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Outstanding analysis. Thank you for sharing.

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jiantan86

284 Posts.

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29/08/17

19:20

Post #: 26846730
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Originally posted by madamswer ↑

"FCF over the last 2 years does look healthy. I note they paid down $30m of debt in FY16. Can I ask what your prospective FCF yield on EV is?"

@vic_wattle,

Yes, they did indeed pay down $30m in debt in FY16, but I'm unsure of the point you are trying to make there. For starters, while borrowings were reduced by $30m, part of the reason for this is that the cash balance fell by some $14m, meaning Net Debt fell by around $16m, which is the more relevant metric. Besides, I'm not sure why you are referencing FY16, when FY17 has already come and gone.

Although I think that were you appeared to be heading with you monitoring of the changing debt position is quite valid, especially when it is considered over a longer investment time horizon.

At the end of Dec, 2013, TME's Net Debt was $140m; today it is $83m. This reduction was brought about despite dividends rising from 16cps to 18.5cps over the past 3 years.

Given that this was brought about purely by organic means, it highlights the cash generating ability of the business, and it has implications for the investment outlook over the foreseeable future, because - even if DPS grows merely in line with EPS, at around 10%pa - in two years' time TME will be essentially debt free according to my modelling of the capital flows into, and out of, the business.

This obviously has some bearing on the investment thinking on the stock, because it will presumably portend some sort of accelerated returns of capital to shareholders.
Unless they undertake a meaningful acquisition, and I can’t see what there is of sufficient scale in the New Zealand market for them to buy.

In terms of your all-important question about the prospective FCF yield, I estimate 5.8% on a Market Cap basis and 5.5% on an EV basis.

While those – when viewed as static metrics – might looked a bit skinny, they need to be viewed in terms of their underlying organic growth rates.

“On the issue of intangible assets and impairments, I find it interesting that the $8m impairment in FY16 caused eps to drop by ~6.7%, which may of contributed to some of the share price correction this time last year. Although I gather the main reason for the sell off was the introduction of the facebook marketplace app in NZ.”

I wasn’t following TME closely at the time, but I would guess that the reason for the sell-off after last year’s result was 90% attributable to the prospect of a major competitor entering the New Zealand market, namely Facebook’s marketplace app.

And that gets to the nub of the investment thesis for TME to a large extent: whether or not you believe it’s commercial moat will be able to withstand all comers, even gorilla ones with very large balance sheets.

My view is that it’s position of first-mover incumbency will allow it to do so.

I think that TME should be viewed as a business in 3 parts:

A mature, utility type business that doesn’t grow, but which generates stable earnings and cash flows (“General Items”, in the segmental accounts),

A fast-growing (15%pa at the Revenue line) business (“Classifieds”) and

A group of businesses (the classically- named, “Other”, which is growing at a rate roughly half way between those two other businesses.

Five years ago, Classifieds represented around 38% of total group sales; today that figure is 53%. Conversely, “General Items” was 44% of total sales in 2012, today it represents 30%.

So, arithmetically, what has been happening over the past 5 years is that something that started off being almost half of TME’s total Revenue has not been growing, and this has created a drag on TME’s overall top line growth, masking what was happening in the other fast-growing parts of the business.

Because when a big proportion behaves in a certain manner, it overrides whatever other smaller portions happen to do.

Of course, mathematically, the Law of Large vs Small Numbers has a finite life, because as the fast growing part becomes proportionally larger, and the slowly-growing parts become proportionally smaller, at some stage a tipping point is reached when the impact of the “strong growth” surpasses that of the “no growth”.

That’s basically where we are now with TME: the best part of the company is becoming a progressively larger part of the company, with the attendant implications for underlying growth rates going forward.

And that’s why I am happy to buy the stock on reasonably modest FCF yields… because I see scope for the FCF to grow at a faster rate than it already has been doing until now.

Don’t misunderstand me here: I’m not for one minute flagging TME as having 50% or 1005 upside from current levels; its valuation multiples are not sufficiently discounted for that outcome.
Rather, I see it as an investment that offers 8% to 10%pa capital appreciation with 4% dividend yield. But, importantly, with relatively little risk.

"The share price is back down to the lows of last year even though FCF is quietly sailing ahead. I am starting to comprehend its importance over P&L accounting."

Yes, the share price down has left FCF yield at a level that I am happy to accept in exchange for my capital.

As for understanding the importance of FCF over P&L accounting, the former should not be seen as a wholesale substitute for the latter when it comes to valuing companies; rather, it should be treated as one piece of the valuation jigsaw puzzle, and not as the whole picture in its entirety.

FCF is certainly the most important piece, I feel, but it isn't the entire picture.

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Outstanding analysis. Thank you for sharing.
TME Price at posting: $4.12 Sentiment: None Disclosure: Not Held
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