CNU - Chorus

[Snoopy]

Normalised profit is divided by shareholders equity at the end of the financial year


FY2016: $99.6m / $871m = 11.4%

FY2017: $131.7m / $944m = 14.0%

FY2018: $97.2m / $1,022m = 9.5%

FY2019: $65.6m / $979m = 6.7%

FY2020: $68.6m / $927m = 7.4%

At no time over the last five years has 'Return On Equity' exceeded 15%

Conclusion: FAIL TEST

[Snoopy]

'Net Profit Margin' is the 'Normalised Net Profit After Tax' divided by 'company sales' over the financial year


FY2016: $99.6m / $1,008m = 9.9%

FY2017: $131.7m / $1,040m = 12.7%

FY2018: $97.2m / $990m = 9.8%

FY2019: $65.6m / $970m = 6.8%

FY2020: $68.6m / $959m = 7.2%

Is there an explanation for what appears to be a 'peak value' in FY2017? This was the first year when every region (except Gisborne and Kapiti) exceeded the government's long term connection target of having more than 20% of customers who had a fibre broadband line cut across their driveway sign up. One could argue that a certain 'economy of scale' balancing off new income and expenditure rolling out new cable came to fruition. It was also a year where the net total number of lines under management went up (more fibre was being connected than copper disconnected). So why has the revenue continued to track down in subsequent years, even though the penetration of broadband internet continues to rise? The answer is that when a customer upgrades their 'copper line based internet' to fibre, or to a fixed mobile plan, those customers become 'unattached' to the Chorus laid fibre network, and so cease being Chorus customers. Thanks to the success of the other monopoly sanctioned fibre broadband suppliers: 'Enable' in greater Christchurch and 'Ultra fast Fibre' in Hamilton and Tauranga in particular; and Spark and Vodaphone pushing 'fixed mobile', there are a lot of customers to lose during the upgrade process. So to keep the nationwide picture moving forwards for Chorus, future 'upselling' opportunities to the retail customers that Chorus do retain will be necessary. So far there is no evidence that the amount of upselling (putting customers on faster plans with more data for example) is making up for the decline in copper line customers.

Conclusion: FAIL TEST

SNOOPY

[Snoopy]

A cursory assessment of Chorus would suggest this is the place to put your money. The internet is the growth engine of the 21st century. Fibre is the best fast technology and Chorus is a monopoly provider of fibre. What is there not to like?

A closer Buffett style inspection tells a very different story. Underlying 'earnings per share' have roughly halved over the last three years. If you believe the company's own cost of capital assessment, earnings now barely cover its cost of capital. And net profit margins remain under intense pressure. We have to bear in mind that Buffett assessments are not friendly towards capital intensive companies. So it is no surprise that under the spotlight of the Buffett criteria, Chorus sings a woeful song.

Chorus last traded on market at a price of $7.76. Based on FY2020 normalised earnings, this is an historical PE ratio of 46.7. That seems incongruous with a low growth company with margins under pressure. Is this evidence that 'Mr Market' truly has gone mad? The hindsight of history may yet prove this to be true. At these prices, you would have to assume that Warren Buffett would be looking at a different home for his investment cash.

Conclusion: Warren would give Chorus the big 'thumbs down' as an investment prospect

P.S. There is a postscript to the Chorus story. It is a company in transformation that is not reflected in this 'historical' Buffett style analysis. Roll out of the fibre cable nationwide is nearing completion. With future calls on capital drastically reduced, but depreciation on the network assets remaining high, from FY22 we will transition to a dividend policy based on a window emerging where cashflow will greatly exceed profitability. In Chorus's own words from the FY2021 result presentation, Slide 21:

"From FY22 we will transition to a dividend policy based on a pay-out range of free cash flow▪free cash flow will be defined as net cash flows from operating activities minus sustaining capex."

It is the expectation of significantly increased dividends well above sustainable declared profits that has investors salivating. What kind of dividends might shareholders expect from FY2022 onwards? The answer to that question will drive the direction in which my 'Chorus' research will now head.

SNOOPY

[FTG]

Very interesting analysis Snoopy. Thank you for making the time to taking this look under the bonnet.

