Dividend Power

Monday, 8 June 2015

Drax - No Reasons to be Cheerful, yet

Drax: Life must have seemed a lot calmer when oil was $100+ and coal-fired generation was more competitive with other sources. Even better was that you could see lots of subsidies and financial carrots in converting some capacity to nice green biomass generation. Unfortunately the oil price collapse has made gas-generation cheaper and government subsidies, even for green energy, have become harder to nail down. Back in February, at the finals to 31^st December 2014, EBITDA was only down £1m at £229m, but underlying eps dropped from 35.3p to 23.7p, as higher depreciation and finance charges from the biomass conversion investment bit. With group dividend policy being driven off a 50% earnings payout, the decision was to cut the total dividend from 17.6p to 11.9p. (It was 32p in CY2010). The balance sheet showed modest debt of £99m, well covered by that EBITDA of £229m. At that stage the 2015 earnings outlook was weak citing the “major deterioration in commodity markets”. Whilst the Drax Power Station had performed well operationally, they sounded frustrated at the, sedate, progress of EU State Aid clearance relating to the Biomass conversion of the third unit.

Roll forward to today’s trading update and the sky still seems fairly grey. Expectations for the year are unchanged, with challenging trading conditions and weak power prices. Some protection has been achieved through forward contracts, but by their nature that is a rolling programme. They are still selling forward, but the 2016 achieved price of £48.80 is down 2.2% on the 2015 figure of £49.90. The shares are down around a third in the last six months and at 375p, are on 25.9x consensus eps for CY2015 of 14.5p. This points to a dividend of 7.3p for a yield of barely 2%. With the spot crude oil price having recovered from the mid $40’s to low $60’s per barrel, this may well be somewhere near the cyclical low for Drax’s prospects. As for EU and National regulators, guessing or second-guessing their actions is akin to a lottery. So, looking at these CY2015 forecasts may not be much help. If you want to “knife-catch” and feel that things can only get better, then the shares may attract. However, by the yardstick of good initial yield and predictable dividend growth, it is clear that Drax comes up short. (Neil Cumming^,8^th June 2015)

These comments are not a personal recommendation to deal. Any investments can fall as well as rise in value, so you could get back less than you invest. I may have a financial interest in some of the stocks written about. www.dividendpower.co.uk or e-mail at info@dividendpower.co.uk Twitter: @DividendPower

Thursday, 4 June 2015

Dixons Carphone - How long will the honeymoon last?

Dixons Carphone: The fourth quarter trading update shows a group (including Curry’s, PC World and Carphone Warehouse) still trading very well, with pre-tax profit for the year to 2^nd May 2015 now guided to be slightly above the top end of the previous guidance range of £355m - £375m. LFL sales seem to be accelerating with a Q4 rise of 9% out-stripping the half-year rise of 8% and the full year number of +6%. The UK has led the way with annual LFLs of 8%, although there has been a very notable Q4 recovery in Southern Europe. Despite posting Q4 revenue LFLs of 8%, this region was still down 5% for the year. All this is without sacrificing price with group gross margins held steady, whilst group net debt is “expected to be ahead of guidance of £300m”. The current effectiveness of Dixons Carphone can perhaps be seen in part in the recent struggles of online UK rival AO World. All this has been achieved against the background of integrating the two sides of the group after last year’s merger. It is to their credit that this has been executed so well so far.

However, I am concerned as to how much of the progress has been the low hanging fruit. There will be more cost savings and integration benefits to haul out in FY2016, but after that the slog might truly begin. Their chosen markets of mobile devices, computers, brown goods and white goods are already very competitive and as AO World and many others have shown, the on-line barriers to entry are not that high. The price transparency offered by the internet means that maintaining, let alone growing, margins looks to be a big ask in the medium term. The group has trusted brand names, but that only gets you so far. For example, in the less exciting DIY sector, B&Q found that being the last man standing isn’t a passport to financial happiness. If eps growth does start to slow after the honeymoon years, then it will be difficult for Dixons Carphone to maintain its current rating. After this upbeat statement FY2016 eps forecasts will probably head up, towards 28p, which at 477p is a PE of 17.0x. This seems quite full for the likely c10% annual eps growth over current forecast horizons. Whilst the balance sheet looks healthy as net debt heads below £300m, dividend cover is being held quite high at about 3.25x. So the FY2016 dividend looks set to be around 8.6p, for a skinny yield of 1.8%. None of this looks exciting, but I came to much the same conclusion in December last year, when the shares were lower at 440p. (Neil Cumming^,4^th June 2015)

