SKC - Sky City

[Snoopy]

Year	Normalised Net Profit {A}	S/h Equity EOFY {B}
FY2012	$140.264m	$809.1m	17.3%
FY2013	$129.209m	$812.9m	15.9%
FY2014	$102.221m	$773.8m	13.2%
FY2015	$130.106m	$816.9m	15.9%
FY2016	$152.319m	$1,113.0m	13.7%

The FY2016 result is a little unfair. The end of the financial year is 30th June. So the $263m of new capital raised from shareholders in June 2016 was only on the books for a month. If I remove this new shareholder equity from my calculation I get an ROE for FY2016 of:

$152.319m/ ($1,113m - $263m) = 17.9%

On this basis I am prepared to overlook the failure for FY2016.

Conclusion: Pass Test

[Snoopy]

Year	Normalised Net Profit {A}	Revenues {B}
FY2012	$140.264m	$960.2m	14.6%
FY2013	$129.209m	$970.7m	13.3%
FY2014	$102.221m	$928.2m	11.0%
FY2015	$130.106m	$1,037.0m	12.5%
FY2016	$152.319m	$1,131.5m	13.5%

Despite the net profit margin being less than five years ago, the turnaround trend over the last three years shows that margin improvement is still possible.

Conclusion: Pass Test

SNOOPY

[Snoopy]

SKC is not a suitable company to apply the Buffett growth model to right now, because the the 'earnings per share' increasing trend that is required is not there. This doesn't mean that SKC is necessarily a poor investment though. It just means that we need a different method to analyse the likely investment potential from here. And that means rolling out the 'Capitalised Dividend Model' method (!). Stay tuned.

SNOOPY

discl: hold SKC

[Snoopy]

The indebtedness of a company is one factor that influences 'investment risk'. 'Investment risk' influences the return a new investor into Sky City today might expect.
Sky City earned $146.847m in normalised profit over FY2016. When you stack this up against the corporate loans that the company must eventually repay:

Current Loans	$38.028m
Non-Current Loans	$389.032m
Total Loans	$427.060m

then the 'minimum debt repayment period' (MDRP) is a mere:

$427.060m / $146.847m = 2.9 years

That is expectedly (given the cash issue a month before balance date) low. Yet there was a reason behind the cash issue. SKC has committed to spending $NZ700m at the Auckland site, the majority of that going towards the new Convention Centre. Furthermore, Sky City is committed to spending $A300m ($NZ333m assuming $A0.9 =$NZ1-) more on the Adelaide development. These are huge committed costs, largely not reflected on the books as at 30-06-2016.

We are told that during the year $8.674m of interest has been capitalised at an interest rate of 6.03%. This implies capital expenditure of:

$8.674m / 0.0603 = $143.8m

I believe that this money relates to capital already spent developing the Auckland site. So this leaves:

$700m - $144m = some $556m still to spend

If we add the Auckland and Adelaide expected development debts to the company debt as at 30th June 2016, a different picture of indebtedness emerges.

Current Loans	$38m
Non-Current Loans	$389m
Incremental Auckland Indebtedness	$556m
Incremental Adelaide Indebtedness	$333m
Total Loans	$1,316m

The MDRT now blows out to:

$1,316m / $152.3m = 8.6 years

I would describe this as getting towards the high end of 'medium indebtedness'. This is not unusual for a company with a relatively secure recession resistant cashflow stream available. I haven't considered any reinvestment via the dividend reinvestment scheme which would reduce this figure. But it is clear to me that SKC does not have a lot of room to move on any other capital initiatives.

Personally I am comfortable with the way SKC is managing its capital requirements, particularly as those very generous fellows at Fletcher Building have agreed to pick up all cost overruns on the Auckland site at least. I reckon retiring Flectcher CEO Mark Adamson deserves a seat on the SKC board - equivalent to a 'nod' (if the Convention Centre was a project the government had paid for I would have expected 'Sir Mark' to be knighted) - for all of the 'construction value' that he has generously donated to managing the Auckland Convention centre costs.

Yet 'medium to high' expected debt is 'medium to high' expected debt. Despite the likelihood of strong future cashflows, I will require a 6.5% gross return on my investment in SKC to make an investment deal in SKC today, work for me.

SNOOPY

[Snoopy]

Yet 'medium to high' expected debt is 'medium to high' expected debt. Despite the likelihood of strong future cashflows, I will require a 6.5% gross return on my investment in SKC to make an investment deal in SKC today, work for me.

