Effect on Profit if structural building depreciation is disallowed
This post is a repeat of post 182, but this time focussed on the change in 'Net Profit after Tax' specifically related to the change in depreciation laws
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 'fit out' depreciation allowed for in the accounts. To reflect this element, I have assumed 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 {A} |
$14.617m |
$14.816m |
$10.331m |
$13.200m |
$14.334m |
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 {B} |
$14.617m |
$14.816m |
$17.099m |
$20.207m |
$20.885m |
Scenario Difference
|
FY2019 |
FY2020 |
FY2021 |
FY2022 |
FY2023 |
Incremental IRD Operational Net Profit After Tax {B}-{A} |
$0.000m |
$0.000m |
$6.797m |
$7.007m |
$6.551m |
Although I have already done the 'Buffett Test' calculations for this company, I am wondering if it is fair to take the actual profit figures I have used for FY2021, FY2022 and FY2023 when a very large impact on the profitability over those years was because of a change in depreciation tax rules, a factor over which management had no control. After all, it is management performance we are trying to measure here - not the government's. As an extreme example, if the government put up the company tax rate to 100%, and the net profit for IPL dropped to zero as a result, could we blame company management for that?
Given this, I intend to rework those 'numerical' 'Buffett Tests', using the profit adjustment figures for FY2021, FY2022 and FY2023 that I have worked out in this post.
SNOOPY
BT2/ Increasing Earnings Per Share (One setback allowed) (FY2023 perspective view B)
Quote:
Originally Posted by
Snoopy
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
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 + $6.797m) / 368.135m = 4.75cps
FY2022: ($13.408m + $7.007m) / 368.135m = 5.55cps
FY2023: ($14.936m + $6.551m) / 367.503m = 5.85cps
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 allowed0 (FY2023 perspective view B)
Quote:
Originally Posted by
Snoopy
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
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: $17.494m / ($765.674m - $36.054m- $164.208m) = 3.09%
FY2022: $20.415m / ($855.042m - $36.054m -$255.802m) = 3.62%
FY2023: $21.487m / ($675.020m - $36.054m - $70.556m)= 3.78%
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 profit margin > inflation (FY2023 perspective view B)
Quote:
Originally Posted by
Snoopy
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
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% (target with 2% inflation 30.4% not net)
FY2021: $17.494m / $64.514m = 27.1% (target with 2% inflation 28.2%, not met)
FY2022: $20.415m / $67.923m = 30.1% (target with 2% inflation 27.6%, met)
FY2023: $21.487m / $70.987m = 31.7% (target with 7% inflation 32.2%, not met)
If we use an inflation rate for FY2023 (YE31/03/2023) of 7%, then inflation adjusted profits for FY2023 would need to be $20.415m x 1.07 = $21.844m on the same revenue. This figure was not exceeded in FY2023 and the revenue went up. However, we have got back to (tax adjusted) pre-Covid-19 net profit margin levels (using non inflation adjusted figures) . Looking at the five results since FY2019, an improvement in net profit margin above inflation occurred only once (FY2022) , while in all other years the expected inflation adjusted profit margin was not met. One swallow is not proof of summer.
Conclusion: FAIL TEST
SNOOPY
Buffett Test Summary FY2023 perspectrve
We have a 'pass' on the 'substantial player in chosen market' test, but a 'fail' on all the other three quantitative tests. A pass in all four tests is needed for Buffett to consider this company a candidate for investment. Of course we have to recognize that this period covers the Covid-19 break out section of the pandemic. But many of Investore's tenants, being essential service providers, would have substantially benefitted from that. So for this particular share, I am not making any 'Covid allowances' in my analysis.
Have you ever met a person that you really want to like, but then they just keep on making stupid decisions? This is the anthropomorphic analogy feeling that I have had when analyzing Investore. The fail on 'Buffett test 3', the 'return on equity test', was not unexpected for a property investment company, which by their nature are 'asset heavy'. All property investors know that when assessing total return, capital gain does inevitably end up being added to your cash return (rent). Hopes are for the capital gain to match inflation at least. However, this just has not happened with Investore.
The total market valuation gain from 2HY2016 (the first reporting period since the company listed) up until the end of FY2023 was $70.556m. This has subsequently been offset by a property writedown of $82.712m in HY2024, with further property writedown losses likely, come 'full year reporting time'. So after eight years this portfolio of 'blue chip big box essential service retail property' outlets is worth less than it was eight years prior! Could Investore in the future go down as a case study as to how to manage a 'certain to win' professional property portfolio particularly badly? What has caused this 'far from wished for' performance?
Investore is signed up to an 'external management contract', where the company contracts out all of its management functions to external operator 'Stride Properties'. Many listed syndicated property company operators, 6-8 years ago, saw this business structure as a millstone around future profitability growth. To mitigate, they bought out their own equivalent of Investore's external management contract, at 'considerable expense.' Ironically this was about the time Stride was listing 'Investore' under the 'old style' 'external contract property management regime'. Is this the reason for Investore's relatively poor performance since listing? My 'Dogs vs Hyenas' series of posts, culminating in post 100 on this thread, was designed to answer exactly this question. Short answer: No, the slightly higher fees as a percentage of asset values, - relative to some other big box owning property companies - at IPL are probably justified by the smaller gross size of the company, relative to the minimum fixed management functions required.
