EBIT/I for Chorus for FY2020 using method 1
Quote:
Originally Posted by
Snoopy
The question I have is, under IFRS16, do I use method 1 or method 2 to calculate EBIT/I? Or do I have a choice which method I use?
Sometimes the easiest way to make sense of these 'theoretical questions' is to do an example. I will do the calculation of "EBIT/I" for Chorus over the last reported year, FY2020.
AR2020 p27 tells us that :
1/ 'Other interest expense' includes $21m of 'lease interest', $5m of amortisation and a $1m restructuring expense due to interest rate swaps. That works out to a total of $27m.
2/ Now, if we go back to p24 of AR2020 and look under the 'expenditure commentary' we can see an entry 'Other $27m'. which ties in.
3/ Back a couple of pages further to p22 of AR2020. Right under the main 'Management Commentary' header you can see how the earnings are calculated. The first step is to take the 'operating revenue' and remove the 'operating expenses'. These are the same 'operating expenses' we have just looked at in a more detailed way on page 24.
These three steps show me that 'lease interest' has already been subtracted from profits. This means we should use 'Method 1' from my previous post when calculating EBIT/I.
EBIT is easy to find, it is listed as $246m on p22 of AR2020.
The slightly more tricky thing is figuring out the 'I' bit.
On page 27 of AR2020 we can see a 'Total Finance Expense' of $185m. But this is not the figure we use.
1/ Right at the top of the page we see 'Finance Income' of $12m that we have to offset against out finance expense.
2/ We must subtract from the 'net interest total' the $29m of 'CIP securities notional interest', because this is an accounting construction that is never actually paid (this is all explained on the Chorus thread, but for the purposes of this exercise please trust me on this point).
3/ Look further up the column and you will see the 'Other interest expense' of $27m that we have been discussing. That $27m has already been used in calculating EBIT. So we have to remove that from the interest bill as well , because if we did not we would, in effect, be counting it twice.
This means the 'Total Net Finance Expense' for our purposes is:
(-$12m + $185m) - $29m - $27m = $117m
So the obvious calculation of EBIT/I for Chorus for FY2020 is: $246m/$117m = 2.10 (using method 1)
SNOOPY
EBIT/I for Chorus for FY2020 using method 2
Quote:
Originally Posted by
Snoopy
The calculation of EBIT/I for Chorus for FY2020 is: $246m/$117m = 2.10 (using method 1)
Now let's look at the alternative calculation method 2, where 'lease interest' (as part of 'Other Interest') is not taken into account when calculating EBIT.
EBIT now changes to $246m + $27m = $273m
With this iteration we have chosen not to take the lease interest into account as earnings. So instead we must include 'Other interest' as part of the total interest bill due by not subtracting it. This means the 'Total Net Finance Expense' for our purposes is now:
-$12m + $185m - $29m = $144m
So the calculation of EBIT/I for Chorus for FY2020 becomes: $273m/$144m = 1.89 (using method 2)
That isn't grossly different, except there is a 'rule of thumb' that says an EBIT/I ratio above 2 is passable, while anything below that is dodgy. So is 'method 1' or 'method 2' the better way of calculating this ratio? I don't know the answer. My solution is to curse IFRS16 and go to bed.
SNOOPY
EBIT/I for Chorus for HY2021 using method 1
Quote:
Originally Posted by
Snoopy
The calculation of EBIT/I for Chorus for FY2020 is: $246m/$117m = 2.10 (using method 1)
The half year results for FY2021 are available. So let's see what EBIT/I did for the six months after EOFY2020. This isn't straightforward, because the disclosure at half year result time is less full than in the whole of year accounts.
EBIT = $114m vs $246m for the FY2020 full year (p5 HYR2021),
Net Finance Expense = $0m - $77m = -$77m vs $12m - $185m = $173m for the FY2020 full year. (p5 HYR2021)
A problem now arises because there is no breakdown of the finance expenses given for the half year. Given the comparative figures are given for the previous full year in the half year report, we have to assume there is no difference in the way the calculations have been made at HY2021 when compared with FY2020. That means if we work out our metric using the raw figures in HYR2021:
EBIT/I = $114m / $77m = 1.48
then we are 'double counting' the effect of 'lease interest payments'. Firstly because they have reduced EBIT in the numerator. Secondly because they have increased I in the denominator. You should do one or the other, but not both. My contention then is that there is insufficient information disclosed by Chorus to allow the calculation of EBIT/I over the half year period.
If we instead focus on the twelve month period comprising 2HY2020 and HY2021, then the calculation changes to this:
EBIT/I = (($246m-$134m) + $114m)/ (($185m - $95m) + $77m) = 1.35
This metric is also wrong, because it suffers from the same 'double counting' problem I have just described. If we look at the published information from third parties:
Morningstar:
https://www.morningstar.com/stocks/xnze/cnu/financials
lists the available EBIT/I for Chorus as 1.38 (close to my 2HY2020 + HY2021 figure in this post)
Simply Wall Street:
https://simplywall.st/stocks/nz/tele...nsidered-risky
lists the available EBIT/I for Chorus as 1.5 (close to my HY2021 figure in this post)
I submit that both of the 'Morningstar' and 'Simply Wall Street' EBIT/I figures are wrong, because they have both 'double counted' lease interest. I can't tell you what the correct figure is because there is insufficient disclosure by Chorus to allow us to work that out. Blame IFRS16 for this mess.
