Starhub

[Dividend Warrior]

You are still confusing EPS with FCF For example in 2010 EPS was 0.15 and DPS was 0.20, but in terms of cashflow it was operating cashflow of $700m and capex $270m so FCF was $430m out of which they paid $343m for dividend

But last year their operating cashflow was only $580m and capex jumped to $300m which was not sufficient to fund their dividend of $343m. That is what we are discussing about.

This is a good summary.

[specuvestor]

And that's why GG we are spending time on this

Something has changed. That's important. Rather than hold on to an idea come rain, shine, earthquake.

Was wondering why so much time being spent analysis a fixed income type of business?

If Starhub is trading half the price, may be worth spending time but now that it is trading at near all-time highs, I think better quality of time should be spent looking at other counters...

Vested
Long Term Investment
GG

[Temperament]

I was then even more surprised to learn from the folks here that even worse, they don't even have sufficient FCF to cover the dividends. And we are not talking about 1 or 2 years. It's several years in a row. I did hear there are companies running in this mode for a long time but personally, I would ask myself, why don't look elsewhere? To be specific, I wasn't targeting starhub and it just turns out that starhub's RE stood out like a sore thumb amongst the 3 telcos. Although this factor alone may not form an investment decision but at least it would lead me to try and understand more (for my learning purposes). Anyway, once again, thanks for sharing the article.

I don't think that is true historically. However what we are trying to analyse is whether it will be the case in the future.

quote='Temperament' pid='91067' dateline='1407561204']

I am kind of puzzle with your statement. Seems like your view is "since i buy low, i can continue be vested". Shouldn't it be based on today price to justify hold or not else you are in the opinion that losing the capital gained does not matter ?

Having bought shares at a lower price, and not selling at a higher price is an investment for the longer term.

A belief that the company is able to generate sustainable dividends and grow its value.

The practice of buy low and sell high is for traders, not a value investor.
Then again how high is high?
That is where some homework needs to be done.

Semcorp Marine is now priced at $3.98 ( or thereabouts). If it was acquired at the price of $2.00 say, 20 years ago, should it be sold, to lock in capital gains?
The opportunity cost of not being invested has to be weighed, no? ( assuming zero holdings after the sale).

In fact, if the belief holds that the company is still sound and the industry is still viable, it may be better to buy even more!

Exactly. Which i am of the view that if current price of starhub makes sense we should continue to invest or more. If the price is out of whack, regardless of entry price, we should sell.

Whatever! Don't we have to take the tendency of share price mean reversion into consideration?

Entry price is irrelevant except as a reminder of WHY we buy at THAT price. And how it gels with the current argument of holding on. And some will argue: If you don't hold it now, would you buy?

And how will the share price act under the 3 different structure scenario presented below? What does the value investor see?

Starhub is a very interesting extreme case study on debt structure

Indeed they can repay their debt in 1.5 years if they choose not to pay dividends. In that case their equity will jump and debt goes to zero. ROE plunges while PE slides

Obviously the company is a cashcow that will not collapse. But will the share price collapse?

Asset and business didnt change but the structure change and shareholders are affected nonetheless

Or take the middle path and use ½ the FCF to retire debt instead of dividends to save interest cost. After 3 years go debt free. Will that be better for shareholders?

It's going to be a very difficult decision for starhub to make if they want to take the bold step of cutting or drastically reducing dividends. Their share price may plunge and the CEO would be under tremendous pressure and his (plus others) options may be underwater. As it is, things are not looking good. If I were a long term investor of starhub, I would prefer them to take the middle path. Their dividend strategy of driving the share price higher has turned them into a 'dividend junkie'.

[/quote]
Sorry, i have declared (before) i am a "Rojak Investor". A little bit of everything to make one of our favourite local dish. Of course some people abhor this dish just like some people have declared war on "Mount San Durian". Not me.

[Stecano]

You are still confusing EPS with FCF For example in 2010 EPS was 0.15 and DPS was 0.20, but in terms of cashflow it was operating cashflow of $700m and capex $270m so FCF was $430m out of which they paid $343m for dividend

But last year their operating cashflow was only $580m and capex jumped to $300m which was not sufficient to fund their dividend of $343m. That is what we are discussing about.

