Declared tax rates: Part 2a
Quote:
Originally Posted by
Snoopy
When a building is recognised as increasing in value over the year, the depreciation charge on those assets goes up as well. But only for reporting to shareholders purposes. As far as the IRD is concerned, the buildings value remains on the Investore books at 'construction cost' or 'acquisition cost' on a second set of Investore accounts that only the IRD reads.
From an IRD perspective, IF the depreciation costs are recorded in the annual report at a level that is too high (as a result of property revaluations), THEN this means the 'operating profit', -as recorded in the annual report-, (which is set off against those too high depreciation expenses) will be too low. Thus the IRD will be looking for 'more tax' than Investore superficially claims it owes, given Investore's declared operating profit. However, the $4.461m depreciation tax adjustment shown in the above table will result in the company paying 'less tax'. The conclusion must be that I have no idea what I am talking about on this issue :(
I like to correct posts that I have made in the past but got wrong. The above post shows how far you can go wrong if you start out on the wrong path. I speculated that the depreciation charges being recorded were too high, when in fact the opposite situation was happening. There were no depreciation charges being recorded in the reported results at all! Now that I know this, my observations of what was happening make more sense.
First point: Property revaluations (or devaluations) have nothing to do with this topic. They are reported on in the next section of the "Consolidated Statement of Comprehensive Income", (below the line of the profit figure I picked out).
Second Point: By leaving out depreciation from the reported result, it appears that the IRD are taxing profits at a much lower than the legislated company tax rate. However, it is accounting reporting standards that are causing the profit to be publicly overstated. The real IRD reported profit is much less, which explains why the IRD are taking off so much less tax than I expected.
Sorry about my previous warped reasoning. But I got there in the end.
SNOOPY
What would the announced profit(s) have been with depreciation disallowed?
What a good question (see post title). But it is a trick question. That is because, as I found out yesterday, the NZ accounting reporting standards do not require depreciation to be included when a publicly owned property company reports its profitability. So the announced profit of the company does not change, no matter what happens to the depreciation allowed for. How good is that!
What is of more interest to investors is what happens to the distributable profit. So let's line up the 'what actually happened table' against the 'what would have happened table' and see what the differences are.
The 'what actually happened table' includes FY2019 and FY2020, two years where the depreciation allowance on buildings was not allowed. Yet there was still some depreciation allowed for in the accounts. I am unclear what this depreciation represents (there is almost no deprecation information in the respective annual reports). But it could be that various parts of the building fit out, like shelving and refrigerators are tax deductible, even if the structural elements of the building are not. To reflect this element, I am going to assume that even with building depreciation disallowed in our hypothetical FY2021-FY2023 measure up (i.e. where there is no 'building depreciation', the 'What would have happened' scenario), that an annual depreciation charge of $6.200m remains. For the purpose of this exercise I have used the legislated company tax rate of 28%, when I calculate 'income tax paid'. I have done this because I believe it is the best way to look at the 'change in profitability' between the two scenarios that I am about to outline in detail. I don't fully understand how the exact dollars of tax are calculated in the published accounts. So it makes no sense to try and replicate a calculation process that I do not fully understand.
