Bank Covenant Ratio Summary [FY2021 perspective]
For this table I have reverted to the 'conventional' calculations, (Not including the case where the discount rate of debt is zero).
|
Interest Coverage |
|
|
|
Debt to EBITDA |
|
|
EBITDA/I (Pre IFRS16) |
EBITDA/I (Post IFRS16) |
EBIT/I (Pre IFRS16) |
EBIT/I (Post IFRS16) |
'Net Senior Debt'/EBITDA (Pre IFRS16) |
'Net Senior Debt'/EBITDA (Post IFRS16) |
Value |
7.0 |
5.8 |
2.3 |
2.0 |
3.88 |
4.23 |
Target |
>2.75 |
>2.75 |
>2.75 |
>2.75 |
<4.75 |
<4.75 |
Result |
Pass |
Pass |
Fail |
Fail |
Pass |
Pass |
Notes[/
1/ 'EBITDA/I' calculations from my post 2810
2/ 'EBIT/I' calculations from my post 2803
3/ 'Net Debt' / 'EBITDA' calculations from my post 2802
Discussion
What to make of all of this?
There are two accepted ways of calculating 'Interest Coverage'. Since Chorus has not announced to the market that they have 'broken their banking covenants', I think it is fair to assume they are using EBITDA/I rather than EBIT/I. The banks would only accept this 'chosen' calculation method if near future capital expenditure costs were well below depreciation costs. Thankfully, because the assets of Chorus are generally 'long lasting' and nearer the beginning of their design life than at the end, this is the situation.
Post IFRS16, which is the standard that brings building leases onto the Balance Sheet, the 'Interest Coverage' ratio has deteriorated a little. This is a mathematical consequence of the 'Earnings', as a percentage of total earnings, in the numerator not increasing as fast as the 'Interest Payable', as a percentage of all interest payable, in the denominator. In fact under IFRS16, the numerical increment in both the numerator and denominator is the same, because the amount added to both ('lease interest payable') is the same. But as the old 'Net Interest Payable' starts from a smaller base than the old EBITDA, the effect of increasing both by the same numerical amount reduces the 'EBITDA' to 'I' ratio - in most instances. Putting my thinking cap on, if EBITDA was really low to the extent that the company was barely breaking even on a 'day to day' cash basis, but still had significant rent expenses (= 'lease interest payable' under IFRS16), then I could imagine a situation where adopting IFRS16 would improve the[/ Interest Coverage Ratio. However if things had got that bad, the bank would have probably intervened already. So I think it is fair to say that in the real world, adopting IFRS16 has made complying with any fixed Interest Coverage Ratio banking covenant a little tougher.
On the topic of 'Debt to Income' ratios, utility type companies with capital intensive assets yet relatively predictable cashflows tend to have high debts. This is usually the result of seeking 'shareholder capital efficiency', rather than underlying past managerial incompetence. Under IFRS16, multi year rent contracts that traditionally did not feature on balance sheets are now brought onto the balance sheet as 'lease payable' liabilities. You might imagine that:
1/ Having a future ten year capitalised rent bill on the numerator side of this particular covenant, with
2/ the 'offset effect' adding to EBITDA being just one year of 'lease interest' (a proxy for rent) increasing the denominator part of this statistic
might make it harder to repay the debt as depicted. In practice this is what has happened with the 'Debt to EBITDA' ratio getting [/worse on the adoption of IFRS16.
