Buffett Test 1/ FY2016: Top Three Position in Chosen Operating Markets
Quote:
Originally Posted by
Snoopy
So I have decided to build on your thread instead of the old one.
I aim to assess whether the 'Westpac Group' is a suitable candidate to which to apply the (Mary) 'Buffett' growth model .
WBC, incorporated in Australia, but also listed on the NZX describes their operation of their business in the FY2015 Annual Report as follows:
"to be one of the world's great service companies helping our customers, communities and people to prosper and grow"
It would be an oversimlification to think of Westpac just as a traditional bank. They have a strong wealth and insurance business through associated company BT Group, in which they sold down their controlling stake in FY2015. The business is based around strong Australian and New Zealand geographic foundations. The New Zealand business is a self contained unit.
The business objectives are to support:
1/ Australian and New Zealand consumers.
2/ Australian and New Zealand businesses, both large and small
2/ Regional Trade and Capital Flows for business customers via the WIB ("Westpac Institutional Banking Division".)
3/ A 'digital ready infrastructure' for the future.
Major Competitors in this sector are listed in order by $A revenue (interest income).
1/ Commonwealth Bank of Australia: $33,817m
2/ Westpac Bank: $31,822m
3/ ANZ Bank: $29.951m
4/ National Australia Bank $27,629m
Conclusion: As number two in the market, WBC passes the first Buffett Point test.
SNOOPY
A profit picture (FY2016 perspective)
Quote:
Originally Posted by
macduffy
A few reservations as to whether maintaining the dividend will prove to be sustainable. But that's for the future!
Bank results tend to be horribly complex if you drill down into them. Fortunately for potential shareholders, Westpac release a 'statutory result' and a 'cash result'. The 'cash result' is of great interest to shareholders because dividends tend to be paid from cash available. Plus all of those horrible normalizing corrections are done for you! But some investors are interested in a true 'normalized profit' result. To calculate this, there are at least a couple of corrections you need to make to the 'cash result' (or a whole heap more corrections to the statutory result). My take on the 'normalized result' is in the table below. (Note all dollar figures quoted are Australian dollars.)
Westpac Group (WBC) |
FY2016 |
FY2015 |
FY2014 |
FY2013 |
FY2012 |
Cash Profit |
$7,822m |
$7,820m |
$7,628m |
$7,063m |
$6,564m |
add back after tax Expense effect of buying J O Hambro Capital Management |
|
|
|
|
0.7x$38m |
less Amortization & Impairment of Intangible Assets and Deferred Expenditure |
$216m |
$221m |
$222m |
$224m |
$231m |
less after tax Net gain on disposal of Assets |
0.7x$1m |
0.7x$103m |
0.7x$97m |
0.7x$67m |
0.7x$46m |
equals Normalized Profit |
$7,605m |
$7,527m |
$7,338m |
$6,792m |
$6,328m |
The annual reports (under Group Segment Information) contains notes on why those adjustments to produce the 'cash result' were made.
Adjustment 1
-----
An historic merger with St.George and the acquisitions of J O Hambro Capital Management (JOHCM) and Lloyds Australia resulted in the recognition of identifiable intangible assets. These assets include intangibles related to core deposits, customer relationships, management contracts and distribution relationships. These intangible items are amortised over their useful lives, ranging between four and twenty years. The amortisation of intangible assets (excluding capitalised software) is a cash earnings adjustment because it is a non-cash flow item and does not affect cash distributions available to shareholders.
Costs (spread over several years) associated with the acquisition of Lloyds have been treated as a cash earnings adjustment as they do not impact the earnings expected from the acquired businesses following the integration period.
-----
Put in this light, the adjustments to Statutory Profit are logical. However, it is equally true to say that the intangibles related to the finite lives of core deposits, customer relationships, management contracts and distribution relationships are recognised by Westpac management. And all the money paid for those 'eroding intangibles' by Westpac management was 'real cash' not so long ago. Therefore I contend that these 'amortised intangible' figures should be removed from the cash profit to get a normalised profit picture.
Adjustment 2
It is undisputed that selling an asset generates real cash. However, once sold an asset cannot be sold again. I therefore contend that asset sales should be removed from the cash result to create a normalised operating result.