[Snoopy]

P.S. There is a postscript to the Chorus story. It is a company in transformation that is not reflected in this 'historical' Buffett style analysis. Roll out of the fibre cable nationwide is nearing completion. With future calls on capital drastically reduced, but depreciation on the network assets remaining high we have a from FY22 we will transition to a dividend policy based on a window emerging where cashflow will greatly exceed profitability. In Chorus's own words from the FY2021 result presentation, Slide 21:

"From FY22 we will transition to a dividend policy based on a pay-out range of free cash flow▪ free cash flow will be defined as net cash flows from operating activities minus sustaining capex."
A company that is to remain a going concern must generally match their 'capital expenditure' to their 'depreciation charges'. This will ensure that as their capital equipment wears out, new equipment is brought into the 'production line' (in the most general sense) to ensure that the company can continue to operate their services indefinitely into the future. However, there are occasions where this 'rule' can be broken. In the case of new and long life assets, there may be several years where depreciation of the equipment, on paper, greatly exceeds the capital expenditure required to maintain it.
It is the expectation of significantly increased dividends well above sustainable declared profits that has investors salivating. What kind of dividends might shareholders expect from FY2022 onwards? The answer to that question will drive the direction in which my 'Chorus' research will now head.

A company that is to remain a 'going concern' must generally match their 'capital expenditure' to their 'depreciation charges'. This will ensure that as their capital equipment wears out, new equipment is brought into the 'production line' (in the most general sense) to ensure that the company can continue to operate their services indefinitely into the future. However, there are occasions where this 'rule' can be broken. In the case of new and long life assets, there may be several years where depreciation of the equipment, on paper, greatly exceeds the capital expenditure required to maintain it. With the fibre broadband network largely rolled out, and completion scheduled over FY2022, this is the situation that Chorus finds itself in. A future benefit to shareholders is that Chorus have indicated that from FY2022, they will be in a position where they can pay out some of this 'surplus cashflow' to shareholders in the form of increased dividends. But by how much might dividends increase? An investigation into the changing Depreciation and Capex balance at Chorus might provide a clue.

A clear distinction between 'sustaining' capital expenditure and 'growth' capital expenditure will give a better indication of 'free cashflow' payout potential. FFLAS (Fixed Fibre Local Access Services) is the main area of growth expenditure as Fibre Broadband is rolled out throughout the country. There is little growth expenditure in the legacy Copper wire based network. This is being run down in favour of more modern technology (Fibre and Mobile- the latter not operated by Chorus).

Over time I would expect the depreciation of the fibre network to go slightly higher as the final assets in that network are completed. Likewise I would expect depreciation in the Copper legacy network to reduce as parts of the network are retired. However, in my forecast years I have not attempted to guess what these depreciation changes will be. Instead I expect my underestimated fibre depreciation ( I am modelling unchanged depreciation) will be close to being cancelled out by an overestimated copper network depreciation figure (which I have modelled as unchanged).

Operational Year (F suffix means forecast)	FY2016	FY2017	FY2018	FY2019	FY2020	FY2021F	FY2022F	FY2023F	FY2024F
Overall Revenue	$1,008m	$1,040m	$990m	$970m	$959m	$?m	$?m	$?m	$?m
Fibre Revenue (5)	$133m	$202m	$276m	$368m	$468m	$592m	$715m	$735m	$755m
Total Depreciation	$263m	$274m	$283m	$303m	$319m	$?m	$?m	$?m	$?m
Depreciation: Fibre, Ducts, Manholes, Poles, Network Electronics	$163m	$178m	$185m	$198m	$219m	$219m	$219m	$219m	$219m
less Crown Funded Depreciation	($15m)	($21m)	($22m)	($25m)	($27m)	($27m)	($27m)	($27m)	($27m)
equals Net Fibre Depreciation	$148m	$157m	$163m	$173m	$192m	$192m	$192m	$192m	$192m
Total Gross Capital Expenditure	$593m	$639m	$810m	$804m	$663m	$690m (6)	$514.9m (6)	$448.2m (6)	$410.9m (6)
Total Capital Expenditure FFLAS	$486m	$503m	$620m	$664m	$548m (3)	$575m (1)	$399.9m (2)	$333.2 (2)	$295.9m (2)
less Sustaining Capital Expenditure FFLAS (4)					$72m	$72m	$72m	$72m	$72m
equals Net CAPEX FFLAS for growth {A}					$476m	$503m	$327.9m	$261.2m	$223.9m
Total Capital Expenditure Copper	$67m	$79m	$132m	$81m	$55m	$55m	$55m	$55m	$55m
less Sustaining Capital Expenditure Copper (4)					$54m	$54m	$54m	$54m	$54m
equals Net CAPEX Copper for growth {B}					$1m	$1m	$1m	$1m	$1m
Total Capital Expenditure BackOffice	$40m	$57m	$58m	$59m	$60m	$60m	$60m	$60m	$60m
less Sustaining Capital Expenditure BackOffice (4)					$60m	$60m	$60m	$60m	$60m
equals Net CAPEX BackOffice for growth {C}					$0m	$0m	$0m	$0m	$0m
Total CAPEX for growth {A}+{B}+{C}					$477m	$504m	$328.9m	$262.2m	$224.9m
Total Sustaining CAPEX					$186m	$186n	$186m	$186m	$186m

