BT3/: RETURN ON EQUITY (>15% for five years, one setback allowed) [perspective 2022]
Quote:
Originally Posted by
Snoopy
Normalised profit is divided by shareholders equity at the end of the financial year
FY2017: $131.7m / $944m = 14.0%
FY2018: $97.2m / $1,022m = 9.5%
FY2019: $65.6m / $979m = 6.7%
FY2020: $62.0m / $927m = 6.7%
FY2021: $52.3m / $948m = 5.5%
At no time over the last five years has 'Return On Equity' exceeded 15%
Conclusion: FAIL TEST
Normalised profit is divided by shareholders equity at the end of the financial year
FY2018: $97.2m / $1,022m = 9.5%
FY2019: $65.6m / $979m = 6.7%
FY2020: $62.0m / $927m = 6.7%
FY2021: $52.3m / $948m = 5.5%
FY2022: $48.3m / $1,029m = 4.7%
At no time over the last five years has 'Return On Equity' exceeded 15%. And I don't like the multi-year trend.
Conclusion: FAIL TEST
SNOOPY
BT4/ Ability to raise margins at above the rate of inflation [perspective 2022]
Quote:
Originally Posted by
Snoopy
'Net Profit Margin' is the 'Normalised Net Profit After Tax' divided by 'company sales' over the financial year
FY2017: $131.7m / $1,040m = 12.7%
FY2018: $97.2m / $990m = 9.8%
FY2019: $65.6m / $970m = 6.8%
FY2020: $62.0m / $959m = 6.5%
FY2021: $52.3m / $947m = 5.5%
A long commentary for FY2020. A somewhat shorter assessment for FY2021: Yikes!
Conclusion: FAIL TEST
'Net Profit Margin' is the 'Normalised Net Profit After Tax' divided by 'company sales' over the financial year
FY2018: $97.2m / $990m = 9.8%
FY2019: $65.6m / $970m = 6.8%
FY2020: $62.0m / $959m = 6.5%
FY2021: $52.3m / $947m = 5.5%
FY2022: $48.3m / $965m = 5.0%
Pretty hard to see any ability to raise margins when the trend is relentlessly down over five years.
Conclusion: FAIL TEST
SNOOPY
Buffett Test: Overall Evaluation Conclusion [perspective 2022]
Quote:
Originally Posted by
Snoopy
A cursory assessment of Chorus would suggest this is the place to put your money. The internet is the growth engine of the 21st century. Fibre is the best fast technology and Chorus is a monopoly provider of fibre. What is there not to like?
A closer Buffett style inspection tells a very different story. Underlying 'earnings per share' have roughly halved over the last three years. If you believe the company's own cost of capital assessment, earnings now barely cover its cost of capital. And net profit margins remain under intense pressure. We have to bear in mind that Buffett assessments are not friendly towards capital intensive companies. So it is no surprise that under the spotlight of the Buffett criteria, Chorus sings a woeful song.
Chorus last traded on market at a price of $7.76. Based on FY2020 normalised earnings, this is an historical PE ratio of 46.7. That seems incongruous with a low growth company with margins under pressure. Is this evidence that 'Mr Market' truly has gone mad? The hindsight of history may yet prove this to be true. At these prices, you would have to assume that Warren Buffett would be looking at a different home for his investment cash.
Conclusion: Warren would give Chorus the big 'thumbs down' as an investment prospect
P.S. There is a postscript to the Chorus story. It is a company in transformation that is not reflected in this 'historical' Buffett style analysis. Roll out of the fibre cable nationwide is nearing completion. With future calls on capital drastically reduced, but depreciation on the network assets remaining high, from FY22 we will transition to a dividend policy based on a window emerging where cashflow will greatly exceed profitability. In Chorus's own words from the FY2021 result presentation, Slide 21:
"From FY22 we will transition to a dividend policy based on a pay-out range of free cash flow▪free cash flow will be defined as net cash flows from operating activities minus sustaining capex."
It is the expectation of significantly increased dividends well above sustainable declared profits that has investors salivating. What kind of dividends might shareholders expect from FY2022 onwards? The answer to that question will drive the direction in which my 'Chorus' research will now head.