The following is a record of all of the dividend payments over the last five years from a New Zealand perspective. 'From a New Zealand perspective' means that the investor concerned can take advantage of New Zealand imputation credits.

Payment Date	Dividend Imputation Percentage	Declared Dividend	Gross Dividend (I/C adjusted)
17-03-2017	0%	10.0cps	10.0cps
16-09-2016	50%	10.5cps	12.54cps
16-03-2016	0%	10.5cps	10.5cps
02-10-2015	33%	10.0cps	11.0cps
02-04-2015	0%	10.0cps	10.0cps
03-10-2014	100%	10.0cps	13.89cps
04-04-2014	0%	10.0cps	10.0cps
04-10-2013	100%	10.0cps	13.89ps
05-04-2013	50%	10.0cps	11.94cps
05-10-2012	60%	8.0cps	9.87cps
Five Year Average		19.8cps	22.73cps

Assuming a required rate of return of 6.5%, this translates to a share price of:

$0.2273 / 0.065 = $3.50

This is a 'business cycle average' valuation. My rule of thumb is that under different market conditions, the share price is liable to fluctuate up to 20% above and down to 20% below 'fair value'. This implies an 'all the ducks lining up' top of the market valuation of $4.20 cum dividend. At a $4.25 close on the market on Friday, but with a dividend payment of some 10c due within a couple of months, SKC is looking very fully priced using this valuation technique. Perhaps reducing one's holding on any market strength from here is the way to go?

SNOOPY

[Snoopy]

Assuming a required rate of return of 6.5%, this translates to a share price of:

$0.2273 / 0.065 = $3.50

This is a 'business cycle average' valuation.

I have to admit, as a long term SKC shareholder, to being disappointed with this $3.50 valuation. It is a 'no eps growth' valuation, that's true. But the record is clear. Despite all the promise, there hasn't been any 'eps' growth over the last five years. That means assuming future growth, given the history, becomes a matter of faith. So far, I am still part of the SKC faithful. One thing that I cannot get my head around is the lack of imputation credits. If all dividends had been fully imputed over the last five years, then my valuation would change markedly:

($0.198/0.72) / 0.065 = $4.23

A lack of imputation credits is often a sign that the company is not making taxable profits. But as far as I can tell from the taxation reconciliation section of the accounts, the shortage of imputation credits is not fully explained by this. At the moment it is a mystery to me why SKC are not able to pass on more imputation credits than they do. The 'Capitalised Dividend Valuation Method' punishes companies that do not pay fully imputed dividends, and rightly so!

SNOOPY

[Snoopy]

A lack of imputation credits is often a sign that the company is not making taxable profits. But as far as I can tell from the taxation reconciliation section of the accounts, the shortage of imputation credits is not fully explained by this. At the moment it is a mystery to me why SKC are not able to pass on more imputation credits than they do.

For the last several years, there has been a note on 'Income Tax Expense' (note 11 in AR2016) that outlines a bridge from the 'nominal company tax' that would be paid at the company rate of 28% to the 'actual tax paid'. I have constructed the table below from the last five years of this information.

	Prima Facie Income tax @ 28% {A}	Actual Income Tax Expense {B}	Implied Earnings Imputed Percentage {B}/{A}	Imputation Credit %ge Available for Dividends (*)
FY2016	$55.235m	$51.597m	93%	100%
FY2015	$47.840m	$42.114m	88%	100%
FY2014	$35.994m	$30.014m	88%	100%
FY2013	$47.018m	$40.538m	77%	96.25%
FY2012	$50.073m	$39.962m	80%	100%

(*) Assuming an 80% payout ratio, in accordance with the dividend policy stated in AR2016 p8: "in line with out stated dividend policy of distributing at least 80% of normalised NPAT to shareholders each year."

Actual tax paid in any one year could fluctuate. For example, There might be a difference in timing of terminal tax based on inaccurate prior provisional tax payments that means that the tax paid in a particular financial year might not equate to 28%, even if the tax bill did come to 28%. Over the years though, such differences should average out.

Imputation credits are earned on all earnings for which tax is billed and paid. This means that if a company does not pay out 100% of earnings in dividends (the case for Sky City), there should be a gradual build up in the imputation credit account. This in turn means that in a lean year (like FY2013), there should be some surplus imputation credits that can be paid out to shareholders, should management dictate that dividend payments should be maintained above actual earnings for that one year.