SNOOPY
Buffett Test 2/ FY2016: Rising eps Trend (one setback allowed)
Quote:
Originally Posted by
Snoopy
WBC passes the first Buffett Point test.
Westpac Group (WBC) |
FY2016 |
FY2015 |
FY2014 |
FY2013 |
FY2012 |
Normalized Profit {A} |
$7,605m |
$7,527m |
$7,338m |
$6,792m |
$6,328m |
Shares on Issue EOFY {B} |
3,313m |
3,140m |
3,114m |
3,087m |
3,043m |
Earnings Per Share {A}/{B} |
$2.30 |
$2.40 |
$2.36 |
$2.20 |
$2.08 |
A lower year on year result in FY2016 is not enough to obscure a longer term trend.
Conclusion: Pass Test
SNOOPY
Buffett Test 3/ FY2016: ROE > 15% (one setback allowed)
Westpac Group (WBC) |
FY2016 |
FY2015 |
FY2014 |
FY2013 |
FY2012 |
Normalized Profit {A} |
$7,605m |
$7,527m |
$7,338m |
$6,792m |
$6,328m |
Shareholder Equity EOFY {B} |
$58,181m |
$53,915m |
$49,337m |
$47,537m |
$46,219m |
Return on Shareholder Equity {A}/{B} |
13.1% |
14.0% |
14.9% |
14.3% |
13.7% |
We aren't far away from that 15% ROE hurdle in any of the last five years. But near enough is not good enough.
Result: Fail Test
SNOOPY
Buffett Test 4/ FY2016: Ability to raise profit margin above inflation
Westpac Group (WBC) |
FY2016 |
FY2015 |
FY2014 |
FY2013 |
FY2012 |
Normalized Profit {A} |
$7,605m |
$7,527m |
$7,338m |
$6,792m |
$6,328m |
Gross Interest Revenue {B} |
$31,822m |
$32,215m |
$32,248m |
$33,009m |
$36,873m |
Net Profit Margin {A}/{B} |
23.9% |
23.3% |
22.8% |
20.6% |
17.2% |
A 'steady with inflation increase in margins over the last three comparative figures, and a rather stronger rise before that.
Result: Pass Test
SNOOPY
Buffett Growth Model Screening (FY2016 perspective): Overall Conclusion
Warren Buffett's scanning of the 'growth potential' of a company can be summarized in four quick questions.
Q1/ Does Westpac Group have a top three market position in the markets in which it chooses to operate? (Ref: my post 32)
A1/ Yes
Q2/ Does Westpac Group have a 'normalised profit' increasing 'earnings per share trend'? (Ref: my post 39)
A2/ Yes
Q3/ Does Westpac Group have a record of earning a superior ( >15% ) return on shareholder equity? (Ref: my post 41)
A3/ No
Q4/ Does Westpac Group have the capability of operating at increasing Net Profit margins? (Ref: my post 42)
A4/ Yes
Overall Conclusion
Westpac is not able to satisfy all the requirements to apply Warren Buffett's compounding growth model. This does not mean that Westpac is necessarily a poor investment going forwards. It just means that Westpac must be analyzed in a different way. It might be sensible to regard Westpac as a pure 'dividend play' from here.
SNOOPY
WBC Forecast Dividend Scenario Analysis (based on FY2012 -16 data) Attempt 1 inputs
Quote:
Originally Posted by
Snoopy
It might be sensible to regard Westpac as a pure 'dividend play' from here.
I now want to use the actual dividend data for FY2012 to FY2016 inclusive to build a 'scenario analysis' looking forwards.
The basis for my model is that market conditions over the last five years are broadly representative of what we might expect over the next five years. Yet in recent times, the capital base of the company has been expanded, because of Basel 3 international banking standards requiring a greater capital base to support the existing bank loan book. The expansion of WBC's capital base has been as a result of a share issue, including a share purchase plan offer to existing shareholders and institutional share placement. Unfortunately for existing shareholders, this means that broadly the same income stream must now be distributed among the greater number of shares now on issue. In other words, unless there is a corresponding growth in profitability from the new share capital (there won't be, because the new capital is required to be used as a beefed up safety net), earnings per share can be expected to decrease in the future.