Wednesday, 3 June 2015

Entertainment One - Peppa Pig meets Grey's Anatomy

Entertainment One: Their best known property is the kid’s character Peppa Pig, but I am surprised how often their name comes up in film credits nowadays. This is a decent sized company (mkt. cap. c£970m) that many have never heard of. In their recent annual results (to 31^st March 2015) there were lots of adjusted and pro-forma numbers following the acquisition of a 51% stake in The Marc Gordon Company (who are behind Grey’s Anatomy). Adjusted pre-tax profits were up 13% to £88.8m, with eps up 12% to 23.5p. On the back of this the (mainly symbolic) dividend was raised 10% to 1.1p. The group re-affirms that it is on track “to double the size of the business over the next five years” (i.e. by FY2020), although the future balance between organic and acquired growth is an unknown. The group has expanded quickly so far and whilst cash conversion has improved, free cash flow was only £41.0m against pro forma EBITDA of £107.3m. Total net debt (including production costs) was £314.2m, which is about 2.7x adjusted EBITDA, so I expect that any further acquisitions might just need an equity component. As expected, the Peppa Pig brand is being expanded with bridgeheads established in the US and a China broadcast launch slated for later this year. The Marc Gordon deal is part of a major push into TV programming, but like film this can be a lumpy volatile business. Sheer scale does help smooth out some of the bumps, although this year did see Film revenues decline, with EBITDA held static. Overall £280.8m was spent on acquiring content last year, slightly up on last year and showing the kind of stakes being wagered. The flip side is that the programme library had a value of $801m at 31^st March 2014 and will have increased further in FY2015, not least because of the Marc Gordon deal.

Clearly Entertainment One is moving fast, although it is worth remembering that few kid’s brands achieve the longevity of a Sesame Street. How long Peppa Pig can keep oinking for is a complete unknown, but the bacon factory is still for a far off day. Looking at forecasts, consensus eps in FY2016 look like 25.5p giving a PE of 12.8x at 327p. A further dividend nudge to 1.2p points to a weeny dividend of 0.4%. Further out, if the doubling in group size can be made to drop through to earnings then in FY2020, eps could be 42p. Further, if ever the voracious cost of content can be tamed then the dividend pay-out might be improved. Even a cautious 4x cover would be a 10p dividend to collect. There are many pitfalls for companies in the entertainment and media content space, but Entertainment One is building a good reputation and in Peppa Pig has a great calling card. So not a yield stock, but it could grow its dividend at a nice clip and generate shareholder value, making it worth considering for the more adventurous. (Neil Cumming^,3^rd June 2015)

Tuesday, 2 June 2015

British Land convertible - what is it good for....?

British Land convertible: Today British Land has launched a £350m convertible bond offering, mainly to help pay for a site in Paddington (One Sheldon Square for £210m) and for Surrey Quays Leisure Park (£135m). The bonds are being issued out of a Jersey based subsidiary with a June 2020 maturity, a 20.0%-27.5% premium to the equity price and a 0.0%-0.5% coupon.

Now, British Land is focused on UK retail and London offices and is a doyen of the sector. However the world around is changing fast and whilst the London office market seems to be bubbly, I would be a bit wary about the prospects for retail property. In the long run, internet shopping will grow and grow. The over-spacing issues seen by the supermarkets could spread to other categories. The prospects for retail property may depend on the ability to recycle space into more leisure based uses or destination shopping for which the internet falls short. So I am not that keen on the equity at the moment.

But let’s say that you like the look of British Land. You can buy the equity for 864p, a modest premium to the last stated EPRA NAV of 829p (at 31^st March 2015). At this price the yield is a (modestly growing) 3.2%. The bonds issued today (when the pricing is set) will give you the right to buy equity by 2020 at a price of around 1035p to 1100p. In the meantime your coupon is between 0% and 0.5% (get the microscope out). To my mind no greek alphabet soup of deltas, volatility value or time value makes this optionality on the equity look great value. If you like British Land then buy the equity. If you don’t like British Land that much, then buy a ten-year gilt. Those that think this type of modern convertible is good value, just leave me scratching my head. All the upside on this deal looks to belong to British Land – clever people. (Neil Cumming^,2^nd June 2015)

Monday, 1 June 2015

National Grid - plugged in to dividend growth

National Grid: In the results for the year to 31^st March 2015, pre-tax profits rose by 11%, with adjusted eps up 10% to 59.6p. On the back of this, the annual dividend was raised by 2.0% to 42.87p, in line with the group policy of inflation benchmarked increases. In the constant game of growing profits, whilst keeping the regulators sweet, National Grid seem to have had a good year. An election win for the Tories is a further boost, as their version of utility baiting is nothing compared to what Ed (and Nicola) might have executed. In the UK they have squeezed further returns out of their regulatory agreements, whilst boosting the regulatory asset value by 2% to £25.4bn. In the US a 7% underlying growth in “rate base” to $17.2bn and weather effects, saw the return on equity dip from 9.0% to 8.4%, although profits were maintained. Overall the group return on equity edged up from 11.4% to 11.8%. The group highlights its “Overall Value Added” in the year as £1.7bn (44.7p per share), some £448m less than the previous year, with this more than accounted for by lower than expected inflation creating an £500m headwind. The balance sheet remains sound, with group gearing of 62% (FY2014: 61%) and the dilutive effect of the scrip dividend programme now being addressed by share re-purchases.

Granted, National Grid is not a sexy beast, but at 931p, modest eps growth in FY2016 to 60.8p gives a bearable PE of 15.0x. A similar dividend increase (but RPI is what matters here) points to 43.73p for a yield of 4.7%. There are operational, political and regulatory risks here, but it is a steady utility and those risks are part of corporate life. At a time when cash returns and investment grade fixed coupon debt offers so little to investors, a quasi index-linked equity with a 4.7% prospective starting yield still looks like very interesting ballast for many an equity portfolio. (Neil Cumming^,1^st June 2015)