Enjoyed the article Paul. Something that came to mind:
- Due to many of the cuts occurring during major economic events it may be more likely that multiple cuts happen at the same time instead of having a constant probability over time.
Yes, Dirk, you are quite right. Back when I was doing a lot of Monte Carlo stuff, much of which ended up on Seeking Alpha, I built some models incorporating that aspect. Overall it did not make much difference, although it did create a new group of worse cases.
A bit more -- one challenge with computational models is that adding complexity not only brings more scope for error but also introduces new parameters that often are harder to pin down based on data. You may think you learn a lot, but you may learn less than you think.
I am baffled by Enbridge, as looking at their accounts their FCF has been less than their Dividend & Current Liabilities for years so they have to issue new share capital annually
To me this seems like cannibalising your Investment
IMO you are reading them wrong, Andrew. Enbridge is a textbook case of how FCF analysis can mislead. There is no 11th commandment that says that all capex must come out of CfO and not from other sources. But if you do take capex from other sources, the FCF likely comes out negative, creating moaning and panic in the Church of Free Cash Flow (sorry but those guys piss me off).
Also note that, so long as current liabilities are representative of ongoing interest costs, they have already been taken out of CfO and thus FCF. This is true enough even if there is some short-term lumpiness.
What matters fundamentally is for CfO less distributions less maintenance capex to exceed zero. It may or may not be accretive to operate with CfO less all capex less distributions
Then what matters is two things:
1) New investments must earn enough to cover the associated interest costs. Rarely is a company dumb enough not to do this and I would avoid any firm doing investments that are at negative cash flow.
2) The increase in FAD/sh produced by the new investments must exceed the decrease in FAD/sh due to the share issuance. This is not always true in practice. Some firms do dumb things. But not Enbridge, I think.
Capex does not show up on the income statement, but likely you know that.
Here is how I stack up the cash flows based on the USD tabulation by SA that you link.
………………………TTM……..2023
CfO………………….10…………..10
Dividends………….6…………..6
Retained……………4…………..4
Maint. capex ……..4…………..4
Net ongoing………0…………..0
So operations pays for itself, including maintenance and the dividend, but funds no investments. How do you do investments?
Issue stock………….2…………..3
Net new debt………8…………..1
Total investable…10…………..4
Acquisitions………….10…………..1
Cash change………….0…………..4
Their TTM investments were mainly the somewhat controversial purchase of Dominion energy, done with more than normal debt and an announced intent to reduce leverage later. Typical of ENB.
That purchase was at a Debt Ratio of about 80%. Higher than ideal, and why the market has them yielding so much. But with their interest rate in the 5% ballpark, the new debt costs $500M. So long as the acquisition throws off more than $500M in cash annually, there is no immediate problem here.
To add a bit, I find FCF useful when thinking about companies who need very large ongoing capex to sustain their business. This includes E&Ps in the energy space and mall REITs. But I do not find FCF helpful at all for midstreams or for most REITs. They think of their business, sensibly, as generating cash flows to cover dividends and maintenance capex and maybe generate investable cash. Then they think about growth activities and their financing separately, subject to a need to be accretive to shareholder cash flows.
Paul, the younger folks would say: "Bro, I loved you article, bro!".
Remarks/questions:
- If you were to translate the 110% of initial spending into a cash buffer, how many years should that cash buffer last until those dividend cuts are "ironed out"? Hope this question is clear, otherwise I will re-formulate :) I think I know the answer but want to cross check my understanding.
- Did not see VICI and EPRT in your GF-list above? GF stands for go-fishing, not girlfriend :)
- I must admit that I am a bit "negatively sursprised" by both the ten year and long term real dividend growth. So I defenetley agree and invest by "one probably should have some funds doing something else too." For example SCHD, both passive and incredible dividend growth. I still think its ok to hold some GF REITS for diversification and because its fun :)
Not sure I understand the first part there. I think duration matters. If you are planning for 30 years with an average cut rate of 0.3% per year per position then every position will cut about once. That would take portfolio value down by the average cut rate, maybe 30%. So for no dividend growth one might oversize by 30/130 = 23%, or hold that much cash. But for 1% real dividend growth you fully compensate for that level of losses.
One way to implement a buffer would be using a long bond ladder.
VICI and EPRT are both in my GF portfolio, but as exceptions. Neither has two investment-grade ratings. Also they are both too young to be of much use for estimating dividend cut rates.
In my view one can make money from REIT mispricing at times, and one can use REITs for income that will keep up with inflation. During strong stock markets, one may get a bit more growth. But that seems best enjoyed in retrospect when it happens.
So you mean 23% of the portfolio value? but that is assuming no real dividend growth, which is indeed too conservative. Will think about a bond ladder or maybe just compensate with other investments that have proven to generate more dividend growth like SCHD.
Regarding mispricing: agree and that is why your appreciation list is so interesting for us.
Enjoyed the article Paul. Something that came to mind:
- Due to many of the cuts occurring during major economic events it may be more likely that multiple cuts happen at the same time instead of having a constant probability over time.