Notes

1/ Forecast from HY2021 presentation: Slide 20
2/ These are the forecast 'Fibre Fixed Line Access Services' FFLAS 'Capital expenditure Proposals' as outlined in the 17th December 2020 market release on the 'Price Quality Expenditure Proposal Overview', Slide 10
3/ For FY2020, $186m of the total Capex for the year of $663m was defined as 'sustaining' (Full Year Result presentation, 24-08-2020, slide 25)
4/ From HY2021 presentation, Slide 19. 'Sustaining Capital Expenditure' excludes 'fibre connections', 'greenfield growth', 'customer retention payments' and 'UFB Communual' (the expansion and enhancement of the fibre network).
5/ Forecast revenue from 26-03-2021 'Initial Asset Value' Presentation, slide 3. (FY2021 and FY2023 values interpolated).
6/ These totals are added from the constituent components comprising company estimates and my assumptions also in this table.

Potentially we have a a very significant drop in CAPEX coming through, notwithstanding the fact that UFB2 and UFB2+ and the Rural Broadband Initiative (in partnership with Vodaphone) are still rolling out. Yet consummate with this, on the incoming cashflow side, a fall in revenues is predicted. So what is the net effect of these two changes?

Chorus have not provided any forecast as to where they expect their non-fibre revenue to go over the next few years. I have inspected the five year revenue trends for 'copper connected revenue' and 'field services, value add network services and infrastructure' as two groups. The latter group I am forecasting constant revenue of $120m over FY2021 to FY2024 inclusive. The 'copper connected revenue', comprising 'copper based broadband', 'copper based voice' and 'data services copper' have over HY2021 already declined on an annualised basis (that means no further deterioration over FY2021) of $70m. So I am forecasting an $80m decline over FY2021, $70m over FY2022, $60m over FY2023 and $50m over FY2024. The diminishing decline rate I am modelling to take account of a slowing trend as easy conversions to fibre have happened already. My table of forecast 'total change of revenue' over the period of inetrest is as follows.

	FY2021F	FY2022F	FY2023F	FY2024F
Fibre Revenue	$592m	$715m	$735m	$755m
Non-Fibre Revenue	$409m	$339m	$279m	$229m
Total Revenue	$1,001m	$1,054m	$1,014m	$984m

Operational Year (F suffix means forecast)	FY2016	FY2017	FY2018	FY2019	FY2020	FY2021F	FY2022F	FY2023F	FY2024F
Overall Revenue {G}	$1,008m	$1,040m	$990m	$970m	$959m	$1,001m	$1,054m	$1,014m	$984m
Total Gross Capital Expenditure {H)	$593m	$639m	$810m	$804m	$663m	$690m	$514.9m	$448.2m	$410.9m
{G}-{H)	$415m	$401m	$180m	$166m	$296m	$311m	$539m	$566m	$573m

The dividend guidance for FY2021 has already been announced: 25cps is to be expected (PRHY2021 Slide 21), The compares favourably to the two previous dividends of 10cps and 14cps, which sum to 24c, the payout relating to the previous year , FY2020. If a payout of at least 25cps is planned for FY2021, and that still allows Chorus to retain enough cashflow to run the business, then investors might consider that any incremental future cashflow might be available to boost dividends going forwards. If we consider that FY2021 forms a 'base' dividend rate year, and there are 444.401m Chorus shares on issue, then the incremental dividends over that base year we might expect from Chorus over FY2022, FY2023 and FY2024 are as follows:

FY2022: ($539m - $311m) / 444.041m = 51cps

FY2023: ($566m - $311m) / 444.041m = 57cps

FY2024: ($573m - $311m) / 444.041m = 59cps

I have rounded down those numbers to the nearest cent to take account of the fact that, in practise, the number of shares on issue may have increased as a result of the dividend reinvestment plan.