A curious point, which I discuss in post 2807 is that if I use EBITDA/I as 'Interest Coverage' this ratio becomes very closely coupled to the 'Net Senior Debt/ EBITDA' which is in effect a debt to income ratio. In fact if interest rates were permanently fixed at a single interest value, these two covenant ratios would be slightly different ways of looking at the same thing. In the real world interest rates do go up and down though. And I would suggest that interest rates are far more likely to go up from where we sit right now. So with today's very low interest rates, I would expect the Interest Coverage Ratio to be far less of a worry for bankers than the Debt to ear[/nings Ratio, simply because the Interest Coverage Ratio was designed in days where interest rates were generally much higher than today. It is likely the Interest Rate Coverage Ratio has been set by the banks (albeit unconsciously) expecting a rebound in interest rates. Sure enough when you compare the 'value' to the 'target' figure in the table above, EBITDA/I comes out at just over two times the target (a 100% safety margin). Whereas with 'Net Senior Debt'/ EBITDA, the safety margin is just (4.75-4.23) /4.75 = just 11%. Unless interest rate charges triple, we aren't going to get anywhere near the historic Interest Rate Coverage restrictions. So I guess this is why we don't hear much about 'Interest Coverage' as a lending covenant restriction these days. Perpetual very low interest rates have rendered 'Interest Coverage' largely irrelevant from a banker's investment perspective.
SNOOPY
What happened to the Imputation Credits?
Quote:
Originally Posted by
nztx
What's happened that no tax credits are available from CNU to add to dividends ?
Past history suggests fully imputed dividends from Oct 12 through to April 22
then bang - Nada credits available ..
Quote:
Originally Posted by
Nor
There are three key factors that determine how many imputation credits a company has to distribute to shareholders:
1/ The proportion of profits earned in New Zealand. Companies that generate a substantial portion of their profits in New Zealand will likely have a more highly imputed dividend than those that derive profits offshore and therefore pay tax in other jurisdictions.
2/ The amount of reported profit. Some companies have lower reported profits than the cash flow from which they can pay dividends. This could be due to, for example, high levels of depreciation which is a non-cash expense, lowering profit but not affecting cash flows. As profits are lower, tax is lower, and these companies therefore have fewer imputation credits to attach to their dividends.
3/ Dividend payout ratios. Companies that pay out a lower amount of their profits as dividends are likely to have a more highly imputed dividend than those that pay out more.
Good question from nztx, and a good explanation of possible answers from Nor. There is a fourth possible reason for no imputation credits too. That being that although the company is making a profit and has generated a tax bill, they haven't got around to paying the tax yet. So let's look and some data to try and get to the bottom of this.
|
FY2018 |
FY2019 |
FY2020 |
FY2021 |
FY2022 |
|
|
Total |
Net Profit Before Tax |
$122m |
$78m |
$73m |
$72m |
$106m |
Income Tax Expense |
($37m) |
($25m) |
($21m) |
($25m) |
($42m) |
|
|
($150m) |
Net Profit After Tax |
$85m |
$53m |
$52m |
$47m |
$64m |
|
|
$301m |
Tax rate |
29.8%-30.9% |
31.2%-32.9% |
27.9%-29.7% |
33.8%-35.7% |
39.0%-40.3% |
Actual tax Paid |
($30m) |
($3m) |
($12m) |
($1m) |
($14m) |
|
|
($60m) |
Depreciation |
$283m |
$303m |
$319m |
$331m |
$335m |
|
|
$1,571m |
Capital Expenditure |
$810m |
$804m |
$663m |
$672m |
$492m |
|
|
$3,441m |
Operating Free Cashflow |
$508m |
$496m |
$474m |
$556m |
$570m |
|
|
$2,604m |
Dividends Paid |
$43m |
$49m |
$76m |
$86m |
$97m |
|
|
$351m |
Dividend Payout ratio |
51% |
92% |
146% |
183% |
136% |
|
Notes
1/ A fully imputed dividend may be paid if the tax rate has been assessed as an income tax expense at 28%, and the bill has been paid.
2/ I have calculated the actual tax as assessed within a range, as -given the raw data declared- it is not possible to determine what the assessed tax rate is any more accurately.
