SKC - Sky City

[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

[peat]

thanks for the posts Snoopy.
I appreciate the effort and the sharing.

fwiw my chartist view confirms a bearish view though a lot of support would be found at $3 the purple line
Note I'm not saying 3 will happen but the bearish gartley pattern will exert a lot of downside pressure.
Attachment 9015
interestingly , or not , the chart resembles FBU another disappointing company although I've drawn a harmonic pattern on this one (the gartley), whereas for the FBU I drew a channel. SKC's channel is slightly expanding though, and it has tested more aggressively the lower levels of the channel , which I admit are not that clear to me (and I havent shown them). It may have even broken them. If that is so the situation now is one of 'coming back to test' and would make a sell even more enticing



Snoopy , your FA view says $3.50 is fair value. This chart targets $2.50 which would exactly be a 20% overshoot on the downside in accordance with your 'rule of thumb'. Probably require something pretty gnarly to happen for that to occur but just an interesting coincidence I thought.

[Snoopy]

Snoopy , your FA view says $3.50 is fair value. This chart targets $2.50 which would exactly be a 20% overshoot on the downside in accordance with your 'rule of thumb'. Probably require something pretty gnarly to happen for that to occur but just an interesting coincidence I thought.

I guess it isn't a real surprise that FA and TA end up being 'tied at the data point'. Ultimately they are different reflections of the same thing. I should point out though that a 20% discount to my 'fair value' of $3.50 is actually $2.80, not $2.50. Of course a 'rule of thumb' is just that. And should be treated with an amount of uncertainty that that phrase implies. I would struggle to paint the circumstances that would reduce the SKC price to even that $2.80 that level though.

I have been to the Sky City venue in Darwin. It is a little 'out of town' (not that town is really that big), so you have to make a conscious decision to go to the site rather than 'just wander in on a night out'. I see the NT government has allowed a 60% jump in pokie machine numbers in the pubs and clubs, while simultaneously grabbing another $1m a year off the casino in local taxes. That has to be a long term hurt. Big money has been spent at Adelaide casino itself, but the car park is still a work in progress. This seems to be management's excuse for the Adelaide refurbishment falling a bit flat (so far). Then there is the problem at all venues with the 'high rollers' not being able to get as much money out of China to gamble with as they had previously. But when it comes down to it, Auckland is what will drive this company going forwards. The coming Convention Centre in Auckland is talked up by all parties. But what happens if it adds on a whole lot of extra costs, without the consummate returns that the increased number of gaming machines should allow? If all these ducks are shot down in a row, maybe a share price plunge down below $3 is not so far fetched?

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

[hardt]

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}	Prima Facie Income tax @ 28%	Implied Earnings Imputed Percentage	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

Deferred income tax is around 80-85M every year, would that have anything to do with the credits being retained by SKC?

My understanding is these credits can roll over and be used for future tax liabilities...

[winner69]

Snoops - 1) imputation credits can only be applied to earnings generated in NZ and 2) did you see that Note in the Accounts that some years they have had to prepay tax to keep the Imputation Credits Balance at year end positive (being negative is a no-no)

[Snoopy]

Deferred income tax is around 80-85M every year, would that have anything to do with the credits being retained by SKC?

My understanding is these credits can roll over and be used for future tax liabilities...

I am not a tax expert Hardt. But using my rudimentary tax knowledge I have always believed that:

1/ 'Deferred Income tax' was money that a company knew they owed to the tax department, and was listed as deferred because it was recorded on the books before the payment was made..
2/ 'Imputation Credits' are only earned as a book entry after the tax is actually paid.

So I find it hard to believe that 1/ could be a substitute for 2/ or vica versa.

Thanks for your suggestion though.

SNOOPY

[Snoopy]

Snoops - 1) imputation credits can only be applied to earnings generated in NZ

I might have to resurrect my spreadsheet where I tried to reconcile all of those divisional results. My memory though is that the Australian divisions are not that profitable.

and 2) did you see that Note in the Accounts that some years they have had to prepay tax to keep the Imputation Credits Balance at year end positive (being negative is a no-no)

I wish they had prepaid a bit more tax in that case!

Presumably if SKC don't keep their imputation balance positive, the liability to pay tax just falls on the shareholders. I guess the government doesn't mind if the company pays the tax or the shareholders pay the tax (which is what happens if the company pays an unimputed dividend). Either way the government gets the tax?

Could 'not paying their tax' just be a way for the company to hang onto some much needed cashflow?

SNOOPY