"The devaluations have reversed, but the SP hasn't followed. Interest rates can't be the explanation, because, if it was, the revaluations wouldn't have happened. I don't understand the reason for the lagging SP. Maybe just lack of interest in an illiquid stock?"
@IndexInvestor,
The latest RBA interest rate announcement - splashed as usual with great alarm across mainstream media outlet headlines - prompted me to dust off my CDP model to see if an investment opportunity exists in the wake of all the wailing and gnashing of teeth.
My conclusion is that I don't believe lack of liquidity is the reason the stock hasn't performed over the past 12 months; rather, it is due to some of the underlying fundamentals of the business which are going in the wrong direction.
Remember that internal asset valuations are just that: internally-derived, so the market rightfully applies a discount to them.
The size of that discount obviously varies and the reason for the variation lies in the schizophrenic way the market views the head stock, namely, as a fixed income security/bond proxy, meaning that at times the discount reduces (during times when bonds are firmly bid) and at other times the discount increases (when bonds come under pressure and yields rise....as they are doing currently).
[Year-end prices used to determine Price-to-NAV]
As can be seen, CDP is currently trading at a level equal to its largest historical discount to book value (in determining the average 82% discount I've excluded the Covid years (i.e., 2021 and 2022) because that was an extraordinary, therefore unrepresentative, period).
The question is why this discount is so wide, and what - if anything - might precipitate its shrinking.
The problems facing the stock, which are fundamental headwinds to closing of the discount to NAV, are two-fold, I think:
1.)
Declining Core Profitability.
Recall that the Carindale shopping centre underwent a major, ~$120m refurbishment between 2011 and 2012, so it enjoyed a significant "refurbishment dividend" thereafter in the form of higher rents and operating earnings.
But the benefits had begun to wear off in around FY2016, and the Revenue-Cost jaws have narrowed since then, with FY2022 Operating Earnings down by more than 13% since the FY2016 peak, and 4% lower than the period immediately prior to Covid (i.e., FY2019):
For a security viewed as fixed income investment, that's not a great-looking picture (even if the business in question was totally un-levered, which it isn't, so there's also that).
On its own, that graph presents an obstacle to induce a re-rating of the stock, but to compound it there is the DRP which was invoked last year, and which has resulted in shares on issue increasing by 3.8% in FY2022 and (a further 2% since the June 2022 balance date), so on a
per share basis, the FY2022's Operating Earnings are 16.3% down on the FY2016 high, and 7.5% down compared to just before Covid.
This segues into the second headwind mitigating against a re-rating:
2.)
The DRP: Short-term capital conservation, but long-term value destruction
As a general observation, DRP's reflect sub-optimal capital management, particularly in businesses where distributions are large fraction of earnings (as is the case with CDP).
Issuing shares in lieu of cash in order to subisdise a desired declared level of distribution could be justified under unique circumstances which are likely to be temporary, or when a stock is obviously overvalued, but to have the DRP switch positioned permanently in the
ON position is a bad thing in the long-term, because what it does is it continuously creates new equity - importantly, it does so at a faster than linear rate (!) - which has to be serviced to perpetuity.
With shares on issue for CDP growing at ~4%pa, it means that every year, the first 4% growth in earnings is consumed just to maintain the distribution to shareholders at the prior year's level.
Which might be fine if the underlying earnings are growing organically at a decent rate, but when they are going backwards, as is the case here, then its a situation of
fewer profits each year needing to be distributed over more shares each year.
It doesn't take great financial insight to realise that isn't the stuff of favourable ultimate shareholder value outcomes.
Additionally, when the shares are issued at NTA, as is happening here, then NTA gets reduced each time, thereby reducing the discount to NTA at which the stock trades.
As had been argued on these threads some time back, the then-distribution of 40cps was unsustainable and needed to be re-based lower. A meaningful re-basing has indeed happened, to around 25cps, seemingly. However, I argue that this is an incomplete re-basing exercise because the 25cps is DRP assisted.
The DRP take-up is high (~70%) so the company is conserving a meaningful amount of capital: up to $14m pa, which is a good thing for the balance sheet.
But the sword is double-edged; high rate of DRP election also means high rate of dilution.
With growth stocks (or stocks subject to share buybacks, which is the opposite of DRPs), time is on your side. By contrast, with DRPs done on an NTA- dilutive basis, time works against you: over a long enough time frame, the discount to NTA will evaporate ... even without the share price rising, and due to the NTA being devalued instead.
The CDP board is painted into a bit of a corner: it only has Free Cash Flow of around $22m to $24m pa to play with. Current DPU of 25cps speaks for $18.5m, leaving just scraps left over for reduction of the non-trivial, $250m in net borrowings (not to mention how any major calls on capital, e,g., for the next refurbishment).
So it is clear why the CDP directors have gone down the DRP path: they want to declare as high a distribution as possible to appease shareholders, as well as make some inroads into reducing the debt.
But it is really sub-optimal capital management, which merely defers the taking of the medicine. And the later the medicine gets taken, the more nasty-tasting it will be.
In the board's defence, the alternatives at its disposal aren't great, namely to:
1.) Suspend DPU for 2 or 3 years, in order to get the debt back under $200m (but they'd have a shareholder revolt on their hands if they did that;
2.) Simply let the business wear high levels of borrowings (but then the options to reinvest in the business are severely curtailed); or
3.) Undertake a capital raising today to get the company back onto an even keel- it would have to be a highly material raising: possibly as hefty as a 1 for 3 issuance, I'd expect, given the level of borrowings is of a similar order of magnitude as the market value of the company (of course, we know that a DRP is a
de facto capital raising, except that instead of happening all at once, it is spread out over time).
The company is in an invidious position.
And while it makes for an interesting case study of capital management evolution, makes it hard for me to want to become an owner of a company in this unenviable situation.
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(20min delay)