What actually happened
i/ Building Depreciation Allowed FY2021,FY2022, FY2023 |
FY2019 |
FY2020 |
FY2021 |
FY2022 |
FY2023 |
Total |
Profit before other expense/income and income tax (as declared) |
$26.993m |
$26.749m |
$29.949m |
$34.265m |
$35.207m |
less Depreciation Charge |
$6.621m |
$6.171m |
$15.600m |
$15.932m |
$15.229m |
equals IRD Profit before other expense/income and income tax |
$20.372m |
$20.578m |
$14.349m |
$18.333m |
$19.908m |
less Income Tax expense @ 28% |
$5.760m |
$5.762m |
$4.018m |
$5.133m |
$5.574m |
$26.247m |
equals IRD Operational Net Profit After Tax |
$14.617m |
$14.816m |
$10.331m |
$13.200m |
$14.334m |
add Cashflow from 'Structural Depreciation' not reinvested (1) |
$0m |
$0m |
$9.400m |
$9.732m |
$9.029m |
equals 'Cash Earnings' available for distribution |
$14.617m |
$14.816m |
$19.731m |
$22.932m |
$23.363m |
(Reference Only) Current tax expense (AR Note 7.3 'Tax') |
$5.549m |
$5.832m |
$7.706m |
$7.639m |
$0.128m |
$26.854m |
Notes
1a/ Calculation for FY2021: ($15.600 - $6.200)m = $9.400m
1b/ Calculation for FY2022: ($15.932 - $6.200)m = $9.732m
1c/ Calculation for FY2023: ($15.229 - $6.200)m = $9.029m
What would have happened
ii/ If Building Depreciation DisAllowed |
FY2019 |
FY2020 |
FY2021 |
FY2022 |
FY2023 |
Total |
Profit before other expense/income and income tax (as declared) |
$26.993m |
$26.749m |
$29.949m |
$34.265m |
$35.207m |
less Depreciation Charge |
$6.621m |
$6.171m |
$6.200m |
$6.200m |
$6.200m |
equals IRD Profit before other expense/income and income tax |
$20.372m |
$20.578m |
$23.749m |
$28.065m |
$29.007m |
less Income Tax expense @ 28% |
$5.760m |
$5.762m |
$6.650m |
$7.858m |
$8.122m |
$34.182m |
equals IRD Operational Net Profit After Tax |
$14.617m |
$14.816m |
$17.099m |
$20.207m |
$20.885m |
This is the point where removing building depreciation as a tax deductible asset starts to do my head in. It is quite clear when comparing the two tables that IRD recognized profit has gone up, with the removal of building depreciation deductability. It is also clear that the income tax paid to the government has gone up (which was the whole point of the touted tax law change: Rich building owners would pay more tax, to pay for tax cuts to the 'squeezed middle'). So the way I see things, dividends to unit holders should now increase because the profits to unit holders have increased.
The counter argument to all of this is that actually buildings still do depreciate over time. So when the time comes around for the building to be re-clad (or whatever), then the company will be required to front up with 'new capital' to do the re-cladding. But under the old regime, where depreciation was allowed, no 'new capital' would be needed, because the 'tax not paid' (the tax paid under the old regime was lower because of lower profits with building depreciation allowed) could be used to refurbish the building without budgeting to put in 'new capital' for the refurbishment. So where will this 'new capital' come from? By reducing the dividend of course (one way of raising it)!
Yet all this 're-cladding' could be many years away. In the meantime, the more tax the company pays, the better off unit holders are, because the company is making more profit and paying the extra tax on potentially higher dividends on the unit holders behalf!!?!!
(Addendum: The point I didn't realise and that confused me was that the PIE fully imputed dividend includes a supplement of depreciation deductions relating to the structure of the building that are added to earnings. These depreciation deductions are not profit, even though the implementation of the PIE tax regime means they can be treated as such for tax and dividend purposes. If tax deductability on building structural elements is taken away, that means the company will pay more tax on their higher profits, and there will be less money left over to supplement the earnings in the dividend pool,)
SNOOPY
'Earned Profit' vs 'Dividends Paid'
Quote:
Originally Posted by
Snoopy
What is of more interest to investors is what happens to the distributable profit. So let's line up the 'what actually happened table' against the 'what would have happened table' and see what the differences are.
I think I must have got out of the wrong side of bed this morning. How is it that my long sought answers are just leading to more awkward questions? Take a look at the dividends paid out below, and the underlying earnings used to support them.
Building Depreciation Allowed FY2021,FY2022, FY2023 |
FY2019 |
FY2020 |
FY2021 |
FY2022 |
FY2023 |
5 year Total |
Dividends Paid during Financial Year (1) |
$19.676m |
$20.701m |
$27.980m |
$28.808m |
$29.050m |
$126.705m |
Profit before other expense/income and income tax (as declared) |
$26.993m |
$26.749m |
$29.949m |
$34.265m |
$35.207m |
$153.163m |
less Depreciation Charge |
$6.621m |
$6.171m |
$15.600m |
$15.932m |
$15.229m |
$59.553m |
equals IRD Profit before other expense/income and income tax |
$20.372m |
$20.578m |
$14.349m |
$18.333m |
$19.908m |
$93.540m |
less Income Tax expense @ 28% |
$5.760m |
$5.762m |
$4.018m |
$5.133m |
$5.574m |
equals IRD Operational Net Profit After Tax |
$14.617m |
$14.816m |
$10.331m |
$13.200m |
$14.334m |
$67.298m |
|
|
|
|
|
|
Capital raised during year (2) |
($2.638m) |
$76.032m |
$102.652m |
|
($1.074m) |
$174.972m |
Building revaluations during year |
$17.206m |
$7.716m |
$139.287m |
$91.593m |
($185.246m) |
$70.556m |
EOFY shareholder equity {A} |
$443.209m |
$526.691m |
$765.674m |
$855.042m |
$675.020m |
EOFY total assets {B} |
$769.877m |
$786.625m |
$1,070.850m |
$1,238.786m |
$1.080.288m |
Equity Ratio {A}/{B} |
57.6% |
70.0% |
71.5% |
69.0% |
62.5% |
Notes
1/ Dividends paid over the financial year are taken from each respective 'Consolidated Statement of Changes in Equity' in the Annual Reports.