The following table shows what would have happened if the number of shares on issue today was constant over the previous five years. I have left out the 'special dividends' (10c paid in the second half of FY2013 and 10c paid in the first half of FY2014) because these payments were made when Westpac had an excess of capital. Subsequent to these payments, late in CY2015, Westpac had to raise more capital in their plan to fulfill Basel 3 capital requirement standards. Had they known this at the time, those special dividends probably wouldn't have been paid out. Westpac do not currently claim to have excess capital. So it would be inappropriate to use historic 'excess capital' dividend payments for my present day dividend payment modelling.
|
FY2012 |
FY2013 |
FY2014 |
FY2015 |
FY2016 |
'Cash Profit' as reported {A} |
$6,564m |
$7,063m |
$7,628m |
$7820m |
$7,822m |
Gross Annual Dividend: (final) + (interim) as reported {B} |
$4,924m |
$5,429m |
$5,527m |
$5,752m |
$6,128m |
Normal Dividend Payout ratio {A}/{B} |
75.0% |
76.9% |
72.5% |
73.6% |
78.3% |
Gross Annual Dividend (NZ Perspective *) 'cps' (final) + (interim) |
$1.69.6 |
$1.86.1 |
$1.91.5 |
$1.96.4 |
$2.00.4 |
Actual Number of Shares on Issue EOFY |
3,043m |
3,087m |
3,114m |
3,140m |
3,313m |
Scenario Number of Shares on Issue EOFY |
3,313m |
3,313m |
3,313m |
3,313m |
3,313m |
Scenario Adjusted Gross Annual Dividend (NZ Perspective *) 'cps' (final) + (interim) |
$1.55.8 |
$1.73.4 |
$1.80.0 |
$1.86.1 |
$2.00.4 |
* In this instance "NZ Perspective" means dividends continue to be expressed in $A, but the $A dividend is a 'gross dividend' because NZ does not recognize Australian Franking Credits. In addition 'NZ Imputation Credits' are added to the $A dividend using the exchange rate $NZ1 = $A0.95.
SNOOPY
WBC Forecast Dividend Scenario Analysis (based on FY2012 -16 data) Attempt 1 calc.
Quote:
Originally Posted by
dela47
Are we now around fair value? Or is there potential for short term upside given the drop we've had over the last two months (to add to the attractive yield)?
Let's see what a 'capitalised dividend value' calculation says about this. Using data from my post 45:
|
Scenario FY2012 |
Scenario FY2013 |
Scenario FY2014 |
Scenario FY2015 |
Scenario FY2016 |
Five Year Average |
Scenario Adjusted Gross Annual Dividend (NZ Perspective *) 'cps' (final) + (interim) |
$1.55.8 |
$1.73.4 |
$1.80.0 |
$1.86.1 |
$2.00.4 |
$1.79.1 |
The other key figure in this calculation a bit more subjective, and you as an investor need to answer the question.
"For a bank such as WBC, what is the gross yield that would feel comfortable with?"
You could say that banks are a quasi-utility, that will be there 'through thick and thin'. I use a 6.0% figure for those.
Yet the WBC, like all the big 4 Aussie banks, has an ivory tower institutional division that does all sorts of high powered stuff with currencies, futures and options. Regular bank customers on the street would go into shock if they found out if they found out their safe solid bank was doing this stuff. Luckily it is so incomprehensible that even half the people who work in the WBC institutional division do not understand what is going on. So no-one worries about it. Very occasionally it all blows up with dramatic effect, such as in the GFC. Boring bank shares I would accept a 6% yield from. But with 'institutional stuff' going on behind the scenes I would add in a further 0.5% 'risk factor' to the WBC.
So my answer to the question I posed is 6.5%:
Divide 'return' by 'the yield' and you get the share price that I would feel comfortable paying:
$A1.79.1 / 0.065 = $A27.55 or in NZ dollar terms
$A27.55 / 0.95 = $NZ29.00
Current share price on the NZX as I write this is $NZ31.40, which is 8.2% above my 'comfortable valuation'. So this means I should sell down, or does it?