FY2023 and FY2024 look like they could become comparatively sweet dividend years for Chorus, before a very heavy debt repayment schedule disrupts things.

SNOOPY

[mikelee]

Is 5G really going to make much difference to Chorus' bottom line? Or would Spark benefit more from its uptake?

[Snoopy]

Is 5G really going to make much difference to Chorus' bottom line? Or would Spark benefit more from its uptake?

Interesting the way you phrased your question mikelee. You write as though 5G is a goal in itself, rather than a tool to achieve a task. I think that Chorus sees any task that requires 5G can equally well be matched in speed and local portability by Wi Fi capable terminals installed in homes and businesses, in a way that retailers no longer need put their own routers in a physical location to grab the end line customers' business. IOW Chorus are offering a locally portable service like 5G ('anything they can do we can do better') with superior peak time capacity and latency. Take that 5G providers!

As to where 5G itself is in the market, you may find the following comments from Chorus's AR2020 p9 of interest:

"Vodaphone NZ announced an intention to invest in 5G capability. 5G coverage was switched on in parts of Auckland, Wellington, Christchurch and Queenstown in December 2019. Vodaphone has said it hopes 25% of its broadband customers will migrate to its fixed wireless network and it will provide 5G fixed wireless services later in 2020. Using its 4G network, it offers fixed wireless plans in datacap tiers up to 600GB in major cities and urban regional centres,"

"Spark launched 5G in five provincial townships in late 2019. with fixed wireless broadband plans sold in three datacap tiers.: 'up to 60GB', 60GB to 120GB and 'more than 120GB'. In Auckland, Spark offers plans of up to 600GB on its 4G network. Spark announced the launch of 5G mobile and fixed wireless services in Palmerston North in July 2020, with four more centres to follow."

I don't know if Spark will look to emulate Vodaphone and get 25% of their customers onto '5G fixed mobile', but I don't see why they wouldn't want that. If one quarter of NZ's broadband business migrates to mobile, this surely will have a big effect in Chorus - but even that scenario wouldn't be terminal. Even mobile data services use Chorus for the back-haul part of any messages communication journey. Exactly how much Chorus charges for these back-haul services, on a per customer basis, I would love to know!

The likes of Spark and Vodaphone will surely benefit from the saving of any wholesale fees they don't have to pay to Chorus. But I guess there will be a point when the number of customers on one 'fixed wireless broadband' node will degrade the service so much that many end line customers will consider moving back to Chorus. Where that point is, I guess, will depend on the usage patterns of those end line customers. The problem for the likes of Spark and Vodaphone is that what 5G level of service is regarded as 'acceptable' will very likely be a moving target.

SNOOPY

[Snoopy]

A very puzzling stock on a ludicrous PE ratio which cant be explained.

PE ratio is not the right way to value Chorus - capex is still high, but will end in the next 1-2 years, depreciation (non-cash) is high and increasing, and this diminishes the E. Free cash flow will increase substantially once the capex ends

Discl - recently invested

Time to demystify the Chorus share price for Couta, and quantify what free cashflow benefits we shareholders might see for RRR.

Note: This quoted post is from 2655 which I have subsequently reassessed and reworked. However, I have kept my original estimates of the potential increase in dividends here as even though I now believe these to be too low, I could be wrong, and it is interesting to look at another point of view.