2a/ Sample Tax Rate Calculation As an example, over FY2022, the income tax expense was declared at $42m. However due to the rounding error applied to this figure, all we can say is that the actual quantum of tax assessed was between $41.5m and $42.5m. Likewise net profit before tax of $106m as declared, means that the actual net profit was between $105.5m and $106.5m. Thus the actual rate of tax paid was between:
$41.5m/$106.5m = 39.0% (lower bound)
$42.5m/$105.5m = 40.3% (higher bound)
We know for sure that the actual assessed tax rate was between those two percentage figures. But we don't know exactly where it sits. Why was the actual tax bill levied above the 28% levied on NZ companies? It can vary from year to year as the cash impact of a tax bill is not paid entirely in the year in which the underlying earnings were taxed. But generally if your tax bill ends up being higher than the standard tax rate, it means your actual income is shrinking (because provisional tax is based on previous years higher earnings). However earnings are not shrinking at Chorus. So I am mystified as tp why the booked tax rate remains higher than the legislated 28%.
---------------
Discussion
Chorus operates entirely within New Zealand. So we can rule out Nor's first possibility of profits being generated overseas not generating sufficient earnings within NZ to pay fully imputed dividends.
Nor's second conjecture that the available cashflow for distribution far exceeds profits looks to be true from the figures above. But this doesn't tell the full story. Alongside their day to day operations, Chorus have been indulged in a huge build out of their broadband cable network which has been highly consuming of their 'spare' cashflow. It is really only over the last year that Chorus's nationwide broadband roll out has neared completion. Considering the last five years, it is only over FY2022 that operating cashflow has exceeded capital expenditure, thus opening the window for higher dividends to be considered.
The converse of Nor's third conjecture, that companies that pay out more than their earnings as dividends will not have the imputation credits to cover those dividends also applies here. But that only explains why the rate of dividend imputation has to be reduced. It doesn't explain why imputation credits have disappeared entirely.
Finally my own conjecture that Chorus simply has not paid their assessed tax bills in full over recent years appears to also be true. How they have got away with not paying their tax is another unsolved question though.
At last it looks like we have the answer to nztx's question. Chorus must have had a stack of imputation credits that, until the dividend before last, allowed them to pay 'fully imputed dividends'. However once they burned through those, they didn't pay their tax on time and so had no imputation credits to pay out, notwithstanding the fact that one third of their dividend payout was from cashflow above earnings. (Cashflows in excess of earnings have no imputation credits attached to them anyway.)
SNOOPY
BT1/ STRONG MARKET POSITION (Top 3 in chosen market sector) [perspective FY2022]
Quote:
Originally Posted by
Snoopy
Chorus is the largest builder and operator of the fibre broadband telecommunications network in New Zealand. Of the 33 identified 'build regions', Chorus has the contract to build 24 of them. Fibre broadband networks not being built by Chorus include:
1/ Greater Christchurch being built by 'Enable' (a wholly owned subsidiary of the Christchurch City Council)
2/ Whangarei and Kaipara being built by 'Northpower' (Northpower is owned by consumers connected to Northpower's Electricity network).
3/ Hamilton, Cambridge, Te Awamutu, Tauranga, Tokoroa, Hawera, New Plymouth and Whanganui already built by 'Ultra Fast Fibre' (owned by Australian firm 'First Sentier Investments')
All of the above are part of a 'Regulatory Asset Base' (RAB) for NZs partially government funded Fixed Fibre Local Access Service (FFLAS).
Chorus is also the owner operator of the legacy copper telecommunications network which is present over the whole country. Chorus is a regulated wholesaler of telecommunications services for many retail partners including Vodaphone, Spark, 2degrees, Vocus, Trustpower and Sky.
By FY2023 Chorus will have made the transition from being a 'builder of broadband' and an 'operator of telecommunications fixed networks' to a 'fully regulated operator of networks'. Despite being a legislated monopoly network provider, Chorus continues to roll out an innovation program for their customers. Over FY2020 they launched:
1/ The new 'Hyperfibre' service. This is new network technology that allows 2Gbps or 4Gbps symmetric connection speeds.