SNOOPY
WBC Forecast Dividend Scenario Analysis (based on FY2012 -16 data) Attempt 2 inputs
Quote:
Originally Posted by
Snoopy
I now want to use the actual dividend data for FY2012 to FY2016 inclusive to build a 'scenario analysis' looking forwards.
I now wish to consider Westpac from the Australian investor's perspective. WBC is listed on the NZX. But as New Zealand investors, we would be overestimating our power on the listed markets if we were to assume that our locally traded shares would do anything other than follow the Australian market lead. This means that how WBC looks to Australian investors on the ASX will be the primary driver of what happens to WBC on the NZX.
All dollar figures below in table are in Australian dollars.
|
FY2012 |
FY2013 |
FY2014 |
FY2015 |
FY2016 |
'Cash Profit' as reported {A} |
$6,564m |
$7,063m |
$7,628m |
$7820m |
$7,822m |
Annual Dividend: (final) + (interim) as reported {B} |
$4,924m |
$5,429m |
$5,527m |
$5,752m |
$6,128m |
Normal Dividend Payout ratio {A}/{B} |
75.0% |
76.9% |
72.5% |
73.6% |
78.3% |
Annual Dividend (Aus Perspective *) 'cps' (final) + (interim) |
80c+82c= $1.62 |
84c+86c=$1.70 |
88c+90c=$1.98 |
92c+ 93c= $1.85 |
94c+94c=$1.88 |
Actual Number of Shares on Issue EOFY |
3,043m |
3,087m |
3,114m |
3,140m |
3,313m |
Scenario Number of Shares on Issue EOFY |
3,313m |
3,313m |
3,313m |
3,313m |
3,313m |
Scenario Adjusted Annual Dividend (Aus Perspective *) 'cps' (final) + (interim) {C} |
$1.48.8 |
$1.58.4 |
$1.67.3 |
$1.75.3 |
$1.88 |
Scenario Adjusted Gross Annual Dividend (30% tax rate) {C}/0.7 |
$2.12.6 |
$2.26.3 |
$2.39.0 |
$2.50.4 |
$2.68.6 |
* Aus Perspective excludes NZ imputation credits and AUS franking credits in this instance. Historic Special dividends have been excluded, because they are not representative of likely future payouts under the current capital structure.
SNOOPY
WBC Forecast Dividend Scenario Analysis (based on FY2012 -16 data) Attempt 2 calc.
Quote:
Originally Posted by
Snoopy
Let's see what a 'capitalised dividend value' calculation says about this. Using data from my post 45:
|
Scenario FY2012 |
Scenario FY2013 |
Scenario FY2014 |
Scenario FY2015 |
Scenario FY2016 |
Five Year Average |
Scenario Adjusted Gross Annual Dividend (NZ Perspective *) 'cps' (final) + (interim) |
$1.55.8 |
$1.73.4 |
$1.80.0 |
$1.86.1 |
$2.00.4 |
$1.79.1 |
The other key figure in this calculation a bit more subjective, and you as an investor need to answer the question.
"For a bank such as WBC, what is the gross yield that would feel comfortable with?"
You could say that banks are a quasi-utility, that will be there 'through thick and thin'. I use a 6.0% figure for those.
Yet the WBC, like all the big 4 Aussie banks, has an ivory tower institutional division that does all sorts of high powered stuff with currencies, futures and options. Regular bank customers on the street would go into shock if they found out if they found out their safe solid bank was doing this stuff. Luckily it is so incomprehensible that even half the people who work in the WBC institutional division do not understand what is going on. So no-one worries about it. Very occasionally it all blows up with dramatic effect, such as in the GFC. Boring bank shares I would accept a 6% yield from. But with 'institutional stuff' going on behind the scenes I would add in a further 0.5% 'risk factor' to the WBC.
So my answer to the question I posed is 6.5%:
Divide 'return' by 'the yield' and you get the share price that I would feel comfortable paying:
$A1.79.1 / 0.065 = $A27.55 or in NZ dollar terms
$A27.55 / 0.95 = $NZ29.00
Current share price on the NZX as I write this is $NZ31.40, which is 8.2% above my 'comfortable valuation'. So this means I should sell down, or does it?
