Robusta fundamental, leveraged investments

[McLovin]

The bulk of Yum's growth is coming from China. They're adding a new store here every 22 hours. It's an amazing business, with the stores retailing a variety of healthy, tasty, local favors.

CanOz
Btw, only a tiny fraction of their stores are franchised. They own 95+% of their stores in China.

I went to a Pizza Hut in China recently. It's completely different to anything in the West. The restaurants aren't just about Pizza and they're more upper-middle class than in other countries (they have a great selection of French wine for instance).

 

[CanOz]

I went to a Pizza Hut in China recently. It's completely different to anything in the West. The restaurants aren't just about Pizza and they're more upper-middle class than in other countries (they have a great selection of French wine for instance).

Yeah, they're nice restaurants. It's a model that looked doomed to fail when they started but they knew what they were doing. As the middle class expanded, their restaurants became busier and more successful.

There's a great book about KFC in China, by the same title.

CanOz

 

[Ves]

The bulk of Yum's growth is coming from China. They're adding a new store here every 22 hours. It's an amazing business, with the stores retailing a variety of healthy, tasty, local favors.

CanOz
Btw, only a tiny fraction of their stores are franchised. They own 95+% of their stores in China.

Thanks for that, I actually didn't know that for certain. It makes sense though, in an emerging market if you have the nous to implement a business model you will make more money by cutting out the middle man (the franchisee). I also wonder if the Chinese have an appetite for owning a franchise? I am not really familiar with their culture to be honest. It will be interesting to see how Yum's strategy in this respect develops when China's middle class, and business world progresses even further.

 

[McLovin]

I am actually surprised by the amount of debt that Yum has on their balance sheet. I guess their cash flow well and truly covers it, so they can afford to leverage to the hilt.

The debt probably goes a fair way to explaining the RoE. But even taking something like EBIT/Assets, return is still ~20.

 

[Ves]

The debt probably goes a fair way to explaining the RoE. But even taking something like EBIT/Assets, return is still ~20.

Last quarter McDonalds (MCD) reported 38% ROE. It's debt-to-equity is 87% compared to 146% on YUM.

The additional leverage definitely inflates the ROE as it should.

MCD's ROIC is 20.7% and YUM's ROIC is 29.4% according to Forbes. This indicates to me that they are making returns way above the cost of capital.

 

[craft]

I am actually surprised by the amount of debt that Yum has on their balance sheet. I guess their cash flow well and truly covers it, so they can afford to leverage to the hilt.

Debt to equity is really not a very useful measure.

Debt servicing ratios are far more informative.

Debt to market cap is sometimes used in Bank Covenants. Compare YUM to CKF on that measure for some enlightenment.

ps.

Good to see somebody using ROIC - far more informative then ROE. Equity has so many cumulative accounting adjustments that any ratio based on it is normally bogus. Not to mention non-comparable between different financial structures.

 

[McLovin]

Debt to equity is really not a very useful measure.

Debt servicing ratios are far more informative.

I agree on this completely. Debt/equity tells you nothing about capacity to pay. In discussing bonds Ben Graham always stressed not to look at what assets secure the bond issue but rather what is the ability of the company to pay the interest bill. Debt/equity is probably somewhat outdated. It was formulated at a time when most companies were still very capital intensive (manufacturing/railroads/shipping etc). For an equity light company it can often make the company appear to be overindebted.

IMO, anyway.

 

[Ves]

Good to see somebody using ROIC - far more informative then ROE. Equity has so many cumulative accounting adjustments that any ratio based on it is normally bogus. Not to mention non-comparable between different financial structures.

Just as an aside to this, how do you usually calculate ROIC?

For a basic overview I normally use something like NPAT / Total Assets - Cash at Bank - Non-interest bearing current liabilities.

I believe that there is a whole discussion around just what to include in the invested capital component.

 

[sinner]

Debt servicing ratios are far more informative.

Can you give some examples?

I found one on wikipedia "Debt service coverage ratio"...but I thought Interest Cover was the commonly used one.

 

[McLovin]

Can you give some examples?

I found one on wikipedia "Debt service coverage ratio"...but I thought Interest Cover was the commonly used one.

Cash-flow-to-debt is the only other one I know of.

You can expand interest cover to include all fixed charges.

 

[craft]

Can you give some examples?

I found one on wikipedia "Debt service coverage ratio"...but I thought Interest Cover was the commonly used one.

Net interest cover (EBIT/Interest Expense) is the most commonly reported.

Gross debt/ Cash flow are Net debt/Cash flow are also common.

But you can come up with anything you like. The emphasis should be on cash flow to service the debt.

Debt generally gets repaid from excess cash flow not assets. – especially if the assets are intangible.

 

[craft]

Just as an aside to this, how do you usually calculate ROIC?

For a basic overview I normally use something like NPAT / Total Assets - Cash at Bank - Non-interest bearing current liabilities.

I believe that there is a whole discussion around just what to include in the invested capital component.

I use EBIT/ Total Assets – Excess Cash – Non-interest bearing liabilities – Indefinite life Intangibles.

Yes there is a whole discussion around defining invested capital, but probably not here.

 

[craft]

Just a question on the profit downgrades, does anyone think this is permanent or cyclical?

My money is obviously on the latter.

Robusta

Here are CKF's banking covenants

The agreement under which the New Bank Facilities will be made available contains undertakings typical for facilities of this nature. The undertakings include financial undertakings which will be tested at financial year end and financial half-year end based on the preceding 13 accounting periods (approximately 12 months).


Net leverage ratio to be not greater than 2.75:1(1)

Lease adjusted interest cover ratio to be equal to or greater than 1.75:1(2)

Notes:
1. Pro forma debt to EBITDA for that period.
2. Consolidated EBITDA plus rental expense for that period to net interest expense plus rental expense for that period.

