AST wishes to retain an A range rating. (…) We believe AST has an unhealthy reliance on the dividend re-investment plan to fund capex. And Deutsche Bank (Nov. 18 as well): AusNet reaffirmed guidance for FY16 distributions of 8.53cps, implying growth of 2%. Consistent with full-year guidance, and DB expectations, AusNet declared an interim distribution of 4.27cps. However, on our estimates, cash coverage ratios will remain stretched with the Electricity distribution business facing lower earnings from next year once the new regulatory period begins (lower regulatory WACC). We forecast FY17 distribution cash coverage of c.93%, which makes the company reliant on its DRP to help fund its FY17 distributions. I had the impression I was all alone with my warning back in June for Ausnet shareholders that the company might not be able to meet its dividend commitments, but financial institutions are becoming increasingly wary of the dividend coverage as well and are now openly wondering whether or not the dividend is sustainable, and the “reset” periods in the next 24 months will be important for Ausnet’s ability to generate cash flow. (click to enlarge) Source: Company presentation Investment thesis So there’s no reason why I would have to change the opinion I expressed in the article I wrote in June. Ausnet is paying a very handsome dividend with a current dividend yield in excess of 5%, but I fail to see how the company can afford this dividend. Right now, the current capital expenditures aren’t covering the dividend expenses, and the investment in growth capex will be offset by the expected lower revenues due to regulatory pressure. Ausnet still remains an “avoid” for investors, and even though shareholders might have been lured by the attractive dividend, I fail to see how this dividend could be maintained in the longer run (unless the company continues to have access to the debt markets, the regulatory situation improves or its shareholders continue to use the reinvestment plan). I understand people are attracted to high-dividend stocks, but I’m not comfortable with Ausnet’s dividend policy right now. And yes, that’s an (arbitrary) personal choice. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

There Is Nothing Total About Total Return

Summary There are several methods for calculating total return, and the results of the different calculations can vary greatly. Total return is an important concept, and for many an indicator of how wisely they invest. Funds, advisors and even individual investors use total return to compare success and profit. Do you as an individual investor know what lies behind the total return concept, and does the number you get actually provide something meaningful to you? We all like to keep a score, and as investors total return is the score to talk about and show off. Unless you are an income-oriented investor, and actually are disciplined enough to only focus on income, your portfolio’s total return will fuel your hubris or smack you down all depending on Mr. Market. So considering the apparent importance of this number we should be talking about the same thing and measure the outcomes that really matter to us. But do we really do that? What is it that you measure when you calculate total return for your portfolio, and can you use the numbers the investment advisors and brokers give you? (click to enlarge) Total return is something I have found a bit difficult to wrap my head around. It is especially hard to calculate total return for a portfolio with cash flowing in and out. I have studied the different total return calculations to try to spot the differences, and decide which one I would use myself. In this article I will sum up my findings, and I hope to initiate a discussion to cast further light on this topic. I’m going to show how total return can be completely different values depending on what you want to measure and how you calculate it. And the “what do you want to measure” part is important – do you want to know how much your portfolio actually grew over a period, or how it performed versus other investment strategies? If you do not have an idea of what and how to measure total return you can end up with numbers that are totally irrelevant , as I have argued before. I will try to show the practical implications of the different calculations using examples. Hopefully that will make it easier to understand why different calculations give different answers. For the examples in this article I will use the daily closing prices from 2015 for Apple Inc. (NASDAQ: AAPL ). There has been quite a bit of volatility in this stock in 2015, so it will serve well as an example of how sequence of returns and cash flow influences total return calculations. Data is downloaded from Yahoo Finance. The simplest form of return: Dollar return Investors are building portfolios to make money grow into more money. Since more money is the ultimate goal, why could we not just measure the return as how much the portfolio value increased? If you started the year with $10,000 and ended with $12,000, with no contributions or withdrawals, the value of your portfolio would have increased with $2,000. You are in fact $2,000 richer at the end of the year. Even accounting for the cash flow is quite simple – just subtract from the year-end value any contributions and add any withdrawals. You will have full control of the increase or decrease in portfolio value. So why are we not happy with just looking at dollar returns? The main issue is that dollar returns cannot be compared across portfolios, and we want to be able to compare our performance against other portfolios. For many individual investors it’s a matter of comparing the performance of a financial advisor or portfolio manager against other providers of these services. To be able to compare we calculate the return as a percentage of portfolio value. In the example mentioned above the percentage return would be 20%. When you have no cash flow this simple calculation will provide your portfolio’s total return. But when we add cash flow to the portfolio the calculation becomes a bit more complex, and you actually have to make a choice regarding the calculation method. How cash flow is handled is actually the only thing separating the different approaches to calculating total return. Single purchase vs. dollar cost averaging Total return for a single purchase of stock is not very complicated. You take the sell price, subtract the buy price, add any dividend received, and divide that total by the buy price. There is no cash flow to complicate the calculations, and you don’t have to worry about reinvesting dividends. If you had bought shares of Apple on January 2nd and held them until October 30th you would have made a nice profit. P 0 = 109.33 (close price on January 2nd 2015) P 1 = 119.50 (close price on October 30th 2015) D = $0.47 + $0.52 + $0.52 = $1.51 Total stock return = ($119.50 – $109.33 + $1.51) / $109.33 = 10.68% This is the return without reinvesting dividends. We can complicate the calculation and reinvest dividends, but still have no other cash flow. Here is the result from a great dividend reinvestment calculator you can find at dividendchannel.com. For this short period (and modest dividend) reinvestment of dividends did not have any effect on the total return. But if you calculate over a longer period it will make a difference if you choose to reinvest dividends or not. We can do another calculation going back to 2012 when Apple started to pay dividends. In this example the total return from Apple increased from 113.27% to 117.52% when dividends were reinvested. We still have only one contribution of cash and a single stock portfolio, but already we have two different numbers for total return. The concept of total return gets more complicated when we start to look at a portfolio that receives monthly contributions, reinvests dividends and where money is withdrawn from the account occasionally. The cash flow will influence the total return calculation, and the sequence of contributions, withdrawals and dividend reinvestment will have significant effect on return calculations along with the stock’s sequence of return. There are two main approaches to this. The first is to ignore the cash flows and sequence of returns – this is called a time-weighted return. The other main approach is to account for both the cash flow, adjusted by the time the cash is at work in the portfolio and the sequence of returns. This is called a value-weighted return. So which one should you use? And which is it that you get from your broker? The short answer is that it depends on what you want to do with your total return. Do you want to compare it to an index or to other investors? Then a time-weighted return is the number you want, and this also is usually the total return you will get from your financial advisor or broker. But not all brokers think this is the best approach. Here’s a screen shot from Motif.com regarding return calculation. (click to enlarge) If you want your total return to more realistically represent the actual performance, in terms of loss or gain of your portfolio, you would have to use a value-weighted return. To show this I will use a portfolio investing $1,000 in Apple stock every month in 2015. As we previously saw, Apple is up over 10% for the year. Below is a table showing the portfolio value for each month of 2015. Date Period Portfolio cash flow Value 01/30/15 $1,000.00 $1,071.62 02/27/15 $1,000.00 $2,184.22 03/31/15 $1,000.00 $3,111.54 04/30/15 $1,000.00 $4,116.69 05/29/15 $1,000.00 $5,314.46 06/30/15 $1,000.00 $6,104.88 07/31/15 $1,000.00 $6,860.34 08/31/15 $1,000.00 $7,368.10 09/30/15 $1,000.00 $8,155.92 10/30/15 $1,000.00 $9,904.50 A total of $10,000 was invested in the portfolio, but the portfolio value was only 9,904.50 at the end of October. The dollar return was -$95.50 for the portfolio despite the 10% appreciation of Apple in 2015. The reason for this is the sequence of returns. The table above shows how the price of Apple soared during the first five months of 2015, and then fell back during the next four months, before the final rally in October. For the portfolio this was most unfortunate. During the “good” months in the beginning of the year the shares from only a few months of contributions benefited from the rise in stock price. For the next few months, new shares were bought at peak prices before the stock tumbled. More shares were bought at a lower cost over the next few months, but even with those fortunate purchases and the October rally the portfolio ended up with a minor loss. Rearranging the sequence of the monthly returns will provide a different return. Many factors clearly have an effect on the return of a portfolio. And the gain or loss of a portfolio is the definitive measure of success or failure as an investor. I have calculated the total return of this portfolio using different approaches to total return to see how well they reflect the experienced success/failure for the investor. Apple stock return 10.68% Portfolio dollar return -$95.50 Simple return on invested capital -0.96% Time-weighted return (monthly periods) 9.07% True time-weighted return 10.64% Value-weighted return (Internal rate of return) 1.85% Value-weighted return (Modified Dietz) 1.87% A bit confusing isn’t it? But it seems quite clear that the value-weighted returns better represent the actual gain/loss of the portfolio than the time-weighted returns. The two different value-weighted returns results from two different methods of calculation. The results in this case were quite similar, but the discrepancies can be significant. Given the finding that the value-weighted return better reflects the actual return of the portfolio, why is the time-weighted return so popular? Imagine you are a financial advisor who told a client to buy Apple in January. The value of Apple appreciated 10% until the end of October, so it was quite good advice. But due to the client’s monthly purchases the portfolio actually ended up losing money. As a financial advisor you might find it a bit unfair if you were compared to other financial advisors based on that loss rather than on the 10% potential gain from the advice. That is the reason for why time-weighted return is the industry standard it allows for comparison based on the advisor’s performance without the client’s influence on the result through cash flow. But as you see from the different time-weighted returns in the table above, there are some traps in the time-weighted return calculation you have to be aware of. The only thing separating the two time-weighted returns above is the choice of sub-periods, but that resulted in a notable difference. Conclusion As an individual investor you might not have a financial advisor. You make your own decisions based on your own research. You are your own financial advisor. You will have to decide yourself what kind of total return you want to calculate for your portfolio. One thing is certain – there is nothing total about total return! Here are some factors that will influence how you calculate total return and the resulting number: Single stock or portfolio? Single purchase or several purchases? Cash flow and purchase dates Time-weighted return or value-weighted return? For time-weighted return: Choice of sub-periods For value-weighted return: Choice of calculation method I will follow up on this article with a few articles that takes a closer look at the different types of total return, how you calculate them and the potential mistakes you can make. Thank you for reading, and please do comment and ask questions! Remember I am just another individual hobby investor. I appreciate all forms of feed-back so I can widen my horizons and learn more about investing!

