The report today says that AZJ gearing is about 40% which I...

The report today says that AZJ gearing is about 40% which I believe equates to around $3.6B if I’m not mistaken.

It was $3.386bn @ 31 December 2017.


"My question is how does AZJ service that debt is 100% of profits are always paid back to shareholders in the form of dividends, am
I missing something here?"

No, you are absolutely right.

If a company pays out 100% of its earnings - and assuming there are no differences between corresponding elements on the P&L and Cash Flow Statements (i.e. depreciation equals payments for PP&E, interest expense equals interest payments, and tax expense provided for equals tax payments) - then a company cannot reduce its debt principal (although it will be able to service its interest).

However, in AZJ's case there are a few reasons why a 100% payout ratio could be maintained (it could be, but it won't) and borrowings could still be reduced.

One reason is that the P&L includes certain non-cash items (such as provisions) which impact the P&L but not the free cash flow, from which dividends can be paid or debt reduced.

Another reason is that the P&L is somewhat conservatively struck, with rates of depreciation running at some $530m, while stay-in-business PP&E spend is only $480m (i.e, the company is "over-depreciating" to some extent).

This means that while the company is paying out all of its reported accounting profits, its cash profits exceed accounting profits, thereby allowing some debt to be repaid (assuming, of course, no investment in growth takes place).


"Also to me a company with that much debt isn’t necessarily deemed as “low risk”, id be interested to hear why you think it is regardless of current gearing levels?"

Well, for starters, "gearing" - as measured by Net Debt to Shareholder Equity (or Net Debt to Total Capital) - is a bit of an outmoded measure of solvency, I think [*].

These days, commercial lenders look more to more dynamic, and relevant, metrics such as Net Debt-to-EBITDA or EBIT-to-Net Interest Coverage.

In AZJ's case, Net Debt-to-EBITDA is ~2.3x and EBIT-to-Net Interest Cover is ~5.0x.

If you speak to any respected commercial banker, he/she will tell you that neither of these is very demanding, especially in the context of the monopoly-type of assets AZJ operates, the company's scale advantages and the fact that its Operating Cash Flow is well above double the company's stay-in-business capex requirements.

This is why AZJ has never skipped a dividend and it means that AZJ will - absent some kind of extraneous economic disaster - always be able to service its debt costs.


[*] "Gearing" is outdated because its denominator, i.e., the notion of Shareholder Equity can be a bit of a rubbery figure and is an outworking of all sorts of sometimes arcane accounting assumptions, many which date back in time, often rendering the the figure a bit meaningless.