Yes, Dirk, you are quite right. Back when I was doing a lot of Monte Carlo stuff, much of which ended up on Seeking Alpha, I built some models incorporating that aspect. Overall it did not make much difference, although it did create a new group of worse cases.
A bit more -- one challenge with computational models is that adding complexity not only brings more scope for error but also introduces new parameters that often are harder to pin down based on data. You may think you learn a lot, but you may learn less than you think.
Hi Paul,
I am baffled by Enbridge, as looking at their accounts their FCF has been less than their Dividend & Current Liabilities for years so they have to issue new share capital annually
To me this seems like cannibalising your Investment
Am I reading things very wrong ?
IMO you are reading them wrong, Andrew. Enbridge is a textbook case of how FCF analysis can mislead. There is no 11th commandment that says that all capex must come out of CfO and not from other sources. But if you do take capex from other sources, the FCF likely comes out negative, creating moaning and panic in the Church of Free Cash Flow (sorry but those guys piss me off).
Also note that, so long as current liabilities are representative of ongoing interest costs, they have already been taken out of CfO and thus FCF. This is true enough even if there is some short-term lumpiness.
What matters fundamentally is for CfO less distributions less maintenance capex to exceed zero. It may or may not be accretive to operate with CfO less all capex less distributions
Then what matters is two things:
1) New investments must earn enough to cover the associated interest costs. Rarely is a company dumb enough not to do this and I would avoid any firm doing investments that are at negative cash flow.
2) The increase in FAD/sh produced by the new investments must exceed the decrease in FAD/sh due to the share issuance. This is not always true in practice. Some firms do dumb things. But not Enbridge, I think.
https://seekingalpha.com/symbol/ENB/income-statement
where is the capex ?
https://seekingalpha.com/symbol/ENB/cash-flow-statement
They issued net debt of $8.3bn in 2023.
Without this they could not afford either the Capex of $4bn or the $6bn Dividend or the $10bn Cash Acquisitions
Sorry but you are illustrating my point.
Capex does not show up on the income statement, but likely you know that.
Here is how I stack up the cash flows based on the USD tabulation by SA that you link.
………………………TTM……..2023
CfO………………….10…………..10
Dividends………….6…………..6
Retained……………4…………..4
Maint. capex ……..4…………..4
Net ongoing………0…………..0
So operations pays for itself, including maintenance and the dividend, but funds no investments. How do you do investments?
Issue stock………….2…………..3
Net new debt………8…………..1
Total investable…10…………..4
Acquisitions………….10…………..1
Cash change………….0…………..4
Their TTM investments were mainly the somewhat controversial purchase of Dominion energy, done with more than normal debt and an announced intent to reduce leverage later. Typical of ENB.
That purchase was at a Debt Ratio of about 80%. Higher than ideal, and why the market has them yielding so much. But with their interest rate in the 5% ballpark, the new debt costs $500M. So long as the acquisition throws off more than $500M in cash annually, there is no immediate problem here.
To add a bit, I find FCF useful when thinking about companies who need very large ongoing capex to sustain their business. This includes E&Ps in the energy space and mall REITs. But I do not find FCF helpful at all for midstreams or for most REITs. They think of their business, sensibly, as generating cash flows to cover dividends and maintenance capex and maybe generate investable cash. Then they think about growth activities and their financing separately, subject to a need to be accretive to shareholder cash flows.
Paul, the younger folks would say: "Bro, I loved you article, bro!".
Remarks/questions:
- If you were to translate the 110% of initial spending into a cash buffer, how many years should that cash buffer last until those dividend cuts are "ironed out"? Hope this question is clear, otherwise I will re-formulate :) I think I know the answer but want to cross check my understanding.
- Did not see VICI and EPRT in your GF-list above? GF stands for go-fishing, not girlfriend :)
- I must admit that I am a bit "negatively sursprised" by both the ten year and long term real dividend growth. So I defenetley agree and invest by "one probably should have some funds doing something else too." For example SCHD, both passive and incredible dividend growth. I still think its ok to hold some GF REITS for diversification and because its fun :)
Not sure I understand the first part there. I think duration matters. If you are planning for 30 years with an average cut rate of 0.3% per year per position then every position will cut about once. That would take portfolio value down by the average cut rate, maybe 30%. So for no dividend growth one might oversize by 30/130 = 23%, or hold that much cash. But for 1% real dividend growth you fully compensate for that level of losses.
One way to implement a buffer would be using a long bond ladder.
VICI and EPRT are both in my GF portfolio, but as exceptions. Neither has two investment-grade ratings. Also they are both too young to be of much use for estimating dividend cut rates.
In my view one can make money from REIT mispricing at times, and one can use REITs for income that will keep up with inflation. During strong stock markets, one may get a bit more growth. But that seems best enjoyed in retrospect when it happens.
Thanks Paul.
So you mean 23% of the portfolio value? but that is assuming no real dividend growth, which is indeed too conservative. Will think about a bond ladder or maybe just compensate with other investments that have proven to generate more dividend growth like SCHD.
Regarding mispricing: agree and that is why your appreciation list is so interesting for us.
To your question about 23%: yes.
Another good thing about using GF is the higher starting yield compared to something like SCHD or other dividend aristocrats funds.