The above table shows that in all years but FY2013, there should have been enough imputation credits to pay out fully imputed dividends to all shareholders. However, if you look at the actual payment record over the last five years (my post 512), only one dividend of the ten was paid out 'fully imputed''. If there were even a few imputation credits in the bank in FY2013, it should have been possible to pay out all ten dividends as fully imputed! So why was only one dividend paid out fully imputed? I am truly baffled. It doesn't make sense.

And lest anyone think I am getting hung up on a minor technical point, the difference between 'paying out dividends as they did' and 'fully imputed' changes the valuation of the company from $3.50 to $4.23. And that makes all the difference as to whether the company is an invest-able proposition going forwards or not.

SNOOPY

[Snoopy]

The following is a record of all of the dividend payments over the last five years from a New Zealand perspective. 'From a New Zealand perspective' means that the investor concerned can take advantage of New Zealand imputation credits.

Payment Date	Dividend Imputation Percentage	Declared Dividend	Gross Dividend (I/C adjusted)
17-03-2017	0%	10.0cps	10.0cps
16-09-2016	50%	10.5cps	12.54cps
16-03-2016	0%	10.5cps	10.5cps
02-10-2015	33%	10.0cps	11.0cps
02-04-2015	0%	10.0cps	10.0cps
03-10-2014	100%	10.0cps	13.89cps
04-04-2014	0%	10.0cps	10.0cps
04-10-2013	100%	10.0cps	13.89ps
05-04-2013	50%	10.0cps	11.94cps
05-10-2012	60%	8.0cps	9.87cps
Five Year Average		19.8cps	22.73cps

Assuming a required rate of return of 6.5%, this translates to a share price of:

$0.2273 / 0.065 = $3.50

This is a 'business cycle average' valuation. My rule of thumb is that under different market conditions, the share price is liable to fluctuate up to 20% above and down to 20% below 'fair value'. This implies an 'all the ducks lining up' top of the market valuation of $4.20 cum dividend. At a $4.25 close on the market on Friday, but with a dividend payment of some 10c due within a couple of months, SKC is looking very fully priced using this valuation technique. Perhaps reducing one's holding on any market strength from here is the way to go?

The following is a record of all of the dividend payments over the last five years from an Australian perspective. 'From an Australian perspective' means that the investor concerned can take advantage of Australian franking credits. Despite being from an Australian perspective, I have expressed all dollar values in NZ dollars to facilitate easier comparison with the NZ perspective case.

Payment Date	Dividend Franking Percentage	Declared Dividend	Gross Dividend (F/C adjusted)
17-03-2017	0%	10.0cps	10.0cps
16-09-2016	0%	10.5cps	10.5cps
16-03-2016	0%	10.5cps	10.5cps
02-10-2015	0%	10.0cps	10.0cps
02-04-2015	25%	10.0cps	11.07cps
03-10-2014	0%	10.0cps	10.0cps
04-04-2014	100%	10.0cps	14.29cps
04-10-2013	0%	10.0cps	10.0ps
05-04-2013	50%	10.0cps	12.14cps
05-10-2012	60%	8.0cps	10.06cps
Five Year Average		19.8cps	21.71cps

Assuming a required rate of return of 6.25%, this translates to a share price of:

$0.2171 / 0.0625 = $3.47

(Note that I have reduced the acceptable return to 6.25% -Aus perspective - from 6.5% (NZ Perspective). This takes into account the reserve bank cash rate being 1.5% in Australia, 0.25% less than the 1.75% in New Zealand.)

This is quite an interesting result, because it shows the value of SKC to the NZ or Aus dividend hound is more or less the same!

SNOOPY

[Snoopy]

This is quite an interesting result, because it shows the value of SKC to the NZ or Aus dividend hound is more or less the same!

Now that we have considered dividends from both the NZ and Oz perspective, it is time to combine the two.

A bit of background: Imputation Credits are an NZ Market creation to ensure that shareholders, the owners of the company, only pay tax on their share of company income once. An 'imputed dividend' means that an NZ shareholder can take credit for any company paid tax that the company in which they own shares has already paid on their behalf. An 'unimputed dividend' means the company has not paid tax on that dividend. So it is up to the shareholder to pay the tax on their 'dividend income' themselves.

