IPL - Investore Property

[Snoopy]

Moving onto the IPL annual report for 2023, there are many years where IPL has 'earned' more from the appreciation of the value of their property portfolio, rather than the underlying rent being paid by tenants on those properties. Property revaluations and (gulp) devaluations are connected to movements in various financial indicators, but are not readily predictable in the short term. That is why it is prudent for IPL management to maintain an 'equity buffer'. This is a way to ensure that a sudden 'property market downturn', will not trigger a 'banking covenant breach' and a concomitant sudden rush to refinance the company on the banking syndicate's terms.

My way of looking at IPL is to see how well the operational earnings (i.e. largely rent) expressed as 'return on assets' covers the bank (and IPL bondholders in this instance) financing costs. From the FY2023 financial statements:

Operational Profit before tax	$35.207m
less Current Tax Expense	($4.972m)
equals Underlying NPAT	$30.235m

When looking at the value of investment properties on the books, most reporting companies use an 'average value of assets' managed throughout the year. I prefer to use just the value of properties at the end of the financial year, because that is the value that will be carried forward into next years accounts and all prior adjustments are historical. The value of Investment properties on the IPL balance sheet as at EOFY2023 is: $1,070.451m. So the underlying return on assets may be calculated as follows:

ROA = $30.235m/$1,070.45m = 2.82%

We are told that the average weighted cost of debt per annum at at 31st March 2023 is 4.0% (AGMPR2023 Slide 8). I am not sure exactly how IPL calculates this. How does this compare with my own 'calculated interest paid' rate from the published accounts? To work out this, I first take the three published loan balances we know about over FY2023 (SOFY2023, HY2023 and EOFY2023) and average them:

($351.530m+$387.576m+$387.037m)/3 = $375.381m
Net finance expense = $16.195m
=> indicative interest rate paid = $16.195m/$375.381m= 4.31%

( I call the above calculation indicative, because we do not know the variations in the loan balance on the other 365-3=362 days of the year where loan data is not published. Nevertheless, there isn't too much difference between 4% and 4.31%)

So straight away we can see that even with a write-down in property values in some years (e.g FY2023), over the medium term we are relying on capital gain to make this funding model work.

In analytical terms, there is something to be said for considering a 'cost of equity capital'. This will help determine if for a particular investment your capital is wisely allocated. However in 'cash terms' there is no cost of equity capital. I say that, because you don't have to pay for the privilege of investing your own money. That means sometimes it is useful to look at a different figure, such as 'Return on Borrowings', or ROB, where your own equity capital is removed from the underlying asset:

ROB = $30.235m/($1,070.45m-$675.02m) = 7.65%

From the above we can see that the underlying IPL 'return on borrowed money' is significantly more than the interest rate being paid on company borrowings. This means there is no imminent 'operational cashflow threat' that might see Investore fold. If ROB > ROA this would also suggest to me that increasing company borrowings as the consequence of a share buyback is, within certain limits, a 'sensible strategy' for IPL to follow, as a rule.

SNOOPY

[Snoopy]

This would suggest to me that increasing company borrowings as the consequence of a share buyback is, within certain limits, a 'sensible strategy' for IPL to follow, as a rule.

The most current released LVR for Investore as at EOFY2023 was 36.5%. How was this calculated?

Value of Investment Properties (from FY2023 balance sheet): $1,070.451m
Borrowings (from FY2023 balance sheet): $385.037m

=> LVR = $385.037m / $1,070.451 = 36.0%

It looks like 0.5% has gone missing (reward offered for anyone who can find it - no not really). But if $385.037m of loans represents a 36.5% LVR, by how much would the property values have to decrease before that new LVR banking covenant of 52.5% would be breached?