Ok time to come clean. Evaluating Chorus against he Buffett criteria was a set up for failure. Why? Because the key to a Buffett style halo company is efficient use of assets. Clearly if you have just made a massive capital investment, as Chorus have done in their broadband network, -ahead of demand-, that network will not be used efficiently from day 1. Furthermore other 'network companies', like the power distribution companies, have built up their assets over decades. Many of those assets will be on the balance sheet at 'historical cost'. It doesn't take a genius to figure out that if your costs are largely historical, but your income is in present day dollars, that is a superior business model to Chorus.
Like the gentailers, Chorus is now a 'cashflow story'. If we evaluate Chorus against the more traditional metric of 'underlying earnings' (or 'normalised earnings' as I put it), Chorus, at $7.85, is currently trading on a PE ratio north of 70. No that is not a misprint!
If we look at the headline profit trend, Chorus is now climbing out of the profit dip that occurred when the network building costs were at their peak. However, once I normalise that profit for each year, this is not the case. Normalised Chorus profits hit new lows over FY2022. The fact that imputation credits on dividends have vanished is indicative of a company making next to nil real money in 'profit' terms. I contacted the CFO of Chorus about this and he claimed it was a 'depreciation issue', and that ultimately imputation credits would return. He was very coy as to when that might be though!
For reasons I have just outlined, I am not too worried about return on equity being low. What is of more concern is the ever reducing net profit margin on revenue that is not growing. I can forgive profit going down if it is a depreciation issue. But I am concerned about the flat revenue. One aspect of this is that -perversely-, the more people nationwide that move to fibre broadband (the barrow that Chorus is pushing), the more people who will move away from Chorus copper onto one of the regional fibre networks that Chorus does not own. And when 'regions' not fiberised by Chorus encompass such populous areas as Christchurch and Hamilton, that will hurt Chorus.
From my brief brush with members of the Chorus leadership team, my feeling is that the company is being run on a 'build it and they will come' mentality. There is nothing wrong with that, provided forward sales projections are realistic. The Australian equivalent company, NBN (National Broadband Network) is not so technology tunnel visioned. NBN use a couple of geo-centered satellites and wireless broadband to cover remote communities. So NBN is a 'technology agnostic' company. Personally I think the threat of wireless broadband is being underestimated by Chorus, and that they will have trouble convincing many 'hold outs' from fibre to switch over. On top of this we have the heavy hand of government regulation that caps overall revenue that may be taken by Chorus over a financial year. And the, according to Chorus, unrealistic cost of capital assumptions that have lead to such revenue caps.
The wrap: Chorus is clearly not a Warren Buffett style target investment. Whether it is a good cashflow style investment will require some more digging on my part. Stay tuned.
SNOOPY
Chorus IRD adjusted tax picture
Quote:
Originally Posted by
Snoopy
My next step will be to create an 'alternative profit picture', similar to that I believe is seen by the IRD, where I add the notional interest back onto income and restore the depreciation claimed back to what would have been claimed had no CIP implied 'depreciation discounts' ever existed.
|
FY2018 |
FY2019 |
FY2020 |
FY2021 |
FY2022 |
Total |
Net Profit After Tax (Declared) |
$85m |
$53m |
$52m |
$47m |
$64m |
add CIP Notional Interest Deducted |
0.72x $17m |
0.72x $22m |
0.72x $29m |
0.72x $34m |
0.72x $39m |
subtract Depreciation Discount |
0.72x ($22m) |
0.72x ($25m) |
0.72x ($27m) |
0.72x ($29m) |
0.72x ($27m) |
equals IRD Adjusted NPAT |
$81m |
$51m |
$53m |
$51m |
$73m |
Implied Income Tax Expense (@28%) |
($32m) |
($20m) |
($21m) |
($20m) |
($28m) |
|
|
add Reinstatement of tax on Building Depreciation |
|
|
$5m |
|
|
|
subtract Prior Period Tax Adjustment |
|
|
|
|
($6m) |
add Other Non-taxable adjustments |
($2m) |
($3m) |
($5m) |
($5m) |
($6m) |
equals IRD Adjusted Tax total (As calculated) |
($34m) |
($23m) |
($21m) |
($25m) |
($40m) |
($143m) |
Income Tax Expense (Declared) |
($37m) |
($25m) |
($21m) |
($25m) |
($42m) |
($150m) |
Tax Paid Actual (Declared in cashflow) |
($30m) |
($3m) |
($12m) |
($1m) |
($14m) |
($60m) |
Current Tax Expense (Tax Note 14) |
($16m) |
($6m) |
($1m) |
($1m) |
$3m |
($21m) |
Notes
1/ To calculate the 'Implied Income Tax Expense' at 28% from NPAT: (NPAT)/(1-0.28) - (NPAT) = 'answer'
2/ Numbers referred to in the above table as 'declared' are from the respective Profit & Loss statements.