There is an exactly analogous system operation in the Australian market called 'Franking Credits'. However, the NZ Inland Revenue does not recognize Australian franking credits and vica versa. This poses a bit of a dilemma for companies that operate with scale on both sides of the Tasman. They have to balance the interests of both NZ investors and Australian investors by doing some 'mixing and matching' as to where they declare their profits. By 'mixing and matching' I am referring to the the practice of transfer pricing. The location of some company costs are optional. And where the company chooses to incur these costs influences the relative profitability on each side of the Tasman.

One reflection of where a company allocates their costs can be seen in whether dividends are either 'imputed' or 'franked'. Income is never franked and imputed, because that would mean paying tax on the same income twice in both countries and no responsible management would allow that to happen. So the balance between franked and imputed income, as reflected through dividends paid from that income, is of interest to shareholders. The amount of imputing or franking for each dividend declared over the last five years I have listed in the table below.

Payment Date	Dividend Imputation Percentage	Dividend Franked Percentage	Imputed + Franked Percentage
05-10-2012	60%	60%	120%
05-04-2013	50%	50%	100%
04-10-2013	100%	0%	100%
04-04-2014	0%	100%	100%
03-10-2014	100%	0%	100%
02-04-2015	0%	25%	25%
02-10-2015	33%	0%	33%
16-03-2016	0%	0%	0%
16-09-2016	50%	0%	50%
17-03-2017	0%	0%	0%

A couple of 'discussion points' arise from this table.

SNOOPY

[Snoopy]

The following is a record of all of the dividend payments over the last five years from a New Zealand perspective. 'From a New Zealand perspective' means that the investor concerned can take advantage of New Zealand imputation credits.

Payment Date	Dividend Imputation Percentage	Declared Dividend	Gross Dividend (I/C adjusted)
17-03-2017	0%	10.0cps	10.0cps
16-09-2016	50%	10.5cps	12.54cps
16-03-2016	0%	10.5cps	10.5cps
02-10-2015	33%	10.0cps	11.0cps
02-04-2015	0%	10.0cps	10.0cps
03-10-2014	100%	10.0cps	13.89cps
04-04-2014	0%	10.0cps	10.0cps
04-10-2013	100%	10.0cps	13.89ps
05-04-2013	50%	10.0cps	11.94cps
05-10-2012	60%	8.0cps	9.87cps
Five Year Average		19.8cps	22.73cps

Assuming a required rate of return of 6.5%, this translates to a share price of:

$0.2273 / 0.065 = $3.50

This is a 'business cycle average' valuation. My rule of thumb is that under different market conditions, the share price is liable to fluctuate up to 20% above and down to 20% below 'fair value'. This implies an 'all the ducks lining up' top of the market valuation of $4.20 cum dividend. At a $4.25 close on the market on Friday, but with a dividend payment of some 10c due within a couple of months, SKC is looking very fully priced using this valuation technique. Perhaps reducing one's holding on any market strength from here is the way to go?

The following is a record of all of the dividend payments over the last five years from a New Zealand perspective. 'From a New Zealand perspective' means that the investor concerned can take advantage of New Zealand imputation credits.

Payment Date	Dividend Imputation Percentage	Declared Dividend	Gross Dividend (I/C adjusted)
1x-03-2018 (*)	0%	10.0cps	13.89cps
15-09-2017	50%	10.0cps	13.89cps
17-03-2017	0%	10.0cps	10.0cps
16-09-2016	50%	10.5cps	12.54cps
16-03-2016	0%	10.5cps	10.5cps
02-10-2015	33%	10.0cps	11.0cps
02-04-2015	0%	10.0cps	10.0cps
03-10-2014	100%	10.0cps	13.89cps
04-04-2014	0%	10.0cps	10.0cps
04-10-2013	100%	10.0cps	13.89ps
Five Year Average		20.2cps	23.92cps

(*) This dividend is a forecast. and in line with the company stated dividend policy. The very strong imputation credit balance (note 13, AR2017) indicates the final dividend ought to be fully imputed this year.

Assuming a required rate of return of 6.5%, this translates to a share price of:

$0.2392 / 0.065 = $3.68

This is a 'business cycle average' valuation. My rule of thumb is that under different market conditions, the share price is liable to fluctuate up to 20% above and down to 20% below 'fair value'. This implies an 'all the ducks lining up' top of the market valuation of $4.42 cum dividend. At a $3.97 close on the market on Friday, but with a dividend payment of some 10c due within a couple of days, SKC is trading at a modest 5% premium to 'fair value' using this valuation technique. I already hold this share, and may look to buy more if the price slips below that $3.70 level.

SNOOPY