Friday, 20 February 2009

REF 1H09 Earnings Drop Cuts Dividend

As indicated in their profit warning, REF recorded 1H09 NPAT of $7.9m a -22% drop from the previous year. The company put the decline in earnings down to a fall in call volumes in both Australia and the U.K as well as increased marketing expenses and start up costs for the Irish operations. A strong AUD/GBP didn't help much either.

The company also announced a $0.09 fully franked dividend. For anyone buying at today's price that represents a more than 9% yield for the half year. However, that dividend is unlikely to be maintained as they continue to pay out more than they earn.

A couple of concerns about REF's health should be noted. The company previously was debt free. On a net basis (cash minus debt) that is still the case. However short term debt has increased to $4.1m. Why is that? Well, when you are paying out significantly more in dividends than you are generating in free cashflow you need to get it from somewhere.

Dividends are paid out in the subsequent period after profits are made. Thus REF paid out $11.1m in dividends in 1H09 whilst only making $7.9m. Thus the rate the company is generating free cashflow is not keeping up with cash needed to cover the divivdend and thus they need to borroiw to cover the shortfall. Clearly this is unsustainable as retained profits are depleting and debt levles grow larger.

The company described the drop off in call volumes as a dip. What does that mean exactly? It dipped and has now stabilized or are volumes still on the decline? The company is stepping a marketing campaign in both Australia and the UK in the next couple of months, however it is not clear if earnings will hold up at current levels.

Clearly I have been too optimistic on the company's earnings outlook. The question now is what is a sustainable level of earnings and thus dividends for REF going forward?

For 2009, I am assuming full year NPAT of $15m, with the second half showing more weakness. However into FY10, to be conservativeI'll assume earnings fall to $12m. for the full year. I'll also assume the the company does not continue paying out more than it earns. The company could at that time pay out $0.12 per share in dividends for the full year. Based on today's prices that represents a yield of slightly more than 12.0%. Much better than any bank is offering.

Still, the economic performance of the business is deteriorating and I would like to get some assurances from management that call volumes are showing signs of stabilising and that they don't intend to rack up more debt just to continue paying out an unsustainably high dividend. I will be followiung up with management on these issues in the enar future.