2/ Negative capital raised during the year indicates a share buyback.
-------------------------
At first glance, the dividend paid over the five year period looks well covered by the profit declared. However this is a spurious comparison. The dividend paid is an 'after tax' figure, including all costs. Whereas the 'declared profit' is before tax and does not allow for any depreciation. The correct comparison for the dividend payout then, both after tax figures, is with the row titled 'IRD Operational Net Profit After Tax'. Using those figures, we can see that, over five years, the dividends paid out have exceeded underlying operational earnings by a total of:
$126.705m -$67.298m = $59.407m
The only way for this to occur in practice is for the difference to be made up by paying out some 'supplementary funds', or shareholder equity in some form. So was the shareholder equity run down over that five year period? No, it was built up:
$675.020m - $443.209m = $231.811m
Yet most of this capital build up relates to a net $177.590m of new capital raised over the five year period under examination. If that capital raising had not occurred, then, on a purely new capital for dividends perspective, the net cumulative property revaluations of $70.556m covered the extra cash demand of paying dividends ahead of earnings.
I am unsure how 'depreciation' fits into this equation. There is certainly depreciation claimed for income tax purposes, and the operational profit that I have calculated above is 'after depreciation'. But as far as the building structure is concerned, whether this depreciation is 'real' over time, in terms of an income adjustment, is open to question.
The accumulated depreciation of $59.553m over the study period has been more than wiped out by property revaluations of $70.556m. So another way of viewing 'what has happened' is that there has been zero depreciation and instead the assets have been revalued by: $70.556m-$59.552m=$11.004m over the time.
Furthermore, if the depreciation is $59.552m less than I have allowed for in may calculations, then the accumulated operational net profit over five years increases to:
$67.298m + 0.72x$59.553m = $110.176m
That figure is much closer to covering the $126.705m in dividends over the period, with only: $126.705m-$110.176m=$16.529m of borrowings (or asset sales?) needed to make up the difference. As long as asset valuations are increasing at a faster rate than debt then this isn't a problem. But the measure of this is 'Equity Ratio', and for 'Investore' the Equity ratio' is pushing up towards those banking covenants. Hmmmm.......
SNOOPY
BT1/: Significant Business Scale (Top 3 in chosen markets): (FY2023 View)
Investore is a property owning entity set up by the Stride Investment Management Limited (SIML), part of the parent Stride Property Group. SIML continue to provide all management functions for Investore, which has no staff of its own. Investore hold, and manage day to day essential service big box retail outlets. The largest tenant by far (64% of all tenancies) is 'Woolworths' of Australia, who run the New Zealand owned 'Countdown' supermarket chain, (which is nevertheless in the process of rebranding to the same name as the Australian parent owner - 'Woolworths'). Other 'essential' retail brands operating out of big boxes, that are owned by Investore are: Bunnings (hardware), Foodstuffs (groceries), Mitre 10 (hardware) and Briscoes (bedroom, dining room and kitchen ancillaries) .
Investore owns a total of 44 properties, containing 143 tenants. Portfolio occupancy by area is 99.5%. The next largest NZX listed big box retail outlet owners are Argosy Properties (with 8 large retail format stores amongst a large selection of diversified type of properties). Other NZX listed big box property owning companies (in particular Goodman Property Trust and Property for Industry) lease their properties out as logistics hubs, factories, and industrial service buildings. Other NZX listed retail property for investment is in the form of multi-tenanted shopping malls (e.g. Kiwi Property Group and parent Stride Properties). That means IF you want to:
i/ Invest in destination big box stores within New Zealand
ii/ Stores that feature tenants with strong 'everyday use brands', and
iii/ Stores come under the investor favourable PIE investment regime envelope,
THEN Investore is your number one investment destination.