A company that is to remain a 'going concern' must generally match their 'capital expenditure' to their 'depreciation charges'. This will ensure that as their capital equipment wears out, new equipment is brought into the 'production line' (in the most general sense) to ensure that the company can continue to operate their services indefinitely into the future. However, there are occasions where this 'rule' can be broken. In the case of new and long life assets, there may be several years where depreciation of the equipment, on paper, greatly exceeds the capital expenditure required to maintain it. With the fibre broadband network largely rolled out, and completion scheduled over FY2022, this is the situation that Chorus finds itself in. A future benefit to shareholders is that Chorus have indicated that from FY2022, they will be in a position where they can pay out some of this 'surplus cashflow' to shareholders in the form of increased dividends. But by how much might dividends increase?

Operational Year (F suffix means forecast)	FY2016	FY2017	FY2018	FY2019	FY2020	FY2021F	FY2022F	FY2023F	FY2024F
Overall Revenue {G}	$1,008m	$1,040m	$990m	$970m	$959m	$857m	$755m	$735m	$715m
Total Gross Capital Expenditure {H)	$593m	$639m	$810m	$804m	$663m	$690m	$514.9m	$448.2m	$410.9m
{G}-{H)	$415m	$401m	$180m	$166m	$296m	$167m	$240.1m	$286.8m	$304.1m

The dividend guidance for FY2021 has already been announced: 25cps is to be expected (PRHY2021 Slide 21), The compares favourably to the two previous dividends of 10cps and 14cps, which sum to 24c, the payout relating to the previous year , FY2020. If a payout of at least 25cps is planned for FY2021, and that still allows Chorus to retain enough cashflow to run the business, then investors might consider that any incremental future cashflow might be available to boost dividends going forwards. If we consider that FY2021 forms a 'base' dividend rate year, and there are 444.401m Chorus shares on issue, then the incremental dividends over that base year we might expect from Chorus over FY2022, FY2023 and FY2024 are as follows:

FY2022: ($240.1m - $167m) / 444.041m = 16cps

FY2023: ($286.8m - $167m) / 444.041m = 26cps

FY2024: ($304.1m - $167m) / 444.041m = 30cps

I have rounded down those numbers to the nearest cent to take account of the fact that, in practise, the number of shares on issue may have increased as a result of the dividend reinvestment plan.

FY2023 and FY2024 look like they could become comparatively sweet dividend years for Chorus, before a very heavy debt repayment schedule disrupts things.

One party that is about to come to an end for Chorus shareholders is fully imputed dividends. The last couple of years have seen dividend payouts far higher than underlying earnings. Over FY2020, dividends amounted to 13.5cps + 10cps = 23.5cps, verses underlying earnings of 16.6cps. Full imputation has been able to be maintained so far because in previous years Chorus built up a surplus of imputation credits. The latest reported imputation credit balance was $74m (AR2020 p56). This $74m represents tax already paid on:

$74m / 0.28 = $264m of earnings

In 'earnings per share' terms this is: $264m / 444.041m = 59cps

That means there are certainly enough imputation credits to cover FY2021 dividends, and maybe even dividends for FY2022. But if the level of dividends really ramps up, then it won't take long to empty the imputation credit piggy bank.

I don't know exactly what track dividends will take under the new distribution policy. What we do know is (from PRHY2021 slide 21):

"From FY22 we will transition to a dividend policy based on a pay-out range of free cash flow ▪free cash flow will be defined as net cash flows from operating activities minus sustaining capex"

Note there is no commitment to pay out 100% of free cashflow like the power companies. Unlike the power companies there will be a need to keep up with technological developments, plus there is the first tranche of a big debt repayment coming in FY2025 ($85.3m or $85.3m/444.041m = 19.2cps). My judgement would be a good meaningful increase of dividend of 10cps, bringing annual dividends to 35cps from FY2022 onwards. However based on three years of such dividend payouts (FY2022, FY2023 and FY2024), I am predicting the dividend imputation rate will fall from 100% to just 50%.

For a long life asset like the fixed broadband network, which carries some technology and regulatory risk, and taking into account the current low interest rate environment, I would judge a gross dividend yield of 5% to be an acceptable 'Mom & Dad' investor return, Consider that my forecast 35c dividend will be paid only half imputed. This implies a 'fair value' Chorus share price of:

( 17.5/0.72 + 17.5 ) / SP = 0.05 <=> SP = (24.31 + 17.5) / 0.05 => SP = $8.36

Such a dividend would still allow enough cashflow to pay down that first tranche of FY2025 debt and still have 7.8cps ( or 0.078 x 444m = $35m) available for 'network enhancement investment' without affecting company debt levels. On Friday the Chorus share price closed at $7.30, which is 12% below my 'fair value' price based on the revised dividend outlook. My accumulation target is normally 20% below fair value for these utility type shares. Should the CNU share price fall below $6.70, I would suggest that might be a good accumulation point for income investors.