Yes, I now realise where my mistake was. I should not have used EPS below DPS as a means to determine whether FCF is sufficient to cover dividends. I should have looked at OCF and capex instead. Thanks for your pointing out my mistake.

[Temperament]

DIVIDENDS PAYOUT RATIO:-
Earnings per share or free cash flow: What's the difference?


The quick and clean method of determining a dividend's safety is by the payout ratio. The payout ratio is calculated by taking the dividends per share and dividing it by the earnings per share (EPS).


It's fairly easy and straight-forward and can be found on just about any financial website. Of course there's all sorts of variations on the payout ratio as you can take the trailing twelve months payout ratio, forward twelve months payout ratio, a blend of the two... The only thing that changes between those is what kind of dividends and earnings per share you're using, the calculation is the same. But for some industries the traditional method just isn't all that useful.

Let's start with the difference between earnings per share and free cash flow per share. Earnings are derived from the net income of a company. Essentially you take the revenue of a company subtract certain expenses such as administrative, depreciation, interest expenses, cost of goods, taxes, and a whole host of other items. That leaves you with the net income for that company and to get the earnings per share you just divide by the shares outstanding. All earnings per share information and calculations can be found on a company's income statement.



Free cash flow on the other hand is a bit different. You start with the net income from before but you have to add back some items that aren't cash expenses, such as depreciation and amortization. This will give you the operating cash flow of a company and the free cash flow is calculated by subtracting the capital expenditures (Capex, "purchase of plant, property, equipment").

Let's run through an example to see what the difference is on earnings and free cash flow. We'll assume a company needs to purchase a truck in order to deliver its goods. The company has a net income of $20,000 each year and the truck costs $10,000. To follow standard accounting practices the truck will be depreciated over a 4 year period, its assumed useful life, at 25% of the cost per year.
Year Net Income Free Cash Flow
1 $20,000 $10,000
2 $17,500 $20,000
3 $17,500 $20,000
4 $17,500 $20,000
5 $17,500 $20,000
Total $90,000 $90,000

So in year 1 the company had to spend $10,000 to purchase the truck. You wouldn't know it from looking at the income statement but there it is showing up on the cash flow statement as capex. So there's a $10,000 difference between the net income (earnings) and free cash flow for the company in year 1. When year 2 rolls around net income will show a depreciation charge of 25% x $10,000 = $2,500 where as cash flow is no longer effected. This will continue on until the depreciation period is up and then net income and free cash flow would be equal in this simple example.

For companies with large capital expenditures (think telecoms like AT&T and Verizon or utilities like PPL and Southern Company), depreciation charges can be very significant and lead to large differences in the earnings and free cash flow that a company generates.

Let's look at Verizon's financials from the last few years. Keep in mind this isn't the end all be all of reading a financial statement, but I just want to highlight a few of the key differences between the balance sheet and income statement and their effect on earnings and cash flow.

Figure 1: Balance Sheet, i.e. earnings per share
[Image: VZ+eps.bmp]
[Image: VZ+cash+flow.bmp]




Figure 2: Cash flow

[Image: VZ+payout.bmp]

Depreciation and amortization charges are non-cash charges so they don't effect the cash flow year after year. You'll notice a big difference between the earnings per share numbers and the free cash flow per share numbers. In 2012 Verizon had only $0.31 per share in earnings but a huge $3.97 per share in free cash flow. That's over a factor of 10 difference. 2011 wasn't on quite the same scale but it was still $0.85 in earnings but $4.77 in free cash flow. That's a difference of over 5.5 times. 2010 saw 6.6 times higher free cash flow than earnings per share.

So how does this effect a dividend growth investor? If you look at the traditional calculation of the payout ratio, dividends divided by earnings, it appears that Verizon's dividend is surely going to be cut. So you might shy away from investing money in a stable company like Verizon.


Figure 3: Payout ratios

The payout ratios were over 200% in both 2010 and 2011 and a whopping 664% in 2012. That doesn't seem sustainable in the least bit. But remember, depreciation charges are a drag on earnings over the expected useful life of the property, plant or equipment that was purchased, whereas it's a one time charge to the cash flow.

