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Is the dividend sustainable?


FFHWatcher
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I guess this is a bit of an accounting question and a bit of a Operating a Business question.  There is a transportation business that pays out about 6% of their revenue as a dividend. 

 

Their business operates in a manner that uses long term debt/financing to grow the business (buying more vehicles to service new routes or to buy entire businesses that own vehicles and have contracted routes) but maintains their existing business out of free cash flow (which is the million dollar question...Do they?).  Their GAAP earnings are virtually non-existent.  Less than 1% of sales.

 

The reason why myself and many others are having problems with determining if indeed they are able to afford their maintenance capex out of free cash flow, is because they have been utilizing lease financing for their vehicles, so while they might lease $1M in new vehicles (hypothetical amt), only a $140,000 annual payment is made (payment is about 14%/yr over 6 years, of cost of the vehicle). The lease obligation is not on the balance sheet.  Out of the $1M in new vehicles, 80% are allocated to replace old vehicles, while the other 20% is to buy new vehicles to fulfill new routes that they 'won'. 

I believe they are basically saying, our depreciation isn't a cash expense, so we are paying a lot of it out as a dividend. 

 

$550M revenue

GAAP earnings are $3M

Dividend is almost $33M/yr

Depreciation is about $49M/yr.

Net cash provided by operations $49M/yr

$202M in LTD

 

If depreciation is 'real' they have no free cash flow because there are no other significant line items. Depreciation always equals "Net cash provided by operations"

Actual cash capex is about $35M/yr but on top of that, they purchased almost $46M in new vehicles ($6.4M annual payment) in replacement vehicles (maintenance capex?) for next year. And they are purchasing a growing amt each year. 

Is maintenance capex $46M or $6.4M?  (stated maintenance capex is actually $55M. Stated growth capex is $55M also >> Total is $110M)

 

I estimate they have over $200M in leases that are not on the balance sheet and they are sucking up more and more of the cash.

 

Should they be able to afford to replace old vehicles out of free cash flow, or should they be financing them in some way?

 

This switching to leasing from owning (finance or cash purchase) is confusing re: depreciation.

They push through 2% price increases/yr plus 5% growth (winning new contracts).

Very stable business. Very visible future contracted revenue.

At the end of the 6 year leases, they generally buy out the lease.  This past year, they purchased $1M in vehicles from their leases with a reported market value of $3M or so.  This suggests the leases do eventually contain some 'equity' value.  They can buy it for $10k when it is worth $30k or so.

 

I will cough up the name shortly but as a shareholder, I wouldn't mind keeping it private for a bit.  I am sure knowledgeable peeps can figure it out.

 

Is this enough info.?  I would love your feedback.

 

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Guest Schwab711

Sounds like they are using operating leases (OL) as opposed to capital leases (CL), see first link for summary. OLs can accelerate tax-deductible expenses relative to purchasing the PP&E and taking the normal expenses from depreciation and interest on debt used to finance the purchase. So, net income (NI) is artificially lower than what "true" GAAP NI could be (OLs just "kick the can" on taxes, which lowers the PV of their tax obligations). You can create a OL v. D/I schedule (2nd link; starting on p.11) to estimate the difference and adjust current GAAP NI accordingly.

 

After adj you'll find NI, FCF, and the debt ratio are all higher than reported (see pic).

 

What does the depreciation represent? E.g. is it for a warehouse that will still be usable after being fully depreciated?

What does the LT debt maturity schedule look like? Are there any possible liquidity crunches in the future?

Can we assume that the excess value of the maturing OLs is a one-time occurrence?

 

 

http://people.stern.nyu.edu/adamodar/New_Home_Page/AccPrimer/lease.htm

http://people.stern.nyu.edu/adamodar/pdfiles/papers/oplev.pdf

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Thanks for the links. It gave me a better understanding.

 

I guess the question I am trying to wrap my head around is 'Should a company be able to use operating cash flow to purchase replacement vehicles that represent maintenance capex?'

This company can't afford to buy $55M of replacement capex vehicles so they are entering into operating leases at $7.7M/yr for the current year.  If they continue to enter into these operating leases and continue to use up all their cash paying out a high dividend, will the annual new operating lease payments eventually use up all the free cash flow to the point where they will have to cut their dividend?

 

Additional info.

13 year useful life of vehicles.

6 year leases with lease buyouts that are approx. 20-25% of the original vehicle value (reportedly buyouts are significantly below market value)

25% of their fleet is currently under operating leases

 

 

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