by: Tam Ging Wien
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NetLink NBN Trust (CJLU.SI) released its 1H-FY2020 results on 01-Nov-2019 (Fri) on the close of the trading day. This announcement is crucial as it forms the first dividend declaration for the 1H-FY2020, setting the tone for dividend expectations for the second half of the financial year.
We had formerly written about NetLink Trust during its initial public offering back in Jul-2017:
For readers who would like to know the background of NetLink Trust, the reads above are highly recommended.
We like dividend paying stocks to pay dividends that is consistently less than its Free Cash Flow (FCF). This is one of the key dividend sustainability trends that we look out to access the quality of our dividend paying companies.
We had previously written about unsustainable dividends various different articles covering examples like Hyflux, StarHub and Asian Pay TV Trust, all which ended up cutting their dividend severely resulting in a plunge in their stock prices. We recommend the following articles for our readers to get a good grasp of how we access dividend sustainability:
Looking at NetLink Trust, financials in FY2018, FY2019 and 1H-FY2020, at first glance it seems like it is going the same route as Hyflux, StarHub and Asian Pay TV Trust. However, this does not mean that it is in any immediate danger as simply taking two and a half years of financials is still too early to predict any severe impact on the trust. Hence, the FY2020 results and dividend declaration is crucial as this gives us an idea if the management is planning on scaling back its payout of its capital expenses in order to bring sustainability to the trust.
As NetLink Trust had only been listed in July-2017, its FY2018 is a partial year. Therefore, we have annualised the figures from FY2018 as if it was for a full 365-day year.
Likewise, the financials for FY2020 is also partial with only 1H-FY2020 declared. Therefore, we forecasted the figures for FY2020 by multiplying by 2. This assumes that the performance for 1H-FY2020 is proportionally representative for the full financial year. This figures for Forecast FY2020 will need to be adjusted after the Q3-FY2020 and full year FY2020 are released.
We observe that revenues for NetLink Trust has been growing steadily in the last 3 years. This is likely owing to increased number of fibre connections that is has taken up.
Both residential as well as non-residential fibre connections have been growing. Residential connections lead the way by growing 2.0% in the last quarter while non-residential connections grew by 0.4%.
Residential connections accounts for the largest component of NetLink Trust’s revenue stream – approximately 61.2%. As NetLink Trust is solely dependent on the Singapore market and with fibre broadband installations becoming increasingly common among households, this revenue stream will show slower and slower growth in the years to come.
In addition to this, NetLink Trust business and ability to charge clients are regulated and subjected to review. The last time the charges have been reviewed and approved was in May-2017, just prior to its IPO. A review is usually conducted once every 5 years with an option for a mid-term review in the third year. The third year mid-term review should be coming up in May-2020 and we anticipate that NetLink Trust will likely to propose to conduct this review. As it stands today, NetLink Trust charges the following, making their business highly predictable:
Source: NetLink NBN Trust
Source: NetLink NBN Trust
Source: NetLink NBN Trust
Breaking down its expenses, NetLink Trust incurs the highest expense due to regulatory depreciation and amortisation of its expenses. For 1H-FY2020, depreciation expense recorded for S$83.8mil. Regulatory depreciation of NetLink Trust assets are over its useful life-time:
Besides depreciation, other major expenses are Staff Cost, Installation and Diversion Cost and Operational and Maintenance Cost.
Capital expenditure (CAPEX) for 1H-FY2020 clocked $43.9mil, much higher than any of the other hard expenses. This would be expected as it would need to replace the depreciated assets annually to maintain the business.
Comparing 1H-FY2020 with the past FY2019 figures, CAPEX seems fairly predictable at around the similar levels.
NetLink Trust pays approximately 80% to 85% of is operating cash flow out as distributions/dividends to its unitholders. This is fairly-high and therefore it retains very little cash for its business purpose.
Operating cash flow is the actual cash received by the company in the course of doing its business. The Operational Cash Flow is the cash left over after deducting all the operational expenses of the business and adjusted based on the working capital. The Operational Cash Flow can be found as a line item in the Cash Flow Statement.
CAPEX is the amount spent by a business to acquiring or maintaining fixed assets, such as land, buildings, and equipment. To justify an expense as a CAPEX, the purpose of the expenditure must be to maintain or expand the business.
The Free Cash Flow (FCF) of a business is the left-over cash that a business has after it has deducted both its Operational and Capital Expenditure.
As a result of the high CAPEX and high payouts, it pays out more dividends than its Free Cash Flow. Another way to look at it is that NetLink Trust pays out the bulk of its operational cash flow as dividends and therefore retains very little of that cash flow to fund capital expenditure. Due to this reason, it will need to borrow more money to fund its capital expenses (CAPEX) leading to decline in cash holdings and increase borrowings. This is elaborated in the next section.
As it needs to payout more dividends that its Free Cash Flow, it will need to draw down on its cash holdings. This has led to a decline in the cash holdings over the last 3 years. There is still significant amount of cash holdings and we think this could easily support NetLink Trust over the coming years.
Without excess cash flow from its operational business, NetLink Trust had to borrow in order to pay for their capital expenditure. From FY2018 to FY2019, it increased its borrowings by $45.8mil.
Fortunately, NetLink Trust’s currently have a very low gearing of just 14.9%. If goodwill assets are excluded from the calculation, the gearing would increase to about 18.1%. Goodwill is the intangible asset that is put on the books to account for the difference between a price paid to acquire an asset that is above its fair value. Therefore, it is common to exclude goodwill on the assumption that nobody would buy the same asset above the fair value.
A total of 3.24c and 4.88c was declared for FY2018 and FY2019. As FY2018 was a partial year, the 3.24c DPU would be 4.15c if annualised to a full year. For 1H-FY2020, the DPU declared was 2.52c, therefore on an annualised basis, this would amount to 5.04c or about 3.3% increase – effectively continuing to pay more than its free cash flow.
Based on our assessment above, we think that the DPU increase next year is unlikely to be significant and management is more likely to maintain payouts with slight increases.
Based on the data for FY2018, FY2019 and the partial data for 1H-FY2020, NetLink Trust shows early signs of unsustainable dividends. This does not in anyway imply that it is in any imminent danger. At a gearing of just 14.9% and backed back SingTel as its biggest shareholder, Netlink Trust could easily just obtain financing in today’s low interest rate environment to continue to finance its capital expenditure.
We think that at this juncture, the management is likely to be taking advantage of the low interest rate environment to leverage up to fund its capital expenditure. If this bet pays off, it could potentially grow it’s business at a faster and eventually generate more cash flow to support is current dividend.
Hyflux, Asian Pay TV and StarHub has been showing this trend for 5 to 6 years before their dividends had to be drastically cut. This trend in NetLink Trust has only been observed for two and a half years giving NetLink Trust plenty of time to adjust its dividend policy, grow its revenue or manage down both is operational and capital expenses.
Therefore, it is simply to early at this junction to determine if NetLink Trust’s dividend is really unsustainable. It is still very low in its leverage and still have a high cash reserve. Its cash flow is also very steady & predictable. The difference between its free cash flow and distributions declared is not significant at about ~$30mil in FY2019 and ~$16mil in FY2020 which it could easily afford to support in the years to come.
Our view is that this observation is a risk that all investors in Net Link Trust should be aware of and should monitor annually, but certainly not an immediate concern at this stage.
In our next article on NetLink Trust, we will be looking at how the upcoming 5G may impact NetLink Trust’s business – boon or bane?
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If you have enjoyed this article and would love to learn more about ready and understanding financial statements of listed companies, head over to some of our popular education series:
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