"I cannot yet find the breakdown of investing cash flow between...

"I cannot yet find the breakdown of investing cash flow between sustaining capital expenditure and growth capital expenditure. Do you have any information about this?"

@Roy2U,

That is a very salient question for the purposes of conducting a steady-state capital balance on the business.

One of the investment analyst tricks that can be employed in arriving at an estimate of sustaining capex is to use the depreciation charge as a proxy for sustaining capex.

In SPO's case, the depreciation charge has been a moving feast over time, as follows:

FY2011: $54m
FY2012: $57m
FY2013: $53m
FY2014: $53m
FY2015: $65m
FY2016: $82m (annualised first-half figure, but that includes accounting for mobilisation and bid costs capitalised in prior periods)


So, it's quite hard to know - because of some of the accounting oddities that make up a depreciation expense - precisely what the appropriate figure should be from this series, somewhere between $65m and $75m, is what I would estimate to be the current depreciaton run rate, so, say, $70m pa.

(Note that this $65m to $75m level seems to reconcile reasoanably conservatively with the depreciable asset base of the business, which was $300m @ 31 December 2015, and the fact that the bulk of those fixed assets are non-Property and Buildings, i.e., catering and laundry equipment, for which the implied asset replacement cycle of about 4.3 years ($300m divided by $70mpa) "feels" about right to me, if not maybe a bit harsh... so maybe the company accountants are over-depreciating a bit currently, which might mean that a figure closer to $60mpa is the more appropriate level of asset depreciation, and therefore, and indicator of sustaining capex).


But, importantly, its not just expenditure on fixed assets that need to be considered when it comes to understanding the capital flows into and out of, the company's bank account.

There is also the matter of the ongoing funding of Non-Goodwill Intangibles (NGIs), which are significant balance sheet items for the business, totaling some $160m.

To support this level of NGI's requires annual expenditure of at least $15m pa, I estimate, based on history:

FY2011: $21m
FY2012: $48m (reflects the peak capitalised SAP expsnditure)
FY2013: $29m
FY2014: $14m
FY2015: $20m
FY2016: $14m (annualised first-half figure).


So adding the $60m or $70m of Capex on PP&E to the $15m level of NGI spend, I get stay-in-business capital requirements of around $75m to $80m pa.


Note: I recall the listing prospectus or one of the result announcements making some mention of sustaining capex of some $30m pa., but have little faith in that number being relevant today because:

1. It bears little resemblance to what actual capex has been since listing, namely running at an average of $110m pa (Sure, there is supposedly a "growth" element to this materially different figure to the official $30m which seems to b attributed to "mobilisation" capital (for the Defence Contract), as well as expenditure on the SAP system. However, my view on this sort of thing is that the upgrading of IT systems and the spending of money on engaging with clients is the normal part of business, and therefore should be treated as such. Actually, I happen to think that this sort of expenditure should not only be treated as "normal" and should therefore be included in sustaining capex, but it should, in the interests of accounting conservatism, actually be accounted for by being expensed directly to the P&L, instead of being capitalised. Which means that I believe that accounting profits, as reported by the company, are somewhat overstated...but that's a separate issue altogether.)

2. $30m of depreciation also bears little resemblance to reported levels of depreciation (as discussed above. Besides, since that figure was quoted there has been further expansion in PP&E from capex being ahead of depreciation, as well as $200m of acquisitions have been made.)

3. It doesn't hang together with the nature of the asset base, because $30m of sustaining capex supporting $300m of PP&E ($240m excluding Property) implies average asset life of 8 years on the Plant and Equipment, and I am certain that is not the case in reality.

4. Determining what constitutes sustaining capex is a highly inexact science, so I prefer to rely on actual figures rather than theoretical figures. (And that is especially the case when I consider who the vendors of this business were, and who were quoting those theoretical figures!)


Then, just a side reference to your investment thesis, if I may.

Sure, 8x P/E probably, prima facie, looks cheap.

But that's a bit to do with the fact that P/E multiples tend to mask Net Debt levels in today's environment of low cost of borrowings. (And note that the $55m Net Interest figure that I had quoted in an earlier post, which you substituted with $34m, was not my own figure... it was a figure that was quoted by @yanlin in an earlier prior post: http://hotcopper.com.au/threads/ann-retention-of-laundries-business-spo-ax.2836734/#post-18541032).

So I think using an EV multiple is better suited to valuing SPO, because it captures the indebtedness of the company.


And, in terms of growing NPAT to $150m; well, good luck with that, because it is unlikely to come from much in a way of new business being won given the constrained state of the balance sheet, and I don't think it will be driven by SPO flexing its price list given the limited pricing power it possesses, so it will have to come from internal restructurings or efficiency gains (but again, crystalising these cost money upfront).


As for quoting ROE of 16%, beware of depending too much on this metric, too, as ameasure of the financial pedigree of this business because as you know, ROE is the product of Operating Margin and Asset Turn, and the problem I have with SPO, besides what I consider to its unsustainably high levels of debt, is that it has, for some years, been consuming capital faster than it has been accounting for it, the result is falling Asset Turn:

Asset Turn (on PP&E plus Non-Goodwill Intangibles)
2013: 7.3x
2014: 7.1x
2015: 6.8x
2016: 6.3x (DH, annualised)

This trend is clearly not sustainable.


Finally, on a positive note, one can expect that the JH2016 Operating Cash Flows are likely to be strong, due to a non-recurrence of the working capital impost (some $70m of it) that affected DH2015's OCF.

So DH2015's $800m Net Debt figure is probably over-stated (all things equal, on a working cap normalised basis, it is probably really of the order of $750m, I reckon).

Which means that the market might be a relieved when it sees that.


I think it is not a very good quality business, but good luck with it nonetheless.