3/ 'Other non-taxable adjustments are taken from section 14 'Taxation' of the respective annual reports.
--------------
Discussion
Please note that I am using some of the information from Ferg's post 2826 (thanks Ferg) to more correctly explain some of the terms and concepts in more recognised accounting terms.
I am working on the assumption that 'income tax declared' cannot be fudged by IFRS. IOW the amount of tax paid to the IRD is the same, no matter what perspective a company takes on how, and over what timeframe, other costs should be attributed. That means the figures of the second to last two rows of the table above should be the same.
One explanation of a deviation in the numbers reported between each of the two referred to rows could occur because I haven't accounted for tax payments from one year spilling over into adjacent years. Specifically I am thinking about payments made in advance called 'provisional tax' and payments in arrears called 'terminal tax'. The timing of such tax payments differ to the income tax expense declared in the annual report. But I am hoping that because Chorus is a closely defined predictable business, any such errors caused because of tax payment timing will be minor.
'Other non-taxable adjustments' (as tabulated above) that increase the actual tax paid above the statutory rate are unspecified but could include items like:
a) Permanent differences which are non-deductible items (such as some legal fees, 50% of entertainment, some IFRS adjustments etc). Note that I have included one class of permanent difference 'notional interest' in its own separate row, further up the table, AND
b) Timing differences claims which vary 'year to year' and usually unwind to a net impact of zero over a long enough time horizon (e.g. asset depreciation may be accelerated or retarded for IRD purposes vs accounting purposes, and the deductibility of holiday pay liabilities are subject to non-straightforward rules etc.) Note that I have reversed the contrary 'slowed depreciation rate', that is a consequence of CIP crown funding, in a separate line in the table above.
A separate issue is the 'Rural Broadband Initiative' (RBI) assets, funded by non‑taxable government grants. The accounting amortisation of RBI government grants and RBI accounting depreciation recognised in the profit and loss are non‑taxable and tax depreciation is not claimed (Refer AR2022 p20).
Conclusion
My measure of how well I understand the tax, and hence tax credit, position of Chorus is how well the third and fourth to last lines in the above table agree. FY2020 and FY2021 are in agreement, FY2022 and FY2019 are out by $2m and FY2018 is out by $3m. Reporting rounding errors could account for around $1m of those differences. Temporary differences from moving tax expenses could account for the rest. However, if temporary differences were the explanation, I would expect that over the years these differences in overpayments and underpayments would balance out. If you inspect the picture of the last five years by comparing the totals of the second and third to last table rows, it looks like underpayment of income taxes is entrenched.
Furthermore I would expect a Rural Broadband Initiative (RBI) effect, where construction is funded by grants and no depreciation is claimed. From AR2022 p20:
"RBI assets were funded by non‑taxable government grants. The accounting amortisation of RBI government grants and RBI accounting depreciation recognised in the profit and loss are non‑taxable and tax depreciation is not claimed."
If depreciation of RBI is not claimed, does that not mean that profits will increase in that arm of the business? Thus more tax will be paid on any RBI profits, thus increasing the tax bill above the statutory 28% rate?
I admit that I am speculating and I don't fully understand what is happening with the tax bills here. Nevertheless, I consider that I have identified enough 'wriggle room' in the taxation picture that could explain why my calculated 'IRD Adjusted Tax total' and the declared 'Income Tax Expense' are not in perfect agreement. Thus I believe my adjusted net profit figures, where notional interest and depreciation discounts are removed, provide a better representation of where the company is headed profit and tax wise than the IFRS reporting sanctioned and massaged 'official' NPAT figures.
SNOOPY