Conclusion: PASS TEST
SNOOPY
BT2/ Increasing Earnings per Share (One Setback Allowed) (FY2023 view A)
Earnings Per Share = (Net Operational Profit After Tax) / (Number of shares on issue at the end of the year)
I am using the Net Profit After Tax figures derived in my post 180 as the basis for this post.
FY2019: $15.031m / 260.076m = 5.78cps
FY2020: $15.019m / 304.499m = 4.93cps
FY2021: $10.697m / 368.135m = 2.91cps
FY2022: $13.408m / 368.135m = 3.64cps
FY2023: $14.936m / 367.503m = 4.06cps
Two setbacks, before the 'great 'eps' climb back' from FY2021. The financial year ends on 31st March. This means FY2021 was the principal Covid-19 affected year.
Conclusion: FAIL TEST
SNOOPY
BT3/ ROE > 15% (One Setback Allowed) (FY2023 view A)
The 'return on shareholder equity' test.
Return on Equity = (Net Operational Profit After Tax) / (Equity at the end of the Year (excluding property revaluations) )
I have removed all annual portfolio revaluations (and devaluations) from the equity base since listing. Over time the value of the real estate tends to increase. These increases are nominally a net benefit to the unit holder. However in the case of a 'return on equity' calculation, the 'return on book equity' will decrease as the equity on the books goes up. Changes in book equity are made both from changes in wider market interest rates and changes in rental contracts. It is only the latter that is under the control of Investore management, and these rent increases are also reflected in the numerator of our calculation. Thus removing property valuation changes from the denominator of our calculation is the better way to measure Investore management's contribution to the change in the return on equity picture over time. Change in property valuations are not an annual cashflow consideration, but changes in rents are very important to cashflow, and operational profit.
FY2019: $15.031m / ($443.209m - $36.054m - $17.206m) = 3.85%
FY2020: $15.019m / ($526.691m - $36.054m -$24.922m) = 3.23%
FY2021: $10.697m / ($765.674m - $36.054m- $164.208m) = 1.89%
FY2022: $13.408m / ($855.042m - $36.054m -$255.802m) = 2.38%
FY2023: $14.936m / ($675.020m - $36.054m - $70.556m)= 2.63%
Notes
1a/ The base Incremental Property valuation to equity representing changes to valuations from the company's inception to the end of FY2018 is:
($0.801m) from 2HY2016, $13.720m (from FY2017), $23.135m (from FY2018), for a total of $36.054m. The company's first full year of operation was FY2017
1b/ Incremental Property valuations to equity for the five years being analyzed are as follows:
FY2019: $17.206m = $17.206m
FY2020: $17.206m + $7.716m = $24.922m
FY2021: $17.206m + $7.716m + $139.287m = $164.209m
FY2022: $17.206m + $7.716m + $139.287m + $91.593m = $255.802m
FY2023: $17.206m + $7.716m + $139.287m + $91.593m +($185.246m) = $70.556m
--------------------------
Not even close in any year! But not unexpected. Companies with substantial tangible assets rarely do well in this test.
Conclusion: FAIL TEST
SNOOPY
BT4/: Ability to raise Net Profit Margin > inflation (FY2023 view A)
Net Profit Margin = (Net Operational Profit after Tax) / (Rental and Management Fee Income)
FY2019: $15.031m / $50.394m = 29.8%
FY2020: $15.019m / $54.416m = 27.6%
FY2021: $10.697m / $64.514m = 16.6%
FY2022: $13.408m / $67.923m = 19.7%
FY2023: $14.936m / $70.987m = 21.0%
If we use an inflation rate for FY2023 of 7%, inflation adjusted profits for FY2023 would need to be $13.408m x 1.07 = $14.347m. This figure was exceeded in FY2023. We have not got back to pre-Covid-19 net profit margin levels. But the three results since FY2021 have shown that an improvement in net profit margin is possible.
Conclusion: PASS TEST
SNOOPY