Maximising Shareholder Value Has Nothing To Do With Maximising The Share Price

The idea that directors should seek to maximise shareholder value has come in for a lot of flak in recent years. James Montier of GMO even wrote a piece on it called ‘ The World’s Dumbest Idea ‘. One of the most prominent criticisms of maximising shareholder value is that it causes directors to focus too much on their company’s share price, which leads them to underinvest in the company’s long-term future in order to boost short-term profits (and therefore, the share price). This is not so much a failing of the concept of shareholder value maximisation as it is a failure to understand what shareholder value is and what directors can do in their attempts to maximise it. True shareholder value is a measure of long-term value The value of a company is essentially the value of all the cash it will return to shareholders over its remaining lifetime. Let’s assume that Sainsbury ( OTCQX:JSAIY ) ( OTCQX:JSNSF ) will survive another 100 years before closing its doors for the last time. In that case, the value of the company today is the value of all dividends paid out over the next 100 years plus any cash returned to shareholders, when the company is wound up (which we can ignore because it is usually zero). A dividend today is preferable to a dividend in 50 years’ time, so future dividends are usually “discounted” by an annual discount rate. If you want a 10% annual return on your Sainsbury investment, then you would discount the value of future dividends by 10% each year, in which case a 100p dividend 10 years from now would have a “present value” of about 42p. Add up those discounted future dividends and hey presto, you have the present “shareholder value” of Sainsbury, at least according to an investor who wants a 10% rate of return. A different discount rate would provide a different shareholder value. Because the company’s shareholder value is the discounted sum of 100 years of dividends, only a fraction of Sainsbury’s value today comes from dividends paid in the next 10 years. Most of its shareholder value comes from dividends that are expected to be paid more than 10 years in the future, as is the case for most mature companies. This is the true meaning of shareholder value; a multi-decade stream of dividends, which directors should be attempting to maximise, without taking unnecessary risk. True shareholder value maximisation should be much more about working to improve and expand the business for the next 10 years and the 10 years after that, rather than hitting short-term profit expectations. Share prices have almost nothing to do with shareholder value Those who believe in the wisdom of crowds might say that yes, the true shareholder value of a company is indeed the discounted value of its future cash returns to shareholders, but we can never know those cash flows and therefore can never calculate an accurate figure for shareholder value. They might go on to say that our best estimate of shareholder value is the market value or share price of a company, and so it is entirely sensible for directors to pay attention to share price and to be paid according to its performance. Utter drivel, is what I would say to that. The share price or market value of a company is, at most, a combined “best guess” by investors as to what a company’s shareholder value really is. However, calling it a “best guess” is wildly optimistic as a large portion of equity trades are carried out by traders who don’t even know the names of the companies whose shares they are buying and selling (especially the computer-driven High Frequency Traders who own shares for thousandths of a second). Even if all market participants were long-term dividend-focused investors, they still wouldn’t have the faintest idea what dividend Sainsbury will be paying 10, 20 or 30 years from now, and therefore no idea what its shareholder value is (and the same would be true for pretty much all companies). Rather than an estimate of shareholder value, share prices are more closely connected to factors like current dividends, current earnings and any and all combinations of news, noise, expectations and emotions; none of which have anything to do with true shareholder value. So the idea that maximising shareholder value means maximising the share price is a joke, which means that compensating executives with one-way bets on the share price (otherwise known as stock options) is equally daft. If executive directors are to be compensated by share price movements at all, it should be by insisting that they invest a significant amount of their own money into the company and to keep it invested for as long as they are on the board. In addition, they should be encouraged to focus on maximising true shareholder value rather than the company’s market value. As Lawrence Cunningham describes in the introduction to his book, The Essays of Warren Buffett : “The CEO’s at Berkshire’s various operating companies enjoy a unique position in corporate America. They are given a simple set of commands: to run their businesses as if (1) they are its sole owner, (2) it is the only asset they hold, and (3) they can never sell or merge it for a hundred years. This enables Berkshire CEOs to manage with a long-term horizon ahead of them, something alien to the CEOs of public companies.”