2/ A new streamlined fault restoration service, instigated for small business.
3/ A streamlined connection service to connect widely dispersed customers at a single network handover point, which will improve customer management for retailers.
4/ A WiFi service that does not require retailer supplied routers.
Looking further out, Chorus are considering the implementation of 'Wi Fi 6', which is expected to deliver a big step up in performance in speed and latency. 'Wi Fi 6' is an effective prospective rival to mobile network 5g services.
Conclusion: As a monopoly fibre broadband provider, that is expected to maintain a bandwidth and latency edge of competing fixed mobile offerings from Spark and Vodaphone (both minor players in terms of market share) , this test result is a PASS
With the winding down of the 'Ultra fast Broadband 1' ('UFB1') and 'UFB2' fibre broadband network construction joint agreements with the government, for:
a/ The initial nationwide roll out of a fibre broadband network (UFB1) AND
b/ Subsequent extension of that to smaller centres (UFB2),
Chorus has now entered a new phase of its operation: Owner and operator of New Zealand's largest nationwide wholesale fibre broadband network.
Did I say nationwide? In fact there are are three substantial geographic regions where the fibre broadband infrastructure has been built by others:
1/ Greater Christchurch City: Built and owned by the Christchurch City Council owned 'Enable Networks'.
2/ Northern cities of Whangarei and Kerikeri, built and owned by the local electricity lines company 'Northpower', in turn 100% owned by electricity consumers of those northern regions.
3/ North Island central cities of Hamilton, Cambridge, Te Awamutu, Tauranga, Tokoroa, Hawera, New Plymouth and Whanganui built and owned by 'Tuatahi Fibre' (formerly 'Ultra Fast Fibre') owned by 'Igneo Infrastructure Partners'. Igneo is a sub brand of 'First Sentier Investors Group' created as a vehicle to hold and manage- at arms length - wholly owned businesses owned by First Sentier. Igneo specialises in owning mature infrastructure assets. First Sentier is a leading manager of global infrastructure assets, and manages capital on behalf of more than 120 institutions representing over 365 million pension fund members and policy holders from all over the world (although 37% of investors are geographically domiciled in Australia and 36% are in Europe).
Nevertheless Chorus is also owner of the legacy telecommunications copper network. Thus as the nationwide copper network is gradually and largely retired, we can expect the former copper network Chorus customers in the three regions listed above to migrate to these other fibre network operators.
Chorus faces broadband competition from the so called 'fixed wireless services' operated over the mobile networks owned by big NZ domestic telecommunications retailers Spark, Vodaphone NZ and 2 degrees. But the big telecommunications retailers remain resellers of Chorus's offering as well, an arrangement that can create perverse incentives on which broadband technology a consumer might be steered towards.
Growth prospects for Chorus are the 30% of homes that lie within the current Chorus fibre footprint but have not (yet?) chosen it. Furthermore there is a prospect of greater use of adjunct WIFI technology as more spectrum becomes available.
Conclusion: As
a/ The pre-emanant broadband provider of all broadband technologies by market share AND
b/ Monopoly fibre provider in all regions in which Chorus has their fibre rolled out, AND
c/ As monopoly provider nationwide of the legacy copper technology,
Chorus is the number one player in all markets in which they choose to participate. 'PASS TEST.'
SNOOPY
BT2/ INCREASING EARNINGS PER SHARE TREND (one setback allowed) [perspective 2022]
Quote:
Originally Posted by
Snoopy
Time to update the earnings per share trend for the current financial year.
Earnings per share are calculated by taking the normalised net profit after tax and dividing that by the number of shares on issue at the end of the financial year.