Recalculating the payout ratio as dividends divided by free cash flow paints a much different picture. The FCF payout ratio has increased from 30% in 2010, to 41% in 2011, to 51% in 2012. That's much different than the 203%, 234%, and 664% from the earnings per share payout ratio.

For companies that are very capital intensive, the earnings per share and free cash flow numbers can vary greatly. You need to make sure that you're using the right payout ratio when analyzing the safety of a potential investment because the wrong one can lead to wildly different conclusions.

*Keep in mind that there are many other factors to consider before investing your hard earned money than just calculating the payout ratio of a company and that this is in no way an all-inclusive lesson in reading financial statements.
Posted by Passive IncomePursuit at 7:30 AM
Email ThisBlogThis!Share to TwitterShare to FacebookShare to Pinterest
Labels: stock valuation method
Thanks to IncomePursuit.
There is really no end to learning.

[Stecano]

Thanks for sharing. Good stuff!

[greengiraffe]

Still can't sell buddy. My CPF investment already over limit liao, sell liao money back in CPF earns 2.5% while Starhub at my costs yields close to 10%.

As long as DPS stays flat and Starhub continues to be a viable concern, no worries. In fact in another 4 years, my investment is already recouped liao... the locked up has effectively turn this yielder into a solid investment.

I remember years ago, I recommended a friend to long APB under $5, he bought 1 lot under srs and simply forgotten about the existence. By 2010, he already recouped all his investments and when the buyout came... $53 plus more dividends....

His motto now, as long as he get 7% yield on costs, please dun privatise my company and return me money to give me more him more headches. His similar type of investment included CMPac (bought under $0.30), Boustead (bought under $0.50), vicom (bought under $0.70), Starhub (bought under $2.00), M1 and he even recently accumulated GPI. A true legend even though he buys a little of such stocks...

GG

And that's why GG we are spending time on this

Something has changed. That's important. Rather than hold on to an idea come rain, shine, earthquake.

Was wondering why so much time being spent analysis a fixed income type of business?

If Starhub is trading half the price, may be worth spending time but now that it is trading at near all-time highs, I think better quality of time should be spent looking at other counters...

Vested
Long Term Investment
GG

[Temperament]

So anyone like to do a real few years analysis on Star Hup dividend payout ratio based on :-

{DIVIDENDS PAYOUT RATIO:-
Earnings per share compare to free cash flow: to find out what's the real difference}
So that GG may or may not change his mind. Who knows i may be buying Star Hup in future.

[greengiraffe]

No matter what can't sell lah... anyway, unless the oligopoly telco industry in Singapore breaksup which may imply something adverse happens to PAP since they have interests in all 3 telcos, then I m done for...

Can't sell lah... money back to CPF generates 2.5% only... at least now under 5% still close to double...

Happy problem lah... Can't sell

GG

So anyone like to do a real few years analysis on Star Hup dividend payout ratio based on :-

{DIVIDENDS PAYOUT RATIO:-
Earnings per share compare to free cash flow: to find out what's the real difference}
So that GG may or may not change his mind. Who knows i may be buying Star Hup in future.

[CityFarmer]

Still can't sell buddy. My CPF investment already over limit liao, sell liao money back in CPF earns 2.5% while Starhub at my costs yields close to 10%.

As long as DPS stays flat and Starhub continues to be a viable concern, no worries. In fact in another 4 years, my investment is already recouped liao... the locked up has effectively turn this yielder into a solid investment.

I remember years ago, I recommended a friend to long APB under $5, he bought 1 lot under srs and simply forgotten about the existence. By 2010, he already recouped all his investments and when the buyout came... $53 plus more dividends....

His motto now, as long as he get 7% yield on costs, please dun privatise my company and return me money to give me more him more headches. His similar type of investment included CMPac (bought under $0.30), Boustead (bought under $0.50), vicom (bought under $0.70), Starhub (bought under $2.00), M1 and he even recently accumulated GPI. A true legend even though he buys a little of such stocks...

GG

It may be good reason(s) not to sell, but it shouldn't be due to "yield at cost". The opportunity cost is a real cost, and an important consideration for value investor, IMO.

I am always skeptical on statement of "recouped all cost already, so it is FOC". It is a misleading statement for newbie, thus my post here.