How are they travelling?

If they breach the covenants or cannot roll their debt at the end of three years – the question of cyclical or permanent may be irrelevant to current shareholders.

 

[craft]

Debt to market cap is sometimes used in Bank Covenants. Compare YUM to CKF on that measure for some enlightenment.

I decided to answer this one for myself

It looks like Yum has about 3 billion debt and a market cap of 33 Billion
Debt / Market Cap = 9%

CKF has debt of about 105 Million on a market cap of 98 Million

Debt / Market Cap = 107%


Hmmmmmm

 

[odds-on]

Debt to equity is really not a very useful measure.

Debt servicing ratios are far more informative.

Debt to market cap is sometimes used in Bank Covenants. Compare YUM to CKF on that measure for some enlightenment.

ps.

Good to see somebody using ROIC - far more informative then ROE. Equity has so many cumulative accounting adjustments that any ratio based on it is normally bogus. Not to mention non-comparable between different financial structures.

I am continually learning on this forum but I have yet to be convinced on the efficiency of analysing the debt servicing ratios, I see them as just another way of saying do you think the business is still going to be earning money in the coming years? Because if you think the business can service the debt you are essentially saying that the company is still going to be earning cash in the coming years. I know it is a minor point but the debt servicing ratios are basically linked to the earnings risk valuation.

IMO, comparing your quantified confidence in future earnings against the multiple to a conservative liquidation value is far more informative for an investment decision. Everybody has their own agenda but I respect that I am a minority shareholder who has no control of the business and capital decisions, therefore I like to look at the worst case and what I will get back (if I get anything) if the business failed. Remember all businesses fail eventually.

ROIC – how about Cash/Net Tangible Assets?

Personally I can lose focus with all these fancy calculations so I refer to the following:-

A cow for her milk
A hen for her eggs,
And a stock, by heck,
For her dividends.

An orchard for fruit,
Bees for their honey,
And stocks, besides,
For their dividends

John Burr Williams, Evaluation of the Rule of Present Worth, 1937

 

[craft]

I have yet to be convinced on the efficiency of analysing the debt servicing ratios, I see them as just another way of saying do you think the business is still going to be earning money in the coming years? Because if you think the business can service the debt you are essentially saying that the company is still going to be earning cash in the coming years. I know it is a minor point but the debt servicing ratios are basically linked to the earnings risk valuation.

Oddson, I think we are in total agreement.

This debt ratio discussion has been in relation to CKF. My interest in the company stopped dead at the balance sheet(which is the first thing I look at), because the continuance of future year earnings is at risk due to the financial structure.

I've just been throwing up some points that worried me, maybe others are happy with the risk - I'm very conservative in this respect.

 

[McLovin]

Net leverage ratio to be not greater than 2.75:1(1)

Lease adjusted interest cover ratio to be equal to or greater than 1.75:1(2)

Notes:
1. Pro forma debt to EBITDA for that period.
2. Consolidated EBITDA plus rental expense for that period to net interest expense plus rental expense for that period.

How are they travelling?

I get 2.44 and 1.96 respectively.

EBITDA I have back of the enveloped at $43.1m. With $105m in debt (and possibly more on the way) a fall in EBITDA to ~$38-$39m will put them in breach of their covenants. And obviously require a capital raising.

 

[robusta]

Sorry have been flat out lately, have not had the chance to respond to some very pertinent comments and questions about my two most recent investments let alone participate in the interesting discussion on debt. Yet I find myself making a new investment today.

New Investment

DTL- Data#3 Limited

1912 x DTL @ $1.045 $1998.04

I have been looking to pick up some DTL for a while now, probably have Wayne Swans horror budget to thank for the opportunity.

High ROE, good dividend yield, nice history of growth.

Take a look at the DTL thread, this is a interesting stock IMO.

 

[robusta]

Based on Comsec, total shareholder return (TSR) for PET is:
1 yr = 2.7% p.a.
3 yr = 14% p.a.
5 yr = -2.7% p.a.

And here are some examples of 10-yr TSR of other LICs:
AFI = 7.9%
MLT = 7.2%
ARG = 6.2%
DJW = 7.1%
WAM = 8.0%
AUI = 6.8%

There isn't a lot left after paying 6-7% interest on your loan. IMO the majority of LICs only offer great return for the management team, and is a relatively lazy way to "value invest".

Anyway, plenty of good information on the ASX website on LICs.

The LIC index (slightly negative since 2006)
http://www.asx.com.au/products/listed-investment-companies-index.htm

Qtrly report by Bell Potter
http://www.asx.com.au/documents/products/Bell_Potter_LIC_Report_December_2011.pdf

This may surprise but in general I think for the passive investor LIC's will generate less returns and probably be less tax efficient than a good ETF, yet I have allocated about the same amount of capital to PET as my largest positions.

Firstly I like the portfolio, if I had the ability to invest directly in international shares I would be happy to hold any or all of the stocks held by PET. To get this ar a nice discount to NTA is a bonus.

The investment manager, Wayne Peters is very conservative, there is a nice chunk of cash on the balance sheet to take advantage of any further volatility along with some nice growth assets like Berkshire and Fairfax Financial who have a long history of doing the same thing.

Apart from Cochlear, my portfolio is very concentrated on Australian earning, this vehicle gives me some nice diversification.

I do not expect this stock to give me fast, spectacular returns but as a nice steady compounding machine I think it is a no brainer.

 

[robusta]

The discussion on Collins Foods has given me a lot to think about. This stock has by far the most debt in the portfolio, perhaps I have underestimated the worst case scenario or overestimated the stability of earnings and cash flow from this business.

The basic question for me now comes down to risk / reward. Hopefully holding until the next reporting season is the correct course of action I am still wrestling with that decision.