$385.037m / 'Covenant Breaking Depreciated Value' = 52.5% = 0.525
=> 'Covenant Breaking Depreciated Value' = $385.037m / 0.525 = $733.404m

This means the 'cumulative critical write down' amount going forwards that will cause the LVR banking covenant to be breached is:

$1,071.451m - $733,404m = $338.047m

A further property valuation reduction of: $338.047m / $1,071.451m = 30% (round figures) from the 31st March 2023 balance date is the critical figure . This would likely require the one year government bond rate to rise from 4.11% (as it was on 31-03-2021) to 4.11% x 1.3 = 5.34%. (1) As at 28-06-2023 the government bond rate is 4.54%. I think it is unlikely that the one year government bind rate will rise further to 5.34% at this stage in the interest rate cycle. But we can't be 100% sure. This could explain why management are taking some pro-active action selling off those Nelson and Blenheim Countdown properties. Looking at the way interest rates have kept rising since the 31st March 2023 balance date, I do predict more property write downs at the September 2023 half year reporting date for IPL. Whether that will 'spook the market again', I guess we will find out,

Note (1) I am not suggesting that calculating any potential future property write down is as simple as just comparing one year government bond rates at comparative period end points. I am suggesting that as a quick approximation this simple calculation is a reasonable indicator as to what the actual property value adjustment might be.

SNOOPY

discl: do not hold, but is on my acquisition radar

[Aaron]

Thanks Snoopy

I will have to go over your numbers to clarify in my head how the return on investment is higher than the bank interest rate, if they borrowed to buy back the shares. a 2.82% ROA c.f. 4% interest rates. Not sure what ROB indicates as ROE is more commonly used. As always you are making me think which goes against my natural inclinations.

Another theory for buybacks is that companies have excess cash that can't find better investments than their own shares so they do buybacks but this is odd as just paying out the excess as dividends would bring the price of their shares back up.

One theory I had is if you did not have enough debt, private equity would make a takeover offer load the company up with debt take the cash and a few years later relist and fob it off onto willing investors.

Also when looking at the debt covenants you look at one year govt bond rates. I guess there is a secondary market for these as I cannot find a quote on the nzdx.

Interest.co.nz says the 1yr is at 5.42%.

https://www.interest.co.nz/charts/in...ent-bond-rates

property company bonds might do better over the medium term if inflation stays high, but then as we rely on central bank policy to make our investing decisions the inflation/deflation question remains the most important one for these markets.

Some people say the retiring baby boomers spending less, large amounts of debt and technology will keep inflation down, although Jeremy Grantham suggested that the lack of investment into mining and drilling almost guarantees inflation over the longer term as supply reduces. Who to believe it is hard to know and nobody does at the end of the day.

[Snoopy]

I will have to go over your numbers to clarify in my head how the return on investment is higher than the bank interest rate, if they borrowed to buy back the shares. a 2.82% ROA c.f. 4% interest rates. Not sure what ROB indicates as ROE is more commonly used. As always you are making me think which goes against my natural inclinations.

Assets (A) are funded by both shareholder equity (E) and borrowings (B).

I think the likes of Winner favours ROA, because that shows the underlying earning power of the assets, irrespective of how those assets are funded.

Generally I prefer ROE, because that shows the earning power of the shareholder equity after it has been leveraged up optimally by bank borrowings (it is the job of the company directors to ensure that the company is leveraged to the Goldilocks point (not too little, not too much, just right) ).

Nevertheless shareholders are still responsible for any borrowings the company makes, which are in the form of debt due to third parties. This is where the concept of ROB comes in. ROB represents the return on those borrowings, assuming that the internal equity cost part of the asset funding is ignored. This makes sense if you consider the company as a 'black box', with only external transactions to and from that 'black box' being considered.

SNOOPY

[winner69]

Snoops ….I prefer ROIC where the Invested Capital is Equity plus Debt

That way can see if an outfit is returning in excess of its cost of capital ….ie adding economic value

[Snoopy]

Another theory for buybacks is that companies have excess cash that can't find better investments than their own shares so they do buybacks but this is odd as just paying out the excess as dividends would bring the price of their shares back up.

You are quite correct. Increasing the dividend would boost the share price. But only until the share went ex-dividend, at which point the share price would fall back by the amount of the dividend.

OTOH, decreasing the number of shares on issue, via a share buyback, increases the earnings per share for all time going forwards. So any resultant increase in share price as a result of a share buyback should stick.

One theory I had is if you did not have enough debt, private equity would make a takeover offer load the company up with debt take the cash and a few years later relist and fob it off onto willing investors.