Let's see what a 'capitalised dividend value' calculation goes using the 'Australian View' data. Using data from my post 60:
|
Scenario FY2012 |
Scenario FY2013 |
Scenario FY2014 |
Scenario FY2015 |
Scenario FY2016 |
Five Year Average |
Scenario Adjusted Gross Annual Dividend (Aus Perspective) 'cps' (final) + (interim) |
$2.12.6 |
$2.26.3 |
$2.39.0 |
$2.50.4 |
$2.68.6 |
$2.39.4 |
I start from the 'Average Across Five Scenarios' 'Gross Dividend: Aussie Investor Perspective'. That figure comes out at $2.394 per share. And this is one key to the valuation.
The other key figure is a bit more subjective, and you as an investor need to answer the question.
"For a bank such as WBC, what is the gross yield that an investor would feel comfortable with?"
You could say that banks are a quasi-utility that will be there through thick and thin. I use a 6.0% figure for those.
Yet WBC, like all the big 4 Aussie banks, has an ivory tower institutional division that does all sorts of high powered stuff with currencies, futures and options. Boring bank shares I would accept a 6% yield from. But with 'institutional stuff' going on behind the scenes I would add in a further 0.5% 'risk factor' to WBC.
So my answer to the question I posed is 6.5%. From an Australian perspective though, I get a slightly different answer. The New Zealand Official cash rate is 1.75%. The Australian Official Cash Rate is 1.5%. To reflect this difference, I am reducing the yield I require from WBC by the difference in those two figures, 0.25%. This means the new yield I am happy with is 6.25%
Divide 'return' by 'the yield' and you get the share price that I would feel comfortable paying:
$A2.394 / 0.0625 = $A38.30 or in NZ dollar terms
$A38.30 / 0.95 = $NZ40.32
Current share price on the NZX when I started this exercise was $NZ31.40, which is 22% below my 'comfortable valuation'. This result tells me that WBC is currently underpriced.
From an investor perspective, I like to buy at below fair value. So what if I was in the market to buy some more WBC? For a quasi-utility type investment this means a 20% discount to fair value, a price of $NZ32.26 for WBC.NZX shares. With current NZX listed price below this, it looks like WBC is a 'buy' on the market today, at least from an Australian perspective.
SNOOPY
The Imputation Credit Conundrum
Quote:
Originally Posted by
Snoopy
Divide 'return' by 'the yield' and you get the share price that I would feel comfortable paying:
$A1.79.1 / 0.065 = $A27.55 or in NZ dollar terms
$A27.55 / 0.95 = $NZ29.00
Current share price on the NZX as I write this is $NZ31.40, which is 8.2% above my 'comfortable valuation'. So this means I should sell down, or does it?
Quote:
Originally Posted by
Snoopy
So my answer to the question I posed is 6.5%. From an Australian perspective though, I get a slightly different answer. The New Zealand Official cash rate is 1.75%. The Australian Official Cash Rate is 1.5%. To reflect this difference, I am reducing the yield I require from WBC by the difference in those two figures, 0.25%. This means the new yield I am happy with is 6.25%
Divide 'return' by 'the yield' and you get the share price that I would feel comfortable paying:
$A2.394 / 0.0625 = $A38.30 or in NZ dollar terms
$A38.30 / 0.95 = $NZ40.32
Current share price on the NZX when I started this exercise was $NZ31.40, which is 22% below my 'comfortable valuation'. This result tells me that WBC is currently underpriced.
From an investor perspective, I like to buy at below fair value. So what if I was in the market to buy some more WBC? For a quasi-utility type investment this means a 20% discount to fair value, a price of $NZ32.26 for WBC.NZX shares. With current NZX listed price below this, it looks like WBC is a 'buy' on the market today, at least from an Australian perspective.
Here we have an example of the true value of tax credits to the NZ based investor. In this instance, WBC is not entirely devoid of NZ imputation credits. Yet the lack of access to Australian franking credits for NZ investors is enough to turn this investment from a 'buy' to a 'hold/sell'. The Oz banks have a long record of capital growth as well as being good dividend payers. Yet there are indicators out there that this long history of capital growth may be coming to an end. So what to do?
SNOOPY
UBS Downgrade of Westpac >>>
Got a few loans with WP hoping they will be cutting me another sharp deal come end of fixed term in JULY