SNOOPY

[Snoopy]

Guess I'll have to do the work myself. I found a summary, so my understanding is that the $929mill funding from CFI is split 50/50 with debt and equity securities.
The debt half is interest free but gets repaid 2025 2030 2033 and 2036 18.5% 18.5% 27.7% 35.4% of the debt.

The equity securities aren't the great dilution I had surmised, they are preference shares with no voting rights so more like a debt security, but the dividend rate on the CFH1 Equity Securities (when payable) is equal to a reference rate (based on the 180 day bank bill rate in New Zealand) plus a margin of 6% per annum. So probably 6% or less depending on interest rates going negative or not. Dividends are payable six-monthly in advance, and the dividend payment dates will be aligned with the dividend payment dates for Chorus Shares.
The number of CFH1 Equity Securities on which the dividend is payable at any date will be reduced by the number of CFH1 Equity Securities which have been redeemed by Chorus up to that date (the redemption terms are described below).
The table below shows the number of CFH1 Equity Securities that will attract dividends
(unless redeemed earlier):

Repayment Year	2025	2030	2033	2036
Cumulative CFH Equity on which dividends become payable	$86m	$172m	$300m	$465m
Cumulative CFH Equity %ge on which dividends become payable	18.5%	36.9%	64.6%	100%

I guess it is a matter of going back and seeing whether the interest on the preference shares will significantly impact cashflow or not. 2036 is a long way away.

Somehow I am expecting interest rates to have risen above zero by FY2025 Aaron! If they rise to 2%, that would equate to a rate that Chorus has agreed to pay of 6% + 2% = 8%
On $86m worth of 'preference shares', that equates to a payment of:

0.08 x $86m = $6.88m or $6.88m / 444.041m = 1.5cps

That sounds affordable to me, although with borrowing rates as low as they are, it would make sense to replace the Crown Financed preferences share, with borrowed money at a much lower interest rate than 8%!

SNOOPY

[Snoopy]

As a result of LLU and regulation in general the only winners with Telco's these days are consumers. We demand newer and better products ($billions of capex) and don't want to pay much for it (less EBITDA) and don't want to be contracted (no switching costs).

There was a shock to the CNU share price on Friday as it fell from $7.49 to $7.30, a drop of 2.5%. I thought this might be connected with going ex a 10.5 dividend but no, that happened on 15th March. What did happen on Friday was this:

http://nzx-prod-s7fsd7f98s.s3-websit...756/343108.pdf

I have to admit I find the flow on effects of these regulatory decisions, or potential regulatory decisions difficult to comprehend.

I think what this report is saying is that Chorus Assets have an underlying value of $5.5b to $6b. But due to proposed price controls, the value of the network will be reduced to only $4b because of regulatory constrained earnings. The report represents this as the company potentially having a $1.5b 'financial loss asset' on the books. If Chorus has to declare a $1.5 billion dollar loss because of regulatory price controls on the fibre network assets, it won't put the company at risk because it is "non cash". Nevertheless, such a loss will have to be shown 'on the books', and the interesting thing is how it flows through (Slide 5 of the presentation).

The copper network is immediately written down from $300m to zero. The phasing out of the copper network is not an unexpected thing to happen. But if Chorus need to write it down to zero, does this mean the remaining copper will be ripped up as soon as possible? If Chorus is 'revenue constrained', I think what they are saying is that they will no longer be able to afford any expenditure on the copper network. Ironically, the network being written down to zero will correspond with price controls being taken off copper. So are Chorus saying that there is no level of price access that will make copper viable, even in a phase out transition sense? IOW Chorus will be disbanding their 'fix-it' crews and allowing the copper network to fall apart?

Even the replacement fibre network is potentially being hit with a $200m write down for the glass wires alone. All in all it seems that regulatory pricing has a flow on effect to Chorus's assets that may particularly effect Chorus's copper customers going forwards. Have I got that right?

SNOOPY