SNOOPY
EBIT/I for Chorus for FY2020 using method 2 (Attempt 2)
Time to eat a bit of 'humble pie' this evening and admit when I did my EBIT/I covenant calculation (post 4 on this thread) - where I adjusted for the effect of any 'lease interest deductions' (that are partially reflective of the old 'rent' charge under the old pre-IFRS16 accounting standard)- I got it wrong.
The 'wrong' calculation I have quoted below.....
Quote:
Originally Posted by
Snoopy
Now let's look at the alternative calculation method 2, where 'lease interest' (as part of 'Other Interest') is not taken into account when calculating EBIT.
EBIT now changes to $246m + $27m = $273m
With this iteration we have chosen not to take the lease interest into account as earnings. So instead we must include 'Other interest' as part of the total interest bill due by not subtracting it. This means the 'Total Net Finance Expense' for our purposes is now:
-$12m + $185m - $29m = $144m
So the calculation of EBIT/I for Chorus for FY2020 becomes: $273m/$144m = 1.89 (using method 2)
That isn't grossly different, except there is a 'rule of thumb' that says an EBIT/I ratio above 2 is passable, while anything below that is dodgy. So is 'method 1' or 'method 2' the better way of calculating this ratio? I don't know the answer. My solution is to curse IFRS16 and go to bed.
.....while the changes I wish to introduce are summarized below (thanks to Ferg for pointing this stuff below out to me).
Quote:
Originally Posted by
Snoopy
OK this is where you and I have rather different adjusted EBIT calculations.
I hadn't considered depreciation before. Because as we were talking about EBIT, I had considered the 'D'epreciation' part of the EBITDA to EBIT calculation already dealt with. But now I see you are correct Ferg, because the 'depreciation of the lease liability' did not exist under the old accounting rules. So to make a comparison with previous years, you have to increase the EBIT by any depreciation that was not present and in fact did not even exist at all under the old accounting rules.
Under the new accounting rules, what were 'rent payments' (an operating cost) have turned into <added> 'lease liabilities' (an operating cost) and </added> 'lease interest liabilities' (a finance cost). Under the new rules of EBIT, all financing costs are yet to be subtracted before NPAT is calculated. Under the old accounting rules the equivalent of 'lease interest liabilities', (<added> part of </added> the old 'rent') would have already come out of the EBIT figure. This means in consideration of interest payments only, that to convert the EBIT you see published in the annual accounts under IFRS16, back to the lower EBIT figure we would have seen under the old accounting rules, we have to subtract the 'lease interest liability' from the EBIT figure quoted. So it looks like you are right again Ferg.
So let's go through this 'step by step', adjusting EBIT back to what it was in the 'old days' (pre IFRS16 reporting standards), to make sure I don't 'stuff up' again.
Declared EBIT |
= $246m |
(AR2020 p22) |
add 'Right of Use Asset' Depreciation |
+ $14m |
(AR2020 p26) (Non existent asset under old regime, so not there to depreciate) |
subtract 'Rent Paid' |
- $20m |
(AR2020 p38, $23m exGST) (post IFRS16 EBIT is not adjusted for the old 'rent' concept) |
equalsAdjusted EBIT |
= $240m |
(Calculated) |
Previously I had also added back a couple of one off interest charges
add 'Amortisation Loss' |
+ $5m |
(AR2020 p47) (One off Swap reset reversed: difference between fair value and proceeds realised) |
add 'Restructuring Loss' |
+ $1m |
(AR2020 p47) (One off cost to restructure interest rate swaps reversed) |
However, these are interest charges, not directly related to Covid-19. While they do produce a higher normalised profit at NPAT, they do not produce a higher profit at EBIT level. So I think, it is best to leave these changes out of my EBIT adjustment.
The interest calculation is therefore as follows:
Declared Interest Expense |
= $185m |
(AR2020 p47) |
subtract Interest Income |
- $12m |
(AR2020 p27) |
subtract 'Amortisation Loss' |
- $5m |
(AR2020 p47) (One off Swap reset reversed: difference between fair value and proceeds realised) |
subtract 'Restructuring Loss' |
- $1m |
(AR2020 p47) (One off cost to restructure interest rate swaps reversed) |
subtract 'CIP Notional Interest' |
- $29m |
(AR2020 p47) (This is an artificial accounting construct based on defined CIP construction and is never paid in practice) |
equals Adjusted Net Interest Bill |
= $138m |
(Calculated) |
So EBIT/I = $240m/$138m = 1.74
SNOOPY