What to look for., page-9

Bednobs,

Earnings for a big infrastructure company can be a bit misleading. The way these companies work you need to look more at the cash flow as this is a much more realistic measure. The depreciation of the assets show up as an expense offsetting the income and meaning that the company pays no tax.

As a simple example imagine that a company has a $1b capital raising to create a $1B toll road and then can collect tolls of $100m for the next 20 years before having to had the asset over to the government. In this simple case pretend that there is no operating cost and that the tolls don't increase each year. If the tax rules allow for that asset to be depreciated in a straight line over 10 years, for the first 10 years the company makes no net profit as the $100m received in tolls can be offset by the $100m depreciation no tax is paid and the company can distribute the whole $100m to its shareholders as un unfranked dividend. After 10 years there is no further depreciation and the company makes $100m profit each year, pays tax on that and distributes what's left as a franked dividend to the shareholders.

For the first 10 years the company would have no earnings and so no earnings per share. After 10 years the earnings would jump to $100m, great earning growth that year! What is interesting is that for a small retail investor getting $1 distribution unfranked or $0.7 franked at 30% makes no difference. The difference is that the international share holders who do not benefit from franking are better off.

In reality it is much more complex. One company might have a range of projects each with their own end dates, upgrades done over time can be depreciated at different rates to the primary asset, tolls increase with time and governments can negotiate extensions. If you have a look at the earnings, cash flow and distribution of TCL for the past 10 years the distribution per share pretty closely follows the cash flow per share with the earnings always much less.