FY2017: ($113m + 0.72( $6m+$3m+$11m+$6m )) / 411.002m = 32.0cps
FY2018: ($85m + 0.72( $5m+$5m+$7m)) / 429.641m = 22.6cps
FY2019: ($53m + 0.72( $1.5m+$2m+$3m+$3m+$6m+$2m )) / 439.288m = 14.9cps
FY2020: ($52m + 0.72( $2m+$6m+$5m+$2m+$1m+$5m+$3m-$3m ) - $5m) / 444.492m = 13.9cps
FY2021: ($47m + 0.72( $2m+$1m-$4m+$7m ) +$1m) / 447.025m = 11.7cps
Notes
1/ Normalised FY2017 result adds back $6m in incremental Consultancy fees spent on strategic review of the regulatory framework and Chorus itself. Removed a $3m interest charge realised from a reset of a GBP Euro Medium Term Note (EMTN) interest rate swap (the interest rate exposure is only partially hedged, explaining the need for a reset). Further interest charges of $11m + $6m, based on the ineffectiveness of the EMTN cashflow hedge have been added back.
2/ Normalised FY2018 result removes a $5m labour restructuring charge, removed a $3m interest charge realised from a reset of a GBP Euro Medium Term Note (EMTN) interest rate swap (the interest rate exposure is only partially hedged, explaining the need for a reset). A further interest charge of $7m, based on the amortisation of the ineffectiveness of the EMTN cashflow hedge (closed out on 9 December 2013), has been added back.
3/ Normalised FY2019 removes $1,5m of labour restructuring costs, $2m of consultants fees investigating the forthcoming regulatory regime, and $3m from a set aside implementation charge to get the new regulatory framework in place. Removed a $3m interest charge realised from a reset of a GBP Euro Medium Term Note (EMTN) interest rate swap (the interest rate exposure is only partially hedged, explaining the need for a reset). A further interest charge of $6m, based on the ineffectiveness of the EMTN cashflow hedge has been added back. A $2m one off expense for restructuring two forward dated interest rate swaps has also been removed.
4/ Normalised FY2020 removes a combined $2m Covid-19 relief payment encompassing Fibre and Copper broadband customers, a $6m increase in Covid-19 staff leave provisions and contractors to help make the transition to the new regulatory framework, a $5m payment to contracted service companies to help them through the lock-down periods (adding to a total $13m of Covid-19 relief response), an incremental $2m increase in consultancy fees related to the regulatory transition, a $1m one off expense for restructuring forward dated interest rate swaps. I have removed a $5m interest charge, realised from a reset of a GBP Euro Medium Term Note (EMTN) interest rate swap (the interest rate exposure is only partially hedged, explaining the need for a reset). A final further interest charge of $3m, based on the ineffectiveness of the EMTN cashflow hedge has been added back, and at EOFY2020 and, this 9 December 2013 transaction, was finally 'closed out' of the account books. I subtract $5m from NPAT, to account for the one off $5m tax refund resulting from the resumption of building depreciation. Finally my normalised FY2020 now removes a favourable $3m one off settlement (not mentioned in AR2020 specifically, but see AR2021 p17))
5/ Normalised FY2021 profit adjusts for a $1m value Added Network one off dispute settlement (assumed non taxable), a $2m one off restructuring labour costs, as a result of the ongoing transition from a 'build it' to a 'manage it' network, and $1m of costs relating to the decommissioning of legacy copper network equipment in Spark exchanges. I have subtracted a $4m reduction of interest costs relating to the "Ineffective portion of changes in fair value of cash flow hedges" and added back $7m interest charge arising from interest rate swap resets.
Lots of adjustments made to gather a normalised result free from one offs and loan adjustments that have nothing to do with the underlying operational performance of the company. There is a steady trend apparent here, but unfortunately the earnings per share trend is steadily down. I can see Warren over there. He is looking even less impressed than last year!
Conclusion: FAIL TEST
Time to update the earnings per share trend for the current financial year.
Earnings per share are calculated by taking the normalised net profit after tax and dividing that by the number of shares on issue at the end of the financial year.