That is no hypothetical you have dreamed up. That is exactly what would happen, with private equity using the excess cash held within the company to fund their takeover. It is exactly this modus operandi that was used by Ron Brierley all those years ago when he used to pick off companies with lazy balance sheets on the NZX as he grew his Brierley Investments Limited empire.

SNOOPY

[Snoopy]

Thanks Snoopy
Also when looking at the debt covenants you look at one year govt bond rates. I guess there is a secondary market for these as I cannot find a quote on the nzdx.

Interest.co.nz says the 1yr is at 5.42%.

https://www.interest.co.nz/charts/in...ent-bond-rates

This is very strange. I go to your link, click on the one year chart, and I get 4.20% as the government one year rate on 31-03-2023 and 4.54% on 28-06-2023.

However, if I go to this alternative link
http://www.worldgovernmentbonds.com/...ealand/1-year/

I get a yield of 5.468% on 28-06-2023 (close to your figure Aaron) and 4.970% on 31-03-2023.

What is not in dispute is that one year NZ bond interest rates have risen over the period 31-03-2023 to 28-06-2023. If I use the figures from the worldgovernmentbonds website, the conclusion to my post 132 changes to the following:

--------------------

The 'cumulative critical write down' amount going forwards that will cause the LVR banking covenant to be breached is:

$1,071.451m - $733,404m = $338.047m

A further property valuation reduction of: $338.047m / $1,071.451m = 30% (round figures) from the 31st March 2023 balance date is the critical figure . This would likely require the one year government bond rate to rise from 4.970% (as it was on 31-03-2021) to 4.970% x 1.3 = 6.461%. (1) As at 28-06-2023 the government bond rate is 5.468%. I think it is unlikely that the one year government bond rate will rise further to 6.461% at this stage in the interest rate cycle. But we can't be 100% sure. This could explain why management are taking some pro-active action selling off those Nelson and Blenheim Countdown properties. Looking at the way interest rates have kept rising since the 31st March 2023 balance date, I do predict more property write downs at the September 2023 half year reporting date for IPL. Whether that will 'spook the market again', I guess we will find out,

----------------

SNOOPY

[Aaron]

This is very strange. I go to your link, click on the one year chart, and I get 4.20% as the government one year rate on 31-03-2023 and 4.54% on 28-06-2023.

The link starts with the 10 year yield there is a chart tab box just above the graph and you need to select 1yr instead of the 10yr.

This is the treasury site. They are the ones that issue the bonds aren't they.

https://debtmanagement.treasury.govt...interest-rates

1yr 5%

[Aaron]

Snoops ….I prefer ROIC where the Invested Capital is Equity plus Debt

That way can see if an outfit is returning in excess of its cost of capital ….ie adding economic value

Using our 2023 Investore Example I guess ROIC would be.

$51,402/(675,020+385,037) = 4.8% for 2023 or 48,310/(855,042+351,530) = 4.0% for 2022

The equity portion of the denominator gets moved around a lot by the change in property valuations.

So at 4.8% ROIC (if I have this right) NZDX says Investore bonds are trading at 6.91% although this might jump around depending on who needs to cash up. And how would you measure the cost of equity. I am guessing $29,050dividends/ $675,020 equity = 4.3% Weighting 64% equity + 34% debt (4.3%*.64) + (6.91% * .36) = 5.23% WACC so currently subtracting economic value ON THE DEBT PORTION???

Just trying it as a quick exercise in my lunch break sorry have not given it sufficient thought but would be interested to know if i am on the right track.

I need to redo my calcs the NZDX site also shows me that IPL is only paying 2.4% to 4% on their bonds they mature in 2027 so interest rates might be negative by then.

Currently adding value while interest rates are suppressed.

[Snoopy]

This is very strange. I go to your link, click on the one year chart, and I get 4.20% as the government one year rate on 31-03-2023 and 4.54% on 28-06-2023.

The link starts with the 10 year yield there is a chart tab box just above the graph and you need to select 1yr instead of the 10yr.

Yes I saw the one year Tab, clicked that,, and the numbers I got were as reported:
4.20% as the government one year rate on 31-03-2023 and 4.54% on 28-06-2023.

There is a comment at the bottom of the page by 'DollarsandSense' which says:
"I think someone has entered some data incorrectly"

Not sure what data they are talking about, or even if they know what they are talking about.

SNOOPY