Instead, the main 'issue' at Investore looks to have been that the negotiated tenant rent rates are low compared to:
a/ Other big box property owning companies., (from BT3/ the 'return on equity' is only half that of the big boxes for a different use company, 'Property for Industry', at the end of each respective company's financial year. PLUS from test BT4/, the net profit margin at Investore is consistently about five percentage points lower than that at Property for Industry/). -AND-
b/ The capitalised values of the buildings owned. The capitalisation rate is the rate applied to the market rental to assess a property’s value. The higher the capitalisation rate, the more the market value of the property concerned is discounted. (the portfolio capitalisation rate at EOFY2023 for Investore was 5.7%, verses 5.0% as at December 2022 for Property for Industry)
Some 'low percent rate' influenced capitalisation on the books is justified, given the 'essential nature' of most of Investore's tenants businesses and the 'blue chip' nature of those tenants names. But that does not mean leases with such tenants should be signed at any cost. The zero capital growth of the property portfolio as a whole over eight years is one sign that this may have happened.
Buffett won't be buying. That was ruled out in the first line of this summary. But is there a case for buying IPL purely as a yield investment? That question will be tackled next.
SNOOPY
Learning from our errors (or not?)
Given we often learn more form our failures than our successes, there will have been lots of lessons learned during this difficult period. Are we now on the cusp of Investore coming right? What lessons have Investore put into place when commissioning their latest property development for Countdown/Woolworths?
From AR2023 p4
"(Investore) Completed the acquisition of land at Hakarau Road, Kaiapoi, for $10.1m, and commenced construction of a new Countdown supermarket on this site targeting a 5 Green Star rating and delivering an expected yield on cost of 5.5%."
Post 200 would suggest that the straight cost of borrowing (leaving out any bank set up fees) is currently above this 5.5% figure. But these rental agreements have inflation adjusted rents and and incremental turnover top ups that lift the real return above that bare 5.5% initiated return figure, right?
Look at the bar graph on AR2023 p21, to see the story on how the Countdown/Woolworths rental agreements are playing out. It goes back six years. For the last 3 years 'base rent' at Countdown has been stuck at $35.2m. This indicates no annual CPI adjustment in the Countdown rent contracts. The only increase has been the 'turnover rent adjustment' (which may be thought of as a delayed inflation adjustment several years after the inflation event). I say this because there is an existing Countdown/Woolworths supermarket nearer to the heart of Kaiapoi that is not closing. So the future growth in Kaiapoi is being taken up by the new supermarket, which will in turn remove much of the future 'turnover rent growth' from the existing supermarket, had the new build supermarket not been erected. Very clever rent management by client company Woolworths here!
In an environment where the overall property portfolio is not growing in value, new investments can be funded by selling properties with lower investment returns for those with investment returns that are higher. Investore has on the market already two Woolworths supermarkets, one in Blenheim and one in Stoke Nelson. If you refer to my post 171 you will see that both supermarkets are currently on the books, yielding a 6.9% rental, based on current rating values. To match the new Kaiapoi supermarket rate of return, the Blenheim and Nelson supermarket would have to sell for a price 25% above the most recent July 2023 and September 2021 valuations respectively.
My conclusion then is that Investore is preparing:
a/ To sell off a couple of higher yielding supermarkets to fund a lower yielding investment,
b/ Where the cost of bank funding exceeds the long term contract investment return.
Seriously, go back to those posts I have referenced for the proof to see that I am not making this stuff up! I wonder if Investore would be better of diversifying into the circus business? It does seem that their management advice team is composed of a bunch of professional clowns!
Fortunately the market is not stupid. Mr. Market knows everything I have just outlined. So Mr. Market knows to apply a valuation discount to fairly reflect management foolishness.
SNOOPY
Snoopy FY2023 Share Price Valuation
Quote:
Originally Posted by
Snoopy
Buffett won't be buying. That was ruled out in the first line of this summary. But is there a case for buying IPL purely as a yield investment? That question will be tackled next.
Posts 196/197 gives this company a no growth 'fair value' capitalised valuation share price of $1.27. This price does not factor in any capital losses that may have occurred over the last eight years, should those losses be indicative of what unit holders might expect in the future.
Capital losses over eight years: $70.556 - $82.712 = -$12.156m
-$12.156m/371.864m = 3.27cps
On an annual basis, this is a loss 'r' of: (1+r)^8=3.27cpc => r=0.16% per year
Incorporating this loss into the capitalised dividend model is done by adding the annual gross capital loss of 0.16%/0.72 = 0.22% onto the required return:
From post 197: Total modelled average net dividends over five years: 34.177c / 5 = 6.835c
As I write this the IPL010 and IPL020 bonds are trading around on the secondary market at the 7.0% level. For equity risk I require a gross level of return greater than that: 7.5%. This means my FY2023 capitalised valuation for IPL to get my required rate of return works out as:
(6.835c/0.72)/(0.075+0.0022) = $1.23
The IPL share price closed at $1.17 on Friday. But we have to remember that Mr. Market does factor in that that projected near future earnings are forecast to be a little less than earnings of the recent past. Capitalised dividend valuation is all about 'reversion to the mean'. So this explains why my loss adjusted capitalised dividend valuation is slightly higher than the market valuation. The market is strictly forward looking using the latest company supplied earnings guidance.
Buffett once said
"I try to invest in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will.”
My judgement is that we are likely nearing 'peak idiot' now at Investore. Management can only get better from here. So on this basis, and given my penchant for sniffing out shares at the bottom of the business cycle, I consider IPL worth accumulating at $1.17, for the income investor.
SNOOPY
discl: do not hold