FY2018: ($85m + 0.72( $5m+$5m+$7m)) / 429.641m = 22.6cps
FY2019: ($53m + 0.72( $1.5m+$2m+$3m+$3m+$6m+$2m )) / 439.288m = 14.9cps
FY2020: ($52m + 0.72( $2m+$6m+$5m+$2m+$1m+$5m+$3m-$3m ) - $5m) / 444.492m = 13.9cps
FY2021: ($47m + 0.72( $2m+$1m-$4m+$7m ) +$1m) / 447.025m = 11.7cps
FY2022: ($64m - $9m -$3m - $3m + 0.72(-$3m+$1m+$1m+$7m-$7m) ) / 446.512m = 10.8cps
Notes
1/ Normalised FY2018 result removes a $5m labour restructuring charge, removed a $3m interest charge realised from a reset of a GBP Euro Medium Term Note (EMTN) interest rate swap (the interest rate exposure is only partially hedged, explaining the need for a reset). A further interest charge of $7m, based on the amortisation of the ineffectiveness of the EMTN cashflow hedge (closed out on 9 December 2013), has been added back.
2/ Normalised FY2019 removes $1,5m of labour restructuring costs, $2m of consultants fees investigating the forthcoming regulatory regime, and $3m from a set aside implementation charge to get the new regulatory framework in place. Removed a $3m interest charge realised from a reset of a GBP Euro Medium Term Note (EMTN) interest rate swap (the interest rate exposure is only partially hedged, explaining the need for a reset). A further interest charge of $6m, based on the ineffectiveness of the EMTN cashflow hedge has been added back. A $2m one off expense for restructuring two forward dated interest rate swaps has also been removed.
3/ Normalised FY2020 removes a combined $2m Covid-19 relief payment encompassing Fibre and Copper broadband customers, a $6m increase in Covid-19 staff leave provisions and contractors to help make the transition to the new regulatory framework, a $5m payment to contracted service companies to help them through the lock-down periods (adding to a total $13m of Covid-19 relief response), an incremental $2m increase in consultancy fees related to the regulatory transition, a $1m one off expense for restructuring forward dated interest rate swaps. I have removed a $5m interest charge, realised from a reset of a GBP Euro Medium Term Note (EMTN) interest rate swap (the interest rate exposure is only partially hedged, explaining the need for a reset). A final further interest charge of $3m, based on the ineffectiveness of the EMTN cashflow hedge has been added back, and at EOFY2020 and, this 9 December 2013 transaction, was finally 'closed out' of the account books. I subtract $5m from NPAT, to account for the one off $5m tax refund resulting from the resumption of building depreciation. Finally my normalised FY2020 now removes a favourable $3m one off settlement (not mentioned in AR2020 specifically, but see AR2021 p17))
4/ Normalised FY2021 profit adjusts for a $1m value Added Network one off dispute settlement (assumed non taxable), a $2m one off restructuring labour costs, as a result of the ongoing transition from a 'build it' to a 'manage it' network, and $1m of costs relating to the decommissioning of legacy copper network equipment in Spark exchanges. I have subtracted a $4m reduction of interest costs relating to the "Ineffective portion of changes in fair value of cash flow hedges" and added back $7m interest charge arising from interest rate swap resets.
5/ Normalised FY2022 profit subtracts $9m, from a one off benefit following a judicial review of a one off interpretation of the Holiday's Act, subtracts $3m from a surplus property sale and subtracts $3m form a legal settlement. Further adjustments where tax effects should be considered include a $3m benefit from a change of lease contract (normalisation reverses this), adding back $1m of make good costs relating to office moving and renovation, adding back $1m spent on external consultants advising on transitioning to the new regulated operating framework, adding back the $7m finance expense credit resulting from ineffective cash flow hedging and subtracting $7m of finance expenses relating to an adjustment of interest swap resets.
Conclusion: